China Tightens Oversight of Local Government Borrowing

What’s new: China’s Ministry of Finance ordered that the allocation of quotas for local governments’ borrowing via special purpose bonds (SPBs) be linked to performance targets for the projects the bonds fund.

Authorities are moving to apply more rigorous oversight to trillions of yuan of local government debt taken on to finance public infrastructure and other projects that often don’t pay for themselves as intended, increasing risks associated with the borrowing.

Under new rules issued Monday, a project operator or supervisor must carry out a performance evaluation and set a performance target before seeking authorization to issue SPBs. The Ministry of Finance and provincial finance departments will take performance results into account as a factor in adjusting the allocation of SPB quotas, according to the rules.

The regulations will apply to all SPB refinancing starting in 2022. Performance targets should be as detailed and quantitative as possible to reflect an underlying project’s expected output, cost of financing and risk of insolvency, the ministry said.

The background: SPBs were introduced in 2015 to fund commercially viable infrastructure and public welfare projects. They are meant to be paid off from income generated by the projects they fund, in contrast to general bonds which can be retired from general fiscal revenue.

In 2020, local governments had SPB quotas totaling 3.75 trillion yuan ($560 billion), almost 75% higher than the 2019 allocation.

As part of its annual monitoring, the State Council had the National Audit Office investigate local governments’ debt management. The audit found that SPBs had been poorly managed with funds used to finance unprofitable projects. Some 41.3 billion yuan, or 3.25%, of the 1.27 trillion yuan of outstanding SPBs issued by 55 local governments were not used for the intended purpose, the audit showed. Some local governments invested 20.5 billion yuan in projects that had no income or whose annual income was insufficient to pay the principal and interest, prompting serious concerns about their solvency, the report found.

Quick Takes are condensed versions of China-related stories for fast news you can use. To read the full story in Chinese, click here.

Contact reporter Denise Jia (huijuanjia@caixin.com) and editor Bob Simison (bobsimison@caixin.com)

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