Launch of Local Government Bonds in China
Eiichi Sekine
Senior Analyst,
Nomura Institute of Capital Markets Research

I.

Establishment of local government bond market

In November 2008 the Chinese government announced an economic stimulus
package worth RMB4trn, which is due to be implemented over two years. As funding
such a package presented problems, the government eventually decided that the costshould be shared, principally by central and local government, the corporate sector
and the banking industry.
It was against this background that, in its report on government activity at its 2nd
Plenary Session in March 2009, the 11th National People's Congress (NPC, China's
parliament) agreed that RMB1,180bn of the cost (i.e., the net new spending) should beborne by the central government. The NPC also agreed that, in order to ensure that theaggressive fiscal spending planned for 2009 was implemented, the Ministry of
Finance (with the approval of the central government) would issue a total of
RMB200bn in local government bonds on behalf of all the local governments and that
this would be included in the budgets of province-level governments (see below).
Article 28 of China's Budget Law, which was promulgated in 1994, stipulates (1)that "the local budgets at various levels shall be compiled according to the principles
of keeping expenditures within the limits of revenues and maintaining a balance
between revenues and expenditures, and shall not contain deficit" and (2) that "thelocal governments may not issue local government bonds, except as otherwiseprescribed by laws or the State Council" (Figure 1). 2009 is therefore a milestone inthat it marks the launch of local government bonds in China, albeit "prescribed bylaws or the State Council." This report examines, first of all, the state of local
government finances in China as well as the financial results for fiscal 2008 and thebudget for fiscal 20091. It then looks at the regulations governing the issue of local
government bonds as well as the actual issuance of such bonds. Finally, it considers
the challenges facing the local government bond market in China.

1

Calendar year from January to December.

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Nomura Journal of Capital Markets Autumn 2009 Vol.1 No.3

Figure 1: Budget Law rules on local government finance
Legislation
Enacting body
Promulgation date
Effective date
Article 28

Source:Budget Law of the People's Republic of China
National People's Congress
22 March 1994
1 January 1995
(Paragraph 1)
The local budgets at various levels shall be compiled
according to the principles of keeping expenditures
within the limits of revenues and maintaining a balance
between revenues and expenditures, and shall notcontain deficit.
(Paragraph 2)
The local governments may not issue local
government bonds, except as otherwise prescribed bylaws or the State Council.

Nomura Institute of Capital Markets Research, based on datafrom China's Ministry of Finance

II. State of local government finances and budget for fiscal
2009
1. Local government and local government finance in China
1） Local government
In China, there are five different levels of local government: province level,
prefecture level, county level, township level, and village level (Figure 2). First (indescending order), province-level government. As of end-2008, China (under thecentral government) was divided into 31 units: 22 provinces, five autonomous regions,and four municipalities. These province-level units are, in turn, divided into 333
prefecture-level units, 2,859 county-level units, 40,828 township-level units, and687,698 village-level units. Under this system, higher levels of government direct
lower levels.

2） Local government finance
China's fiscal year begins in January and ends in December. Public finance is no
exception. The budget is divided into a central government budget and a local
government budget, with the latter subdivided according to the different levels of
local government (Figure 3). The budget is drafted by the Central Economic Work
Conference, which is convened by the CPC Central Committee and State Council by
December of the preceding year. Local people's congresses (i.e., local government
assemblies) begin discussing local government budgets every January and pass them
before the NPC meets in March. The Ministry of Finance drafts the central
government budget on the basis of the local government budgets and the requests ofcentral government departments. The central government budget and the local
government budgets are then discussed and passed by the NPC when it meets in early

Launch of Local Government Bonds in China

2

March each year. The NPC is responsible for overseeing central government finances,while local people's congresses are responsible for overseeing local government
finances.

Figure 2: Administrative divisions of China (as of end-2008)
CenterCentralgovernment
Province-levelgovernment

31 units
22 provinces, 5 autonomous regions, 4 municipalities

Prefecture-levelgovernment

333 units
Cities, autonomous prefectures

Regions

Source:County-levelgovernment

2,859 units
Counties, county-level cities, districts, autonomous countie

Township-levelgovernment

40,828 units
Townships, towns, subdistricts, ethnic townships

Village-levelgovernment

687,698 units
Neighborhood committees, village committees

Nomura Institute of Capital Markets Research, based on China Statistical Abstract
2009

