What Muni Market?

China wants to create a municipal bond market. It's got the municipal bond part of it.

Local Debt Restructuring: A Case of Ongoing Authoritarian Reform
When the State Audit Bureau went through local government debt as of the end of June 2013, they came up with a total of 10.89 trillion RMB, or just over 19 percent of 2013 GDP. Now, the provinces were instructed to self-report and update the debt figure to December 31, 2014. Moreover, they were told to report to the Ministry during January 2015. As described in CLM 46, the provinces now had an incentive to report the largest possible number at this stage, since this would be the basis both for loan term concessions and for their new bank debt ceiling.2 Moreover, local governments tend to report virtually all the debt as “government debt,” and very
little as “enterprise debt.” That is, they try to pull debt onto the government’s balance sheet, so that it can qualify for whatever bailouts or partial bailouts may be coming, and reduce possible headaches from future payment defaults.3

When the provincial reports came back, the Ministry of Finance was not happy. Officially, the numbers have not been disclosed, but press accounts say the provinces reported in aggregate that between June 2013 and December 2014, local government debt had jumped 47 percent to 16 trillion (or 25 percent of 2014 GDP).4 The Ministry of Finance just said no. The self-reported numbers were returned to the provincial governments with the instruction that they re-audit and resubmit more-accurate debt totals by March 8. The message was clear: submit a smaller number. Local governments did not meet the March 8 deadline, either. Really, what could they report in such a short
time period without looking foolish?5

...Even by the strictest calculation, 1.85 trillion in debt was coming due in 2015, with the peak repayment in the second quarter (this was the figure from the State Audit Bureau’s calculation of debt in mid-2013, which had totaled 10.89 trillion). The workaround was simply to calculate 1 trillion divided by 1.85 trillion, or 53 percent, of the amount of debt each province showed coming due in 2015, and use this to distribute a debt swap quota to every province and danlie city, which was done in March.7 This allowed the debt swap process to go forward, but it inevitably weakened the idea of a cap on total debt, since the figures being used could no longer pretend to be accurate.

...Provinces were having difficulty structuring bonds and then selling them into the market. Local governments wanted low interest rates (to reduce their funding costs), while the market wanted to be compensated for the risk and uncertainty of these new products with high interest rates. This broad problem came to a head on April 23, when Jiangsu Province’s offering of 64.8 billion in debt swap bonds failed. Nobody wanted the bonds at the rate Jiangsu was willing to offer.

...On April 30, the Politburo held a meeting specifically to consider the economic situation, and particularly the rapidly cooling economy.10

...Some commentators proclaimed this a watershed meeting, marking the shift to an overall more expansionary policy to pump up aggregate demand.11 Supporting this interpretation was the fact that the same Politburo meeting approved the plan—closely associated with Xi Jinping himself—to reconstruct the Beijing-TianjinHebei region, beginning with the transportation network. Although the plan itself was not released, the press was throwing around huge figures for total investment contemplated: one source claimed that the Ministry of Finance had estimated that 42 trillion RMB would be invested over the next six years: essentially a trillion U.S. dollars a year.12 However, this claim was denied by the Ministry of Finance, which described it as a misunderstanding and misinterpretation of the data.

...Within two weeks, cooperating with the PBC and CBRC, the Ministry of Finance rolled out a revised and very different version of a debt swap.13 Instead of debt being offered on the open marketplace, the new debt was allocated to those who held the existing bank loans. The principle we might call, “you cooked it, you eat it.” Existing debt-holders, overwhelmingly banks, were responsible for taking the bonds that replaced the loans they
had originally extended. A lead syndicate was to be established to handle the bonds, but the ultimate responsibility was to rest with the originators. Indeed, the bonds were temporarily not allowed to circulate on the marketplace. The banks not only had to take the bonds in the first place, they had to hold them on their books for an unspecified period.

The interest rate on the new bonds was to be “negotiated,” mutually agreed by the banks and the local government. This was portrayed as a “market conforming” type of price determination. This is not convincing.

...These bonds clearly have the implicit backing of the central government; after all, unlike the LGFV bonds that they replace, this is debt issued by the local governments themselves, for which they have full responsibility. China is not a federal system: local government are subdivisions of the central government. Moreover, the whole process of issuing the bonds had been set up by the central government, and structured from the top down. Therefore, one had to assume the central government backed the process fully: as a result, Moody’s (for instance) rated the bonds AAA, the highest investment grade. Moreover, they explained that the rating was explicitly because of the central government backing, rather than the fiscal soundness of the individual provinces.18 In this sense, the policy represents a movement away from market reform, which requires that less wellmanaged
localities would have to pay a higher market price for debt, because of a risk of forfeiture.
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