Finding a way out of local debt

It is not a publicity campaign. And in China, officials doing something without an accompanying publicity campaign often means the activity is still of an experimental nature.

But recent developments suggest that China appears to be edging toward a possible solution to the more than 1 trillion yuan ($1,610 billion) of debt that local governments have accumulated during the financial stimulus round of five to six years ago.

So much debt, and the ill-advised borrowings from which it was incurred, are considered a problem of the stimulus program back then, which was doled out in haste to mitigate the impact of the 2008 global financial crisis.

That's why the central government hates to call whatever it does nowadays to boost economic growth a stimulus program, or a Chinese version of the quantitative easing seen in the United States.

In the forthcoming debt solution, the central bank (which must have been prompted by the premier's office) is making State-owned banks buy the bonds that would be issued by designated provincial governments.

By doing so, local governments would transfer their ownership of debt (at least a considerable part of it) to the banks from which they borrowed loans a few years ago, but now may have difficulty in paying them back on time.

Incentives and terms would be provided by the central bank for commercial banks to participate in the solution, although the size of each province's issuance, and the total size of such a grand scheme would remain unclear for some time to come.

The securitization of local governments' debt will help China, first of all, to know the size of the local governments' debt, because if they keep hiding their debt, it would remain their liability and they would have to pay it back entirely by themselves, and second, to develop the open market instruments and related terms to regulate local governments' debt financing activities.

Presumably, the central government can't, and really has no need to take over all the local debt. Some debt represents pure waste. Some represents the kind of investment projects that are unlikely to generate worthy returns under government management and are better off being sold to private and more capable managers.

The financial contributions that officials received from their private business friends can't be allowed to be part of the solution.

The solution, in its first step, is only for the centralized State banking system to take over the local governments' debt. But down the road, banks, for their part, may need to develop their methodologies to manage local governments' bonds, including, most importantly, an open market practice for measuring a local government's credit worthiness. It is a kind of inevitability. China can't dodge it.

It would be interesting to find out how the central government's relationship with local governments can be redefined in the long run. But in the short run, it is important to find out which province can convert how much of its debt into bonds. The pilot issuer, as widely expected by the domestic financial markets, is to be Jiangsu province in East China.

Jiangsu is one of the three coastal provinces that lead the rest of the country in GDP, 6.5 trillion yuan last year, out of a national total of 63.6 trillion yuan.

Jiangsu should be at the top of all provinces in its ability to repay its debt. But, as reported by the Chinese business press, even such a province has to trim the size of its planned bond issue, by cutting down around 10 billion yuan, obviously because of complaints from the potential bond investors (first of all the banks).

For the provinces from China's inner and western areas, how much debt they can convert into a bond issue is even more questionable.

Indeed, if based entirely on the common sense of market economy, China's provincial bonds, as what they appear to be now, will not be a very attractive investment.

For serious investors, the forthcoming debt solution is still a hasty structure. It does point in the right direction, namely letting the market finance local development. But it is still designed as a temporary relief of the local governments' debt burden.

The debt-bond conversion now needs another conversion, one that converts a temporary solution to a stable system of local development financing. Market-based project evaluation, credit rating, fundraising and financial reporting are all indispensable parts of the system.

Most probably, the knowledge structure of China's all local governments will have to undergo a major change and, along with it, many of their economic officials.

The author is editor-at-large of China Daily.