Figure 3: System of public finance in China
Debate, vote

Central budget

NPC
Supervision

Local budgets

・Budgetary funds
・Extra-budgetary funds
・Government funds
・Operating revenue and expenditureof public administrative bodies
Province-levelgovernment budget

Debate, vote

Prefecture-levelgovernment budget

・Budgetary funds

Supervision

County-levelgovernment budget

・Extra-budgetary
funds

Local people's
congresses

Township-levelgovernment budget

Source:3

Nomura Institute of Capital Markets Research, based on data from China's Ministryof FinanceNomura Journal of Capital Markets Autumn 2009 Vol.1 No.3

China's budget consists of "budgetary funds" and "extra-budgetary funds"2. The
former is the government budget based on the Budget Law and corresponds to thegeneral account budget in Japan. The latter is the charges levied by government
agencies (including parliament, the judicature, the Communist Party, and everything
related to the People's Liberation Army as well as government departments) following
official procedures and with official approval. Extra-budgetary funds are distinguishedfrom budgetary funds and regarded as a supplement to the government budget. Theygo back to the 1950s and have been adopted by both central and local government as ameans of achieving fiscal flexibility. Also, just because these funds are "extra"budgetary does not mean that they are not subject to any controls. The government
manages them as part of the fiscal system in accordance with the pertinent regulations.

3）Fiscal transfers to the regions in accordance with the distinction between
central and local government taxes
China's present system of local government finance, and especially fiscal transfersby central government, is based on the distinction between central and local
government taxes that was introduced in 1994 to strengthen the fiscal position ofcentral government and reduce regional inequalities 3 . Under this system, theproportions of fiscal revenue regarded as central government fixed revenue, local
government fixed revenue, and shared (central and local government) fixed revenue
are decided on an item-by-item basis. In addition, central government revenue istransferred as local government revenue in the form of tax rebates and transfer
payments (Figure 4).
The former returns some of central government's revenue (rebased to 1993) to local
governments to ensure that they are not disadvantaged as a result of the adoption of
the distinction between central and local government taxes. The latter consists of two
main types of transfer payments. The first is "fiscal transfers," of which "generaltransfers" are a principal example4. General transfers are calculated on the basis ofobjective factors using a standard formula and are not restricted in how they may be
used. They correspond to the Japanese system of revenue transfers to local
governments. The second is "special transfers," subsidies whose use is specified.

2

3

4

See Onishi (2004) for further details of China's system of public finance. As well as"budgetary funds" and "extra-budgetary funds" there are "government funds" and"operating revenue and expenditure of public administrative bodies". "Government funds"
corresponds to Japan's "special accounts," while "operating revenue and expenditure of
public administrative bodies" corresponds to the revenue and expenditure of incorporated
administrative agencies, public service corporations and authorized corporations in Japan.
See Jingu and Ri (2007) for further details of the historical background and the distinction
between central and local government taxes.
Beginning with the budget for fiscal 2009, what used to be called "fiscal transfers" will berenamed and redefined as "general transfers," while what used to be called "generaltransfers" will be renamed and redefined as "equilibrium transfers."

Launch of Local Government Bonds in China

4

Figure 4: Schematic diagram of local government revenue
and expenditure in China【Central government】【Local governments】

Central government
revenue

Local government
revenue

Transfers from local
governments

Transfers from
central government(Revenue)

Local government
bonds (from 2009)(Expenditure)

Source:Central government
expenditure

Local government
expenditureTransfers to local
governments

Transfers to central
government

Nomura Institute of Capital Markets Research, based on data from Chinese
Ministry of Finance and other sources

2. Current state of local government finances
1) Central government revenue and expenditure, and transfers to local
governments
Let us take a closer look at central government revenue and expenditure (Figure 5).
According to an announcement at the March 2009 NPC, central government fiscal
revenue (i.e., revenue from the central government's own resources) in 2008 was
RMB3,267.2bn while transfers from local governments to the central government
amounted to RMB94bn. Similarly, central government expenditure consisted of
RMB1,337.4bn in fiscal expenditure (i.e., expenditure from the central government's
own resources) and RMB2,294.6bn in transfers to local governments.
The budget for fiscal 2009 envisages central government fiscal revenue of
RMB3,586bn and transfers from local governments to the central government of
RMB98.2bn. Similarly, it envisages RMB1,497.6bn in central government fiscal
expenditure and RMB2,987.1bn in transfers to local governments (excluding anallowance for transfers from local governments ).

