Fitch: China's Municipal Bond Rules Give Local Governments More Flexibility

Fitch Ratings says the Chinese government's extension of a programme to allow local and regional governments (LRGs) to issue municipal bonds on their own credit will help these subnationals to optimise their debt structures and bring more transparency and accountability into their debt management.

The new rules, unveiled on 16 March 2015, follow a pilot scheme in 2014 under which 10 LRGs were allowed to issue tax-supported bonds. In addition to bonds with tenors of five, seven and 10 years, the new rules allow LRGs to issue bonds with tenors of one and three years. This will give the subnationals more flexibility to meet their funding needs and help them achieve a better debt maturity profile. As with the pilot scheme, the bond proceeds are to be used for capex such as public infrastructure projects. LRGs will also include the debt servicing plan in their fiscal budgets, which will improve transparency about debt issued by such entities and make clear who is ultimately responsible for the debt.

The new municipal bond rules give clear direction and a framework for implementation, which demonstrates the central government's strong willingness to promote municipal bonds and remove the implicit sovereign guarantee on LRGs' debt. Fitch expects municipal bonds to eventually be priced based on each subnational's own creditworthiness, although this will take place only gradually.

Fitch expects the extension of the municipal bond issuance programme to allow LRGs to smooth out revenue volatility and improve their liquidity during this period of slower economic growth and weakness in the property market At the same time, public-private partnerships and public-sector entities with sound credit profiles will continue to be important channels through which LRGs raise funding. This is particularly so because the current aggregate bond issue quota of CNY500bn falls short of the subnationals' funding needs.

In addition, the central government's move to encourage pension funds, social housing funds, social security funds, insurance companies and other types of investors to buy municipal bonds could translate into lower financing costs and a larger market for long-tenor bonds for LRGs.