Li Xu, Senior Economist, Research Department , ADBI

ADBI, Tokyo, Japan, Nov.30, 2017

Reforms in Managing Local

Government Debt in the People’s Republic of China

Main issues

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Brief review of Local Government Debt ( LGD ) management in the People's’ Republic of China(the PRC)

What is the current situation of LGD in the PRC?

What reforms have been implemented?

The effects of these reforms

New challenges are facing Chinese government

What are the next steps?

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Brief Review of LGD Management in the PRC

Two Stages: New Budget Law is the watershed of borrowing behaviours of Chinese local governments

Local governments were not authorized to issue debt directly before the revision of

the Budget Law

New Budget Law (2014)

Local governments can issue LGD after the New Budget Law

took effect in Jan.1,2015

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The First Stage: before the amended Budget Law in 2014 How to finance the gap between fiscal revenue and public

expenditure: Local governments mainly depended on setting up some companies, which is called local government financing vehicles (LGFV) for the construction of public interest projects.

In 2009, the State Council approved Ministry of Finance (MOF) on behalf of provincial governments to issue local government bonds.

The scales of local government debt as of December 31,2014: the outstanding debt of local governments was about RMB 15.4 trillion.

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The Second Stage: After the New Budget Law Took Effect in 2015 In 2014, the National People’s Congress (NPC) amended the budget

law. The New budget law allows provincial governments to raise LGD directly, but only in the name of Local Government Bonds(LGBs).

In 2014, after amending the budget law, the State Council also published the Opinions on Strengthening the Administration of Local Government Debts, which proposed a detail legal system framework to standardize the debt financing of local governments.

From then on, relevant rules and regulations have been issued by the State Council to promote the standardization, institutionalization and transparency of LGD management.

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What are the major differences between the two stages? Before the New Budget Law After the New Budget Law LGs can’t borrow directly. Loose rules and regulations Soft budget constraints. LGD

was not included in budget. Repayment Mode:

significantly depends on Land Sale Revenue.

Risk assessment: relatively higher level of possible risk.

Provincial LGs can raise LGBs directly and publicly.

A series of rules and regulations for strengthening management and supervision of LGD

Strict budget constraints. Repayment Mode: fiscal

revenue, government funds, projects earnings, etc.

Risk assessment: lower risk.

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What is the current situation of LGD in the PRC

The Status of Managing LGD in the PRC

Sustainable

Affordable

Stable

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The Status of Managing LGD in China

Supporting Data

Institutional Guarantee

Repayment Guarantee

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Supporting Data---Stability The Outstanding LGD

in 2016

• The outstanding LGD was RMB 15.32 trillion in 2016, which was controlled within the limit of RMB 17.19 trillion as approved by the NPC.

LGD Ratio in 2016

• The ratio of outstanding LGD to corresponding comprehensive financial capacity in 2016, was 80.5%, lower than international standard.

LGD+ CGD in 2016

• The total outstanding public debt throughout China have reached RMB 27.33 trillion. The debt ratio (outstanding debt obligations/GDP) was 36.7% (Central:16.1%; Local:20.6%), which was not only lower than EU’s warning line of 60%, but also lower than that of major market economy countries and emerging economies.

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An International Comparative View LGD ratio in PRC showed declining trend these years

Subnational Govt Debts ratios of advanced countries were higher than that of PRC since 2014

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0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

Outstanding Subnational Govt Debts over GDP in Selected countries

Australia

Canada

France

Germany

Japan

United Kingdom

United States

Greece

Ireland

Italy

Portugal

Spain

China0

2000

4000

6000

8000

10000

12000

14000

16000

18000

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

22.0%

24.0%

26.0%

2014 2015 2016 2017

RM

B Bi

llion

s

Outstanding Public Debt and Debts over GDP in PRC

OutstandingCGD(billion)

OutstandingLGD(billion)

OutstandingCGD/GDP

OutstandingLGD/GDP

Institutional Guarantee---Sustainability Debt Ceiling Management---Upper limit of the scale of

LGD determined by the State Council and approved by NPC or NPC Standing Committee.

Categorization of Management---Local government general debt(LGGD) for public welfare projects without earnings and local government special debt(LGSD) for public projects with earnings.

Supervision Mechanism---MOF is in charge of the supervision and management of Chinese LGD, the National Audit Office of the PRC has the responsibility of external supervision.

Risk Assessment and Early Warning Mechanisms--- the designs are underway.

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Repayment Guarantee---Affordability

Golden Rule

• Strictly prohibited within capital projects,

• not recurrent expenditure

Fund Guarantee

• Fiscal revenue for LGGD,

• Government Funds or project earnings for LGSD.

Material Guarantee

• High quality assets

• Convertible assets

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What reforms have been implemented?

What Reforms have been implemented Establishing Credit Rating and Information Disclosure Mechanism

Diversifying the Investors

Performing Risk Assessment and Early Warning of LGDs Establishing the Risk Emergency Settlement Mechanisms of LGD

Strengthening supervision of LGD

Implementing Pilot Projects of LGSB

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Credits of all local government bonds must be rated before issuing.

Local governments are required to disclose their debt information on time.

Setting up the Positive list and the Negative list in order to prohibit the disguised debts in the name of the governments.

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Establishing Credit Rating and Information Disclosure System

Diversifying the Investors Besides the inter-bank market, MOF motivates local

governments to issue bonds in exchange market and pilot free trade zones as well.

Data shows:

-----Shanghai government issued bonds of RMB 30 billion in Shanghai Stock Exchange, RMB 3 billion in Shanghai Pilot Free Trade Zone in 2016 .

-----As of Oct.2017,RMB 700 billion of LGBs were issued at Shanghai Stock Exchange and RMB 1 billion at Shenzhen Stock Exchange.