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Nomura Journal of Capital Markets Autumn 2009 Vol.1 No.3

Figure 5: Financial results for fiscal 2008 and budget for fiscal 2009
Units: RMB100mn
Revenue
FY08 results FY09 budget

CentralLocal

Overall(FY09 budget:
excluding an allowancefor transfers fromlocal governments )35,860.00
35,860.00 Central government
fiscal expenditure (c)982.00 Transfers to local
governments

Central government
fiscal revenue (a)Transfers from local
governments

32,671.99

Revenue from Central
Budgetary Adjustment
Fund
Total
Central government
fiscal deficit
Local government
fiscal revenue (b)Transfers from
central government
Income from local
government bonds
Total

1,100.00

505.0034,711.92-1,800.00

36,365.00-7,500.00

28,644.91

30,370.00

22,945.61

28,889.00(a) + (b)Note:

Source:939.932,000.00
51,590.52

61,259.00

61,316.90

66,230.00

Expenditure
FY08 results FY09 budget

13,374.31(FY09 budget:
excluding an allowancefor transfers fromlocal governments )14,976.00
14,976.00

22,945.61

28,889.00

29,871.00

36,511.92

43,865.00
43,865.00

44,847.00
44,847.00

30,370.00 Local government
expenditure (d)29,871.00 Transfers to central
government
2,000.00

49,052.72

61,259.00

61,259.00

62,241.00 Total
Reserves andamounts brought
forward66,230.00 （c）+(d)49,992.65
1,597.87

61,259.00
61,259.00

62,241.00
62,241.00

62,427.03

76,235.00

76,235.00

505.00 Transfers to Central
Budgetary Adjustment
Fund37,347.00 Total-7,500.00

192.00939.93982.00

Beginning with the budget for fiscal 2009, central government revenue in the formof transfers from local governments (RMB98.2bn) will be treated as an allowancefor central government expenditure in the form of transfers to local governments.
Nomura Institute for Capital Markets Research, based on Chinese Ministry of
Finance data

2) Local government revenue and expenditure
Let us now take a closer look at local government revenue and expenditure (Figure
5, as above). Local government fiscal revenue (i.e., revenue from local governments'
own resources) in 2008 was RMB2,864.5bn while transfers from central government
amounted to RMB2,294.6bn. Similarly, local government expenditure consisted of
RMB4,905.3bn in fiscal expenditure (i.e., expenditure from local governments' own
resources) and RMB94.0bn in transfers to central government.
The budget for fiscal 2009 envisages local government fiscal revenue of
RMB3,037.0bn, RMB2,987.1bn in transfers from central government (excluding anallowance for transfers from local governments), and RMB200.0bn from the issue of
local government bonds, beginning in fiscal 2009. Similarly, it envisages
RMB6,125.9bn in local government fiscal expenditure and RMB98.2bn in transfers tocentral government.

3) Growing importance of local government finances
Local government fiscal expenditure has increased in recent years (Figure 6). In
addition, it has increased in relation to the size of the economy. As a proportion of
GDP it has increased since the adoption of the distinction between central and local
government taxes in 1994 (Figure 7). This has been particularly noticeable since
President Hu Jintao and Prime Minister Wen Jiabao came to power in 2002 with apledge to rectify regional inequalities.

Launch of Local Government Bonds in China

6

Figure 6: Local government revenue and expenditure(RMB100mn)
70,000Local government bonds

60,000Transfers from central government
50,000Local government fiscal revenue

40,00030,00020,00010,0000
10,00020,00030,00040,00050,000Local government fiscal expenditure

60,00070,000Transfers from local government
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 (CY)(budget)Source:Nomura Institute for Capital Markets Research, based on Chinese Ministry of
Finance data

Figure 7: Fiscal expenditure as a percentage of GDP
（％）
18
16
14
12
10
8
6
4
2
0
78 80 85 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

Central government fiscal expenditure

Source:7(CY)

Local government fiscal expenditure

Nomura Institute of Capital Markets Research, based on data from Chinese
Ministry of Finance and National Bureau of Statistics

Nomura Journal of Capital Markets Autumn 2009 Vol.1 No.3

However, it has also made local government finances more dependent on central
government. As a proportion of local government revenue, local government fiscal
revenue increased from 49.2% just after the adoption of the distinction between
central and local government taxes in 1994 to 60.8% by 1997, after which it declined(Figure 8). The corresponding figure for transfers from central government (excluding
an allowance for transfers from local governments) in 1994 was 50.8%. The figure for
local government fiscal revenue briefly increased again (to 57.5%) in 2006 but has
since declined again and is estimated in the budget for fiscal 2009 to be 48.8%. Local
governments therefore need their own sources of revenue as much as ever.

