BOFIT Viikkokatsaus / BOFIT Weekly 2018/32

Local government bond issues are currently on the decline. China's finance ministry reports that local governments last year issued bonds worth a total of 4.4 trillion yuan, a decrease of 28 % from 2016. In the first six months of this year, new bond issues amounted to just 1.4 trillion yuan, nearly 25 % less than in the same period a year earlier. The volume of bond issues is only a fraction of what local governments are permitted to issue this year. Moreover, only a quarter of bond issues in the first half represented actual new debt. Most new debt goes to rolling over old bonds or paying off high-interest loans of local government financial vehicles (LGFVs).

China earlier required local governments to have balanced budgets, a requirement that forced many local governments to seek outside sources for additional funding. Off-budget LGFVs were created to acquire short-term, high-interest loans, mostly provided by the shadow banking sector (i.e. financing arrangements outside the realm of official regulation). Bond quotas for local governments have gradually been increased since 2011. At the start of 2015, the law was amended to allow local governments to show budget deficits.

Under a three-year programme launched in summer 2015, local governments were required to swap out pricier debt for bonds. The goal was to reduce the debt-servicing costs of local governments, introduce market discipline and make it easier to get a handle on local governments' indebtedness through greater transparency. China Chengxin Credit Rating reports that, as of end-June this year, local governments still held 860 billion yuan (130 billion dollars) in debt commitments that should be swapped for bonds before the swap programme ends this month.

Growth in infrastructure investment has slowed substantially as many local governments have postponed or cancelled their investment plans. In fact, negative public investment growth was registered for the March-June period. The central government has been forced to motivate local governments to fulfil their financing needs so that justified current projects at least are completed. The central government has increased its quota of "special bonds" tied to specific projects from 800 billion yuan last year to 1.35 trillion yuan (about 200 billion dollars) this year. Such special bonds may be used to finance projects such as subway construction or construction of toll roads. Instead of being paid out of the local government budget, investors are paid off from the revenue stream generated by the project.