-----The number of individual investors increased correspondingly. Nearly 30,000 individual persons subscribed over RMB 1 million in LGBs by Oct.2017.

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Performing Risk Assessment and Early Warning of LGDs Since 2015, MOF has annually organized the debt risk evaluations

for local governments at all levels through the comprehensive application of debt ratio, debt service ratio and other indexes.

To send the notification on local government debt risk situations to related departments and each provincial government.

To urge certain provincial governments to prepare risk resolution planning or emergency settlement plans to raise funds from multiple channels to eliminate the risks of outstanding debts.

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Establishing the Risk Emergency Settlement Mechanisms of LGDs To establish the hierarchical response mechanisms.

implement classified emergency response, strictly implement the accountability, make a systematic arrangement of the emergency settlement of LGD risks.

To make the emergency policy reserves of the risk incidents. The objectives are to achieve the reasonable risk sharing between the creditors and debtors and to enhance their abilities to cope with the debt risk emergencies.

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Strengthening supervision of LGD Establish the Normalized Supervision Mechanism. Officers from local offices of MOF are authorized to conduct in-situ investigation, achieving the normal supervision over local government debts.

Strictly Investigate & Punish and Disclose the Illegal debts and Illegal Financing Guarantee.

According to the handed-over auditing clues and special reporting clues from individuals, MOF organizes its subordinate offices nationwide to check the illegal debts and illegal financing some local governments.

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Pilot Projects of LGSB Improve the management of LGSB.

Carry out the pilot projects for Land Reserves, toll roads and other selected key fields across the country.

to realize the self-seeking balance between the projects benefits and financing under the legal limit of LGSD.

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The Effects of these Reforms in the PRC

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Achievements of these Reforms Supporting the Implementation of Active Fiscal Policy Standardizing LGD management for Risk Avoidance

Reducing Financing costs

Diversifying the investment entities

Promoting LGB Market to Grow Rapidly

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Pushing Forward the Supply-ide Structure Reforms Promoting steady growth of local economy

LGDs are mainly financing for public interest projects

The newly-added LGBs in 2015, 2016 and 2017 were RMB 600 billion, RMB 1.18 trillion and RMB 1.63 trillion, respectively.

Financing for public welfare projects (such as poverty alleviation, shanty town reconstruction, etc.), the Belt and Road, the Joint Collaborative Development of Beijing, Tianjin and Hebei Province, Yangtze River Economic Belts, etc. 25

Standardizing LGD Management With rapid conversion of existing debts, the management

of LGBs has become much more standardized.

The accumulated existing debts converted to bonds in accordance with the Budget Law in 2015 and 2016 approximated RMB 8.1 trillion.

The standardized bonds already accounted for nearly 70% of the local debts by the end of 2016. Local government non-bond debts have declined sharply, less than RMB 2 trillion estimated by the end of 2017.

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Standardizing LGD Management (to be cont.)

Outstanding debt by the end of June 2013

Outstanding debt by the end of December 2016

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LGBs, 5.6%

non-LGBs 94.4%

LGBs, 69.4%

non-LGBs, 30.6%

The Financing Cost is Reduced, and the Repayment Pressure is eliminated Average interest of LGBs was much lower than that of existing

LGD before swap. The issuing rate of LGBs averaged 2.93% in 2016, much lower than previous costs for the debts raised through ways other than government bonds, and the interest costs reduced throughout the year approximated RMB 400 billion.

LG repayment pressure is also relieved. From 2015 to September 2017, the accumulated outstanding LGDs replaced nationwide are RMB 10.2 trillion, which had alleviated the risks of outstanding LGDs and would be conducive to improving the institutions and individuals received repayments consumption abilities.

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The Investment Entities have been diversified

Policy banks, security companies, fund companies, insurance companies, and foreign banks hold higher proportion of LGBs than before at various levels.

Domestic commercial banks hold less.

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Market size of LGBs grows rapidly

In 2016, the issuance of LG bonds was RMB 6.05 trillion with about 60% year on year growth, 17% of the total issuance volume of China bond market.

By the end of 2016, the outstanding obligation of LGBs equaled RMB 10.63 trillion, 16.7% of the total outstanding bonds in the market.

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New Challenges are facing Chinese Government

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New Challenges At present, LGDs in the PRC are at the manageable level ,

but new challenges and obstacles have shown as follows: Illegal guarantee: some financial institutions still

require LGs to provide a covenant of warranty. Non-standard financing in disguised forms still

exists: in some areas, the scope of government purchased services has been illegally expanded; fake PPP projects(promising to buy back the principal or bearing the principal loss of social investor’s, etc.)

The investor base needs to be more diversified.

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What are the Next Steps

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What are the next steps The basic principle: undoubtedly persisting in blocking the back door and safeguarding the front door by controlling the increasing volume of LGD and fighting against illegal debt financing and guarantee. Enhance the supervision of local governments to carry out debt

management regulation, further strengthen debt ceiling management, insist on LGs debt financing solely by issuing LGBs to resolve to curbing the implicit debt increase.

Strictly implement accountability system. Urge LGs to fulfill their entity responsibilities and improve the system of accountability, responsibility claim and investigation, to improve the government performance assessment system for lifelong accountability and responsibility tracing.

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What are next steps (to be cont.) Accelerate the market-oriented transformation of

financing platform companies and urge financial institutions to perform the compliant and prudent operations to realistically strengthen risk control and maintain fiscal sustainability.

Improve information disclosure and credit rating system.

Steadily promote the reform of LGSB management. Further diversify the investor base.

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Conclusions LGD in China is stable, sustainable and affordable. New challenges still exist. Further reforms are expected. When the sun is shining, we should fix the roof!

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Thank you！

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