Figure 8: Breakdown of local government revenue
3.21

100%
13.8
23.1 20.1 19.2
80%
50.8

45.9 42.1 39.2

60%
40%

20%

43.5 44.5
40.0 42.2 42.1 43.5 46.3 45.6 46.7 43.2
42.5

48.0

86.2
76.9 79.9 80.8
57.9 60.8 60.0 57.8 57.9 56.5 53.7 54.4 53.3 56.8 57.5 56.5 55.5
49.2 54.1
48.8

0%1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 (CY)(budget)Local government fiscal revenue

Source:Transfers from central government

Local government bonds

Nomura Institute of Capital Markets Research, based on data from Chinese
Ministry of Finance and National Bureau of Statistics

A breakdown of such sources for 2007 reveals that RMB1,925.2bn (81.7%) camefrom tax revenue while RMB432.1bn (18.3%) came from other sources (Figure 9). In
descending order of magnitude, the three most important local government taxes arebusiness tax (27.1%), domestic value-added tax (16.4%), and company income tax(13.3%), which together account for 56.8% of local government revenue. Bothbusiness tax and domestic valued-added tax are indirect taxes, the former being on thesales of service industries. Although China needs to increase the proportion of direct
taxes such as income tax, we see little prospect of a big increase in income tax in viewof the outlook for the economy in the near term. Although local government bonds are
expected to account for only 3.21% of local government revenue in fiscal 2009, they
are now seen as a source of funds for the government's RMB4trn in emergency
stimulus measures as well as of local government fiscal revenue.

Launch of Local Government Bonds in China

8

Figure 9: Local government fiscal revenue

１．Tax revenue
Domestic value-added tax
Business tax
Company income tax
Personal income tax
Resource tax
Urban maintenance and development tax
House property tax
Stamp taxof which, stamp tax on security exchange
Urban land using tax
Land appreciation tax
Tax on vehicle and vessel use
Tax on the use of arable landTax on contracts
Tax on tobacco
Other tax revenue
２．Non-tax revenue
Special revenue
Administrative and institutional charges
Fines and penalties
Other non-tax revenue
Local government fiscal revenue (1 + 2)

Source:2007
19,252.12
3,867.62
6,379.51
3,132.28
1,273.78
261.15
1,148.7
575.46316.6
60.16
385.49403.1
68.16
185.04
1,206.25
47.8
1.18
4,320.5
1,088.16
1,543.69
812.01876.64
23,572.62

Units: RMB100mn(Breakdown %)
81.67
16.41
27.06
13.29
5.40
1.11
4.87
2.44
1.34
0.26
1.64
1.71
0.29
0.78
5.12
0.20
0.01
18.33
4.62
6.55
3.44
3.72
100.00Nomura Institute of Capital Markets Research, based on data from Chinese
Ministry of Finance and National Bureau of Statistics

III. Local government bond issuance
1. Associated legislation
As we saw in Chapter I, "the local governments may not issue local government
bonds, except as otherwise prescribed by laws or the State Council." As a result, on 18
February 2009, the Ministry of Finance enacted with immediate effect Measures for
the Budgetary Control of Local Government Bonds in 2009 ("Control Measures"),which apply only for fiscal 2009 (Figure 10). In addition, it has published a press
release (in FAQ format) on the issuance of local government bonds by proxy andissued rules on fiscal budgeting, accounting and computation as well as on auctions,bids and due diligence.
The proxy issuance of RMB200bn in local government bonds was debated andapproved by the NPC, and reported in the fiscal 2008 budget implementation report aswell as the draft budget for fiscal 2009.

9

Nomura Journal of Capital Markets Autumn 2009 Vol.1 No.3

Figure 10: Local government bond legislation and disclosure documents
Legislation

Report on the Implementation of the Central andLocal Budgets for 2008 and on the Draft Central
and Local Budgets for 2009
Measures for the Budgetary Control of Local
Government Bonds in 2009
Press Conference Given by Official in Charge ofIssuance of Bonds on Behalf of Local Governments
in 2009
Measures for the Comprehensive Fiscal Budgeting,Accounting and Computation of Issuance of Bonds
on Behalf of Local Governments by Ministry ofRules on the Auction of, Bidding for and Due
Diligence of Bonds Issued on Behalf of Local
Governments in 2009

