Part I: Banqueting on Local Finance Options

by Caijing editors

Related Article：
Part II: Cities Rush into Debt -- and Possible Peril
Part III: Growth Targets Fan Shaanxi's Finance Flame
Part IV: Full Steam Ahead for New Financial Troikas

(Caijing Magazine) Financial crisis? What financial crisis? Local governments across China simply can't fathom the fuss. They're not starved of credit. In fact, they're enjoying a veritable financing feast.

Figurative chopsticks are digging deep into financing platforms offered by investment companies created by and operating inside local government offices, from city finance bureaus to local branches of the National Development and Reform Commission (NDRC).

These days, a single city hall may be sponsoring several financing platforms at once, perhaps one for construction projects and another for alternative energy programs. Investment vehicles are also doing business at provincial and township government levels.

Various kinds of platforms, but all designed to raise revenue for local governments, have been around for more than a decade. But in recent months the feasting table has gotten a lot bigger, to the point where it seems everyone in China's investment circle is talking about local financing platforms.

Much of the feeding frenzy involves quasi-public investment firms created by local governments to get around central government restrictions on fund-raising through bond sales. These firms offer investors hybrid municipal bonds indirectly backed by local governments. Bona fide municipal bonds, which cannot be issued without special permission from central authorities in Beijing, are avoided.

Bond issuer assets may include land – since all land in China is government-owned – or equity. Repayments may come in the form of government subsidies. A single financing platform may inject equity into one or several projects, ranging from a city building to public utilities. 

The basic model for these platforms first emerged in Chongqing with the advent of a local fiscal stimulus project in 1998. With equity capital loans from the central government's China Development Bank, the city began what has now become a model for state-assets investment.

One advantage of this financing model is that it offers opportunities to integrate resources and assets. In addition, through financing platform shelters, debt can be converted into equity capital for projects run by subsidiaries of a city investment firm – a scheme that supports future debt financing goals by increasing leverage.

Among governments, investors and others who tap these financing platforms, the global financial crisis raging since last year is someone else's problem. Their field of vision is focusing on the unprecedented opportunities encouraged by recent loosening of fiscal and credit policies by the central government.

It's true that projects for the Chinese government's 4 trillion yuan economic stimulus package are currently marked by huge gaps between local and central government funds. It's a situation that seems to encourage creative financing. But many local governments also have their own reasons -- outside the realm of stimulus projects -- for raising funds.

"Local governments want to use this period to make full use of their local financing platforms," said Jia Kang, chief of the Fiscal Science Institute at the central government's Ministry of Finance. "Now, the era of expansion has arrived."

And local governments are not alone at the financial banquet table. Commercial banks, trust companies and securities firms are also filling their plates. Some write loans, others offer wealth or trust products, and still others arrange bond sales.

Platforms are being exploited full-tilt. For example, some local government-linked investment firms are the main borrowers of bank loans for infrastructure projects. And bank trust products, through which banks sell trust wealth products and transfer customer investments to the trust, are getting popular. In the past five months, these structured products have raised more than 100 billion yuan, with most funds injected as equity into local government projects.

Whatever the form of finance, the fundamental aim is to turn bank loans into equity capital, thus increasing leverage for local governments.

Yet this feast has a foggy side, sometimes as thick as pea soup. Details about liability ratios, capital flow and repayments are not always shared with the public. Some financial institutions tied to local government fund-raising are operating in an information haze. And some financial decisions are based on mere trust in local governments' ability to pay.

Central government regulators and experts have started to worry. In addition to concerns over standard risks, questions have been raised about close relations between local investment firms and their government sponsors.

"Some financing platforms are constantly getting more money, but have no idea how to repay," warned Ni Hongri, a researcher at the State Council's Development Research Center (DRC).

Another sign of risk-taking is that some leveraged financing arrangements are built on an assumption that China's economy will soon turn better. If the optimists are wrong, fiscal revenues fall, and land income does not materialize, local governments may find themselves in deep trouble.

Experts are divided over the phenomenon. Guo Lihong, DRC former director-general, argues that local financing platforms should be carefully regulated. He suggests defining relations between financing platforms and local government financial offices, and establishing a framework for financier responsibility.

UBC China's chief economist Wang Tao argues a more critical need is an overhaul of the financial model through which bank loans are used as equity for local government projects. He said fiscal stimuli should be utilized more often than credit.

Fundamentally, Wang said, sources of all fiscal funds should be publicly identified, and the 3 percent deficit ratio cap should be changed.

But the debate over local government financing has been muddled by a lack of information. Due to the complex nature of financing platforms, there is no proven, authoritative data on local debt conditions. So Caijing dispatched reporters to three provinces -- Zhejiang, Anhui and Shaanxi -- for close inspections of local financing. Their reports follow.