Local govts not allowed to raise new 'hidden' debt

China will not allow new local government debt to be raised in "hidden ways", nor will it ease the controls on government debt financing despite the heavy fiscal pressure the country faces this year, Minister of Finance Liu Kun said on Thursday.

China has decided to make unprecedented cuts to taxes and corporate pension payments and increase investment in such fields as agriculture, infrastructure, technological innovation and social causes, officials said. That will predictably lead to heavy fiscal pressure as a result of reduced fiscal income and increasing expenditures.

But any new local government debts raised in "hidden ways" will be strictly prohibited, Liu said at a news conference during the ongoing second session of the 13th National People's Congress. The central government will not provide any bailout for local debt defaults, he said.

The minister added that China will not allow the establishment of new local government financing vehicles－usually companies set up by local governments to obtain loans from banks and others, which can lead to liabilities contingent on future results and other potential debt risks. "Financial institutions should not provide funds for projects without stable cash flows or legal pledges," Liu said.

As of the end of last year, outstanding local government debts stood at 18.39 trillion yuan ($2.74 trillion), up by 11.4 percent from a year earlier. That accounts for 55.14 percent of all government debt, according to the Ministry of Finance.

"China's current risk level for local government debt is under control," Liu said. "But we have to take measures to defuse potential risks to maintain sustainable fiscal financing."

The country's government debt-to-GDP ratio was kept at a stable level of about 37 percent in 2018, the ministry said. It is lower than the European Union's warning line of 60 percent, beyond which debt risks may become uncontrollable.

"Financing through local government financing vehicles is expected to become subject to increasingly strict regulation and more transparency" as the country strengthens risk controls, said Fu Yubin, a sub-sovereign research analyst at Moody's Investors Service.

Some analysts had predicted that the government might ease regulations on debt financing given the economic slowdown and trade tensions with the United States. The funding gap might be further enlarged, they worried, as the government cuts nearly 2 trillion yuan in taxes and fees and maintains a high level of infrastructure investment.

"But the answer, given by the finance minister today, is no," said Zhang Lianqi, an economist and consultant with the Ministry of Finance.

Liu conceded that it will be "very challenging" to maintain the balance between fiscal income and expenditures this year. To narrow the funding gap, the authority has decided to increase the quota for local government special-purpose bonds by about 60 percent over last year, to 2.15 trillion yuan.

The Ministry of Finance will also increase infrastructure investment by 40 billion yuan year-on-year to 577.6 billion yuan this year, Liu said.

To improve debt management and maintain stable investment growth this year, the National People's Congress broke with tradition and approved an order that had granted authorization as of Jan 1－instead of later in March as in previous years－to local governments to issue part of their 2019 full-year bond quota.

The early allocation was up to 60 percent of the annual quota, mainly to support infrastructure spending and bolster economic growth.

The increased quota is expected to provide local governments with much-needed funding to help meet capital expenditure needs, analysts said.