Fitch says several new measures under Circular 22 are credit positive for China's local government finance and the healthy development of China's muni bond market. The circular will also usher in higher transparency of the local government fiscal stance.

Released by China's Ministry of Finance (MoF) on 28 January 2016, Circular 22 lays out a few new measures that are critical to the healthy development of China's muni bond market. The new rules are based on the achievements and experience of last year's CNY3.2trn debt swap program, which intends to swap high cost local government financing vehicle borrowing with low interest muni bonds.

In each quarter, local governments can only issue muni bonds up to 30% of the whole year's quota. The new rule aims to provide the market with stable supplies of muni bonds in an attempt to balance the supply and demand. According to local media reports, some muni bonds issued in June and November 2015 were met with tepid demand due to surges in supply, with issuing size of more than CNY700bn in each month. By controlling the supply of muni bonds, Fitch believes this will prompt local governments to align expenditures with revenues.

The circular puts a cap on outstanding local government debts, and any alteration of that cap requires approval from National People's Congress, China's top legislature body. The cap is in line with Fitch's previous expectation that the central authorities will set up debt limits, which will be credit positive for local government finance and the development of the muni bond market.

Muni bonds will be offered to foreign investors under the new rule. For the first time, circular 22 allows muni bonds to be issued in China's several free trade zones, where foreign investors can participate in China's domestic bond market. Previously, Fitch said that the inclusion of foreign investors into China's domestic bond market will facilitate MoF's local government debt-for-bonds swap program and could also lower the financing costs of local governments. The debt swap program is expected to continue and will cover local government finance vehicle debt classified as local government debt.

Higher fiscal transparency will be ushered in under Circular 22. Local governments are required to disclose their operating revenue/ expenditure, capital revenue/ expenditure and most critically, their outstanding debt as of end-2014 and end-2015. In Fitch's opinion, better disclosure of the local government fiscal stance, especially the outstanding debt amount will allow market participants to better assess each local government's credit. Fitch expects local government bond yields to differentiate to better reflect local government's fiscal fundamentals, which will also contribute to the sustainable development of China's nascent muni bond market.