Accounting and budget reforms trigger growth in direct borrowing

The fledging regional and local government bond market in China is poised for more significant developments in 2015, with additional steps toward greater transparency and responsibility in borrowing.

The changes expected this year will be in line with the revised budget law that took effect on Jan 1, which will eventually allow some local administrations to issue bonds outside of an existing pilot program. The value of issuance this year will rise by 50% from 2014, according to the 2015 budget proposal .

The decision to expand the bond program dovetails with the State Council guidelines released in October that encourage local governments to begin issuing debt directly to reduce their reliance on riskier indirect borrowing.

The national government wants to develop a genuine municipal bond market because the buildup of opaque local government leverage in recent years could hurt the sovereign and banking sectors.

For example, the Ministry of Finance was reported to have approved a quota of 3 trillion yuan according to which local governments can swap informal legacy liabilities into formal local government debt.

One of the biggest challenges for the development of a municipal bond market is the continued dearth of accurate data on debt and financial performance and the absence of timely disclosure of such information.

Improvements in this area remain a work in progress. Market participants are unable to monitor the indebtedness of individual local governments. Accountability also needs further improvement.

Beyond creating the legal framework for a municipal debt market, the central government is also launching new accounting systems and enhancing disclosure rules to ensure that market participants have the information they need to make investment decisions.

Under the new system, local government debt will be reported in local government budgets, and it will also appear on their balance sheets.