Meeting singles out municipal finances as an urgent item on budget agenda

China has identified "containing local government debt risk" as a major task for next year's economic policy, underscoring Beijing's growing concern about local governments' excessive borrowing.

In an announcement following the annual Central Economic Work Conference, the Communist Party of China vowed to treat the debt issue as a critical task and promised to put different kinds of debt under broader budget management.

"Governments at various levels have to be held accountable for government debt within their jurisdictions. Education and evaluation should be strengthened to put right any incorrect official performance orientation," the announcement read.

Analysts said the fact that the meeting singled out the issue indicated its seriousness. Because the current budget laws ban local governments from deficit financing and borrowing directly, numerous "local government financial vehicles" (LGFVs) have been set up in the past few years to feed their gigantic construction financing needs. With no rules requiring them to be financially transparent, the debts raised by these LGFVs have ballooned. Market estimates of the total debt vary between 15 trillion yuan ($2.5 trillion) and 25 trillion yuan.

Market fear of the problem grew so strong that the National Audit Office in July started a nationwide audit of local government debt. It is thought the audit is completed but the results have yet to be released.

"Local government-related debt poses risks for banks, sovereign and local governments," a recent report by Moody's Investors Service said. "Chinese banks' large exposure to LGFVs, many of which have weak standalone credit quality, exposes banks to potential losses from bad loans."

Li Yan, a local government financing analyst with China Chengxin International Credit Rating Co Ltd, said various debts could be put under the "government-funded budget" or "the State capital budget", making them more transparent.

China currently runs four budgets — the general budget, the government-funded budget, the State capital budget and the social security fund budget. Unlike the general budget, how the other three budgets are specifically run is not disclosed to the public. The latest commitment to "put various debts under broader budget management" means the opaque LGFVs would be subjected to greater transparency, analysts said.

"The consensus now is local governments should be granted the ability to borrow directly, which could ultimately lead to greater transparency. A standard municipal bond market should also be developed," Li said.

Her research showed that increasingly, LGFVs are spending more on repaying interest on loans. In 2012, interest payments represented 13.9 percent of the total cash flow into LGFVs, up from 10.39 percent in 2010. A total of 69.5 percent of matured loans are repaid by new loans, rather than revenue generated by the projects.

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