Source:Enacting body

Promulgation date

Effective date

Ministry of
Finance

15 March 2009-

Ministry of
Finance
Ministry of
Finance18 February 200917 March 200918 February
2009-

Ministry of
Finance

13 March 2009

13 March 2009

Ministry of
Finance

23 March 2009

23 March 2009

Nomura Institute of Capital Markets Research, based on data from Ministry of
Finance and National Debt Association of China

2. Issue terms of local government bonds
1) Definition of local government bond
Article 1 of the aforementioned Control Measures states their aim. We would
paraphrase this as for central government to allocate more funds to local governments
and to give central and local governments the investment capacity for the government
to implement its proactive fiscal policies. It confirms that the aim of issuing the bonds
was to help finance the government's RMB4trn economic stimulus program.
Article 2 defines local government bonds as bonds that are issued and redeemed(1) with the approval of the State Council, (2) on behalf of province-levelgovernments (including those of autonomous regions, municipalities, and designatedcities), (3) by the Ministry of Finance, which also pays the principal, interest and issue
costs (Figure 11). The main aims of having the Ministry of Finance issue the bonds onbehalf of all local governments are to enable it to negotiate the issue terms with theunderwriters (see below) on their behalf, to avoid the complication of different credit
ratings for different local governments, and to issue the bonds at the same cost as
Chinese government bonds by using the central government's credit rating. The actualissuance is to be managed by the Ministry's treasury department.

2) Budgetary control
Revenue and expenditure related to the issuance of local government bonds is to be
subject to government budgetary controls (Article 4). Province-level governments will
manage all the proceeds of the issue. Province-level governments can either use theproceeds themselves or lend them to prefecture- and county-level governments(Article 3). However, in the latter case, each county-level of government is also
responsible for managing the proceeds as part of its budget. Budgetary control is the
responsibility of the Ministry's budget department.

Launch of Local Government Bonds in China

10Figure 11: Procedure for approving issuance of local government bonds
State Council
Decides annual issue amount
Allocates amounts
Issues by proxy

Local
government
bonds

Ministry of FinanceInterbank bondmarketExchange markets

Applies
Approves
issuance

Province-level people's
congress
Approves
issuance

Province-levelgovernment(Finance department)

Japanese prefecture level

Grants loan
(re-lends funds)

Prefecture-level
Countygovernment (Citylevel
level government) government
ImplementsJapanese municipal level

Implements

Public welfare
project

Source:Nomura Institute of Capital Markets Research, based on data from Chinese
Ministry of Finance and National Bureau of Statistics

3) Uses of the issue proceeds
Article 5 stipulates that the issue proceeds must basically be used to further themodification and transformation of the economy in accordance with the concept of"The Scientific Outlook on Development." This is in line with the current
administration's aim of trying to focus more on the quality than the pace of economic
growth and to improve public welfare.
Uses of the proceeds is limited to (1) public welfare projects in which the central
government invests and to which local governments also allocate money, and (2) otherpublic welfare projects for which it is difficult to raise capital from sources other than
the government. The use of the proceeds to invest in projects for which funds areavailable from the markets is strictly controlled, while their use for recurrent spending
is prohibited.
Specific examples of permissible uses are for (1) low-cost public housing projects,(2) public welfare and basic infrastructure projects in rural areas, (3) basic healthcare,sanitary, educational, cultural and other public welfare infrastructure, (4) nature
conservancy (ecological construction processes), (5) disaster relief projects, and (6)other public welfare projects.

4) Approval and monitoring processes
In order to use issue proceeds, province-level governments are required to apply to
the State Council and incorporate in their budgets the amount they are allocated

11 Nomura Journal of Capital Markets Autumn 2009 Vol.1 No.3

(Article 5). How much of the RMB200bn each local government is allowed to "issue"
in fiscal 2009 will be decided using a formula that takes account of factors such as (1)how much of the public welfare projects funded by the central government should beallocated to the regions, (2) how much of the cost of such projects should be borne by
local governments, and (3) how much each region is able to repay. These factors boil
down to the number of projects undertaken jointly by central government and each
local government, each local government's overall fiscal position, its debt ratio, therate of improvement in its fiscal position, and the degree of its financial distress.
However, the greatest weight is attached to each local government's need for funds tocover its share of the cost of such projects. Furthermore, China's central and westernregions will be allocated a particularly high proportion of the issue amount in linewith the aims of the economic stimulus program.
Once a local government has been allocated its issue quota for 2009, it needs toredraft its budget if it has not already been approved by the region's people's congressand submit it for approval. If its budget has been approved by the region's people's
congress, it will need to incorporate its share of the issue proceeds in the budget andsubmit an amendment for approval. The proceeds of the 2009 local government bondissues will be incorporated in each local government's budget (see Figure 5 above).
There is no explicit guarantee that the central government will repay the principal of,and pay the interest on, local government bond issues.

