The bounty of the muni

China’s capital markets

Shanghai’s government borrows in its own name for the first time in decades

How big is your balance-sheet?

IN 1861 Shanghai came under attack from the Taiping rebellion, a bloody uprising led by the self-proclaimed younger brother of Jesus Christ. To help pay for their defence, China’s provincial governments borrowed money from foreign investors. As collateral, they offered claims on Shanghai’s customs revenues. Foreigners were happy to accept, because foreigners themselves ran the custom house.


Provincial debt has its uses. Besides saving Shanghai from a divine sibling, it is also a rational way to finance long-lived infrastructure, spreading costs over the same period as the benefits. But since 1994 China’s provincial and municipal governments have been prohibited from borrowing. That changed on November 15th when Shanghai sold the first bonds under a new scheme, raising 7.1 billion yuan ($1.1 billion).
In allowing the sale the central government is quietly acknowledging that the 1994 ban has become counterproductive. It conspicuously failed to stop China’s sub-national governments from borrowing indirectly. They have set up more than 10,000 financing vehicles, which took out loans from banks to pay for public works, such as roads and irrigation. The central government has struggled to count this debt, let alone control it. Analysts guess that 30%-60% of these loans may turn sour.
If local governments are going to borrow, it is surely better that they do so on their own balance-sheets, using instruments everyone can count and price. By selling bonds they can replace opaque debt with transparent debt, “formalising their past misdeeds,” says one analyst.
But the central government is still a long way from allowing local governments unfettered access to the capital markets. The pilot scheme is so far confined to two of China’s richest cities, Shanghai and Shenzhen, and two of its most prosperous provinces, Guangdong and Zhejiang. The amounts scheduled are also tiny.
The central government will not let provincial governments abuse the bond markets. And even if they did, it would surely not let them go under. That is perhaps why Shanghai’s five-year bonds yielded only 3.3%, the same as the central government’s own paper and half the coupon offered by one of the city’s financing vehicles less than a month ago.
Judging by the yields, investors see Shanghai’s bonds as central-government securities in all but name. The coupon payments will even pass through the central government’s systems, just as Shanghai’s customs revenues once passed through foreigners’ hands. This suggests the bond-sale is a way to raise money from the same savers, on the same terms, as the central government, but not on the same balance-sheet. It is, in other words, the beginnings of a bail-out in disguise. China’s sub-national governments may be issuing their own paper, but they are not yet writing their own fiscal destinies.