While they may not want to jump in yet with both feet, bond investors should be keeping an eye on China. Its amendment to its Budget Law at the end of August has put in place a legal framework that will govern the sale of bonds directly by municipalities—something that has been proscribed, except for certain test areas—to investors for the financing of infrastructure projects.
The move comes as the latest step in China’s migration toward greater openness of its financial markets and a changing approach to regulation and transparency. Municipalities, which have been borrowing money in ways that raised eyebrows and concerns, are responsible for approximately 80% of their spending, according to an estimate from the World Bank.
However, the way the country’s tax-sharing system is currently structured, those same municipalities are only able to draw on about 40% of tax revenue. As a result, they’ve turned to a wide variety of financing methods to bring in money for everything from infrastructure projects to day-to-day spending.
In fact, worries had run high around the beginning of the year that there was a possibility of China’s economy imploding around the high level of various unconventional means of debt financing. George Soros had expressed concern over the potential for fiscal disaster in China, but Beijing was already taking steps to prevent disaster and began to subject its shadow banking sector to tighter regulation.
And while its municipal bond issuance program had begun as a trial back in 2011 with the provinces of Zhejiang and Guangdong, as well as the cities of Shanghai and Shenzhen, being allowed to issue their own bonds, in 2013 it added Shandong and Jiangsu provinces. This year it has added the city of Beijing itself, along with Qingdao, Jiangxi province and the Ningxia region as it moved farther along the road of regulation.
And while it still forbids the issuance of bonds to cover day-to-day operating expenses, it’s making a great deal of changes regarding the issuance of the bonds it does allow.
“The municipal bonds that were issued were limited to seven-year terms, and the municipalities weren’t responsible for paying” bond proceeds to investors; instead, the Ministry of Finance was responsible and “withheld the municipality’s pocket money to pay” the proceeds, according to London-based Edmund Harriss, who manages the Guinness Atkinson Renminbi Yuan & Bond Fund, under the earlier trial.“
“But to move forward, issuers have to take responsibility and budget it themselves,” Harriss said. Under the current terms of the program, he said, the government has said that “the maturities issued will be five, seven, and 10 years, and the municipalities will be responsible for servicing and repayment.”