3. Issuance of local government bonds
1) Mainly for the benefit of China's central and western regions
China's local government bonds will be issued by the Ministry of Finance onbehalf of all local governments using the same procedure as for book-entry
government bonds. All the issue terms apart from the coupon are decided in advance.
A total of 26 issues with a total face value of RMB111.8bn were issued between
March and end-May 2009 (Figure 12). In line with the Ministry of Finance's policy,
the plan is to initially issue bonds on behalf of inland regions and central/westernregions (such as autonomous regions of ethnic minorities) that wish to implement the
government's economic stimulus measures but do not have the necessary funds, andthen to issue bonds on behalf of the coastal regions (Figure 13). The issue coupon will
be a maximum of 9 basis points over the secondary market yield on three-year bookentry government bonds5.
In all cases, the maturity of the bonds is three years. Issuance of three-year central
bank bonds on China's interbank bond market has been suspended since early 2009.
According to statistics from the People's Bank of China, RMB968.0bn (or 13.7%) of
the RMB7,072.7bn in bonds issued on the interbank market in 2008 consisted ofcentral bank bonds with a maturity of 1–3 years. We therefore think there would be apoint in issuing three-year bonds with the same credit rating as that of central bank5

Ministry of Finance press release dated 27 May 2009.

Launch of Local Government Bonds in China

12

bonds. The Ministry of Finance has pointed out that a maturity of three years would
also satisfy the ALM needs of the commercial banks6.

Figure 12: Local government bond issues
Issuer
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26

Xinjiang Uyghur Autonomous Region (first issue)
Anhui Province (first issue)
Henan Province (first issue)
Sichuan Province (first issue)
Chongqing City
Liaoning Province (first issue)
Tianjin City
Shandong Province (first issue)
Jiangsu Province
Jilin Province (first issue)
Qinghai Province
Qingdao City
Hubei Province (first issue)
Hebei Province (first issue)
Shaanxi Province (first issue)
Inner Mongolia Autonomous Region (first issue)
Heilongjiang Province (first issue)
Yunnan Province
Zhejiang Province (first issue)
Dalian City
Sichuan Province (second issue)
Hubei Province (second issue)
Beijing City
Shanghai City (first issue)
Henan Province (second issue)
Guangxi Zhuang Autonomous Region (first issue)

Note:
Source:Issue dateIssue amount(RMB100mn)

Coupon(%)

Maturity(years)2009/3/30
2009/4/1
2009/4/7
2009/4/8
2009/4/13
2009/4/14
2009/4/14
2009/4/16
2009/4/20
2009/4/23
2009/4/23
2009/4/23
2009/4/23
2009/4/30
2009/4/30
2009/4/30
2009/5/11
2009/5/11
2009/5/11
2009/5/14
2009/5/14
2009/5/14
2009/5/25
2009/5/25
2009/5/25
2009/5/25

30
40
50
90
58
30
26
30
84
30
29
11
50
40
36
30
30
84
40
10
90
31
56
40
38
35

1.61
1.6
1.63
1.65
1.7
1.75
1.78
1.8
1.82
1.82
1.82
1.82
1.82
1.8
1.8
1.8
1.77
1.77
1.77
1.71
1.71
1.71
1.67
1.67
1.67
1.67

3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3

The Beijing, Shanghai, Henan (second issue) and Guangxi bonds were auctionedon 25 May 2009.
Nomura Institute of Capital Markets Research, based on data from Ministry of
Finance, Shanghai Wind Information Co, and National Debt Association of China

Also, in view of the period of construction and operation of the public welfare
projects for which the issue proceeds are intended, there may well be cases that takemore than three years. No details have been published thus far of how the Ministry of
Finance intends to refinance the local government bonds that have been or will be
issued. However, at a State Council press conference on 27 May 2009 about the stateof implementation of the government's economic stimulus measures, Vice Minister ofFinance Zhang Shaochun said that the planned issuance of local government bonds
after 2009 would depend on how the projects progressed rather than be decided eachfiscal year.

6

See above press release.

13 Nomura Journal of Capital