Clear and present challenge
Beijing's desire to develop a municipal bond market centre hindered by lack of disclosure by local governments on assets, cash and liabilities
The mainland's quest to solve its US$3 trillion-and-growing public debt problem by starting a domestic municipal bond market hinges on the one thing officials are most afraid of: transparency.
As markets absorb the results of the latest audit of state finances, Beijing's long-standing vow to develop a municipal bond market to curtail rapid growth in other types of hidden public debt will take centre stage once more.
By letting local governments sell bonds for cash, Beijing wants to rely on nimble markets rather than inflexible regulations to keep spendthrift units in check.
The stakes are high. A bond market is the centrepiece in a blueprint to mop up fiscal troubles and keep the economy growing at an even pace, giving it room to start other financial reforms.
But analysts say the quest to develop a municipal bond market has been impeded by a lack of disclosure from local governments on how much money and assets they have, and how much they owe.
"If you want to lend to a specific government, you need to have a clue as to what the financial conditions are like," said Tan Kim Eng, a senior director of sovereign ratings at Standard & Poor's in Singapore. "There's still a lot of work to be done on the fiscal transparency front."
The National Audit Office said in its report on Monday that local governments had total outstanding debt of 17.9 trillion yuan (HK$22.7 trillion), including contingent liabilities and debt guarantees, at the end of June.
Although the debt load is far less than those of fiscally troubled Japan and Greece, it raised eyebrows among analysts for its 67 per cent jump since the last state audit was published in 2011.
The auditor did not say which provinces have the heaviest burdens or face the biggest risks, except to note "certain" dangers in some unnamed regions.
Standard & Poor's, in a separate note on Tuesday, said: "Any improvement to fiscal transparency will be limited unless the central government regularly publishes similar audit reports.
"It's also unclear whether China will disclose the debts of individual local and regional governments."
Market fears that the mainland's banking system will be compromised if a portion of the government debt is not repaid have been amplified by a dearth of information in the past year.
Beijing in August ordered a comprehensive review of all government balance sheets. A delay in its release - publication had been expected by October - fed speculation the debt total could top US$4 trillion.
The need for transparency is not lost on Beijing. In a plan published in November about the mainland's most ambitious road map for financial reforms in 30 years, Beijing said it would create a "standardised and transparent budget system" for local governments and the funding of public works.
Beijing is mulling other options for cleaning up its debt mess, including allowing private investors to pay for public works, and letting the central government absorb more spending responsibilities. But no plan resonates better with reform-minded officials than that for a municipal bond market, partly because it fits perfectly with the goal of reducing central planning.
Underscoring the importance placed on restructuring the economy, Xinhua said President Xi Jinping would head a group that will lead reforms that include relaxing state control over the yuan.
At the local level, the need for more transparent funding sources is reinforced by Monday's audit report, which showed that shadow banks accounted for at least 13 per cent of all local government borrowings.
Advocates of a municipal bond market says it will decide which governments deserve funding, and spendthrift ones will be punished with higher borrowing costs.
Beijing is testing the ground for such a market in six cities, including Shanghai and in Guangdong.
But short of full disclosure of just how much governments take in and borrow, analysts doubt the mainland's experiments with its local bond market will go far.
"Banks and rating agencies do not have easy access to local governments' overall fiscal position, which includes not only budgeted revenue and expenditure but also extra-budgetary revenue and expenditure," the International Monetary Fund said in October.
"This lack of transparency prevents banks and rating agencies from pricing credit risk properly and prevents local governments from managing related risks prudently," it said.