In Depth: China’s Rising Local Government Bond Risks Spur Policy Changes

China is simplifying its approval processes for special-purpose bonds (SPBs), allowing local governments more control over the issuance and project approvals to drive economic growth[para. 1]. Analysts support this move for its potential to quicken the use of SPB funds and reduce idle funds, though repayment concerns remain due to inadequate project returns[para. 2][para. 4]. A new directive by the State Council enables 10 provincial-level governments and the Xiongan New Area to independently decide on issuing SPBs and project approvals[para. 3]. A "negative list" outlines ineligible projects, including purely unprofitable ones and certain commercial developments, but allows funding for affordable housing and land reserves[para. 4]. This step is anticipated to facilitate faster utilization of SPB funds[para. 5][para. 6].

SPBs are crucial to local infrastructure and public welfare projects, repaid through revenues from these projects and government-managed funds. Before the recent directive, projects required dual approvals from the National Development and Reform Commission and the Ministry of Finance (MOF), often delaying implementation[para. 7]. The new directive brings autonomy to pilot regions, predicted to enhance SPB utilization and positively impact related industries[para. 8][para. 9]. The adoption of a “negative list” gives local governments broader choices for allocating SPBs, increasing flexibility beyond previous restrictions[para. 10]. Outside pilot areas, processes for obtaining additional SPBs for approved projects have been streamlined, reducing repetitive bureaucratic hurdles[para. 11][para. 12].

The directive acknowledges the growth in idle or misappropriated funds—a longstanding issue—and mandates that SPB proceeds cannot be used for salaries, pensions, or debt service[para. 17][para. 18]. Reviews revealed considerable funds either misused or unused, heightening the need for proactive local government management of SPBs[para. 19] [para. 21].

Moreover, the directive adjusts the cap on SPB proceeds used as equity capital to 30% and expands eligible project areas, addressing previous underutilization[para. 23][24[]. However, analysts reported that from 2020-2024, such equity represented less than 10% of SPB proceeds, signaling existing restrictive challenges[para. 25].

Repayment challenges persist across projects with insufficient returns and declining revenues from land sales, critical for SPB debt service[para. 26][para. 27]. Audits illustrate the issue, with notable project underperformance in regions like Ningxia Hui and Jiangsu[para. 28][para. 29].

Local governments often refinance to pay off SPB principals, though such refinancing is not allowed for interest payments, exacerbating financial strains as revenue decreases[para. 32]. Liu's analysis highlighted surging interest payments on government-managed funds’ revenue, corroborating the strain amid declining land sales, with some regions showing alarmingly high percentages[para. 33][para. 34].

The directive introduces the use of fiscal subsidies to assist with SPB repayments when funds fall short and permits the reallocation of revenues from other SPB projects[para. 36][para. 37]. It emphasizes provincial responsibility for financial balance across regions, allowing profitable projects in some areas to compensate for deficits elsewhere[para. 38][para. 39].

Overall, the shifts aim to enhance the effectiveness of SPBs while balancing local governments' financial obligations across broader regional jurisdictions[para. 40].