No quick fix for cancer of local government debt
For the mainland's financial markets, government intervention at every level continues to distort prices and hamper growth.
But in some sectors, such as the local-government debt market, intervention doesn't seem like such a bad idea.
After three decades of existence, local-government debt is showing every sign of spinning out of control. And it seems the central government has begun to fret over the chance that runaway local debt will eventually cripple its banking sector, with Beijing making an about-turn on a proposal to let local authorities sell bonds directly.
Lower-level governments were not allowed to issue bonds before 1979. Beijing coined the term 'regional government bonds' when it embarked on an opening-up and reform policy that year, giving the local authorities the go-ahead to issue debt and use the proceeds to fund infrastructure projects. This liberalisation move was a double-edged sword as it gave local governments the freedom to map out their own development plans and helped streamline the decision-making process.
In 1994, Beijing, in an apparent effort to better police local governments' debt sales, stipulated that bond offerings by regional governments must be conducted by the Ministry of Finance on their behalf, with full sovereign guarantee.
It was not until last year that Beijing began a trial scheme after a 17-year hiatus under which four local governments - Shanghai, Zhejiang, Guangdong and Shenzhen - were approved to directly sell bonds. That move followed a bond offering spree as the nation launched an infrastructure-focused stimulus package to tackle the global financial crisis.
By the end of 2010, the total outstanding local government debt was valued at 10.7 trillion yuan (HK$13.1 trillion) and risks of insolvency of local-government financing vehicles (LGFVs) - companies set up to borrow from banks on behalf of local governments - increased as the projects weren't expected to generate enough cash to repay the debts.
In mid-2011, an LGFV named Shanghai Rainbow Investment, responsible for raising funds and overseeing the construction of a transport hub in the Hongqiao area, asked for an extension of loans worth several hundred million yuan because of cash-flow problems.
It was widely believed that Beijing's go-ahead to affluent regions such as Shanghai to sell bonds directly was only a temporary measure.
'Beijing hoped the trial programme would help the regions issue long-term bonds and use the proceeds to pay back the short-term debts,' a Shanghai-based banker said.
'The officials believed that the buoyant local economies in places such as Shanghai could help infrastructure projects generate enough cash in future.'
When the State Council launched the stimulus package in late 2008, it encouraged local governments to actively raise funds for infrastructure construction. The lack of oversight and thorough feasibility studies resulted in a huge number of overlapping projects and white elephants.
The root cause for that lay in the mindset of local government officials, who recklessly chased growth targets since that was the key yardstick by which their achievements would be measured and their promotions determined. Consequently, the local governments were unfazed as debts kept piling up.
For one thing, they could use the proceeds of land sales to repay the debts. The regional authorities put parcels of land one after another under the hammer, drawing developers to build residential complexes or office buildings. The land auction system, lacking both transparency and fairness, resulted in hundreds of under-the-table deals. The winning bidder would inevitable end up making a killing in the red-hot property market, passing on the high land costs to the homebuyers.
For another, the local governments tightened supervision of tax collection, hoping to rake in higher fiscal revenues to cover the debts.
'Tax revenue is always seen as an ace up the local governments' sleeves,' Shanghai Vstone Capital president Chen Jiwu said. 'Bad-debt worries are often offset by bullishness on increasing tax collections.'
A source close to the Shanghai government said the municipality used proceeds from auctions of vehicle number plates - valued at more than 50,000 yuan each - to rescue the debt-ridden LGFVs.
Number-plate auctions have long been viewed with suspicion, with local car owners questioning the end-use of the money collected this way.
The central government began to realise the severity of the problem arising from local-government debts in 2010 and began to rein in bank loans to LGFVs as well as new bond issues.
'Whatever policies or rescue measures the central government takes to solve the problem, they can only provide symptomatic relief, with the disease left untreated,' the banker said. 'In the long run, the disease will turn worse, and the next generation of leaders may not be able to fix responsibility.'
The value, in yuan, of outstanding mainland local government debt by the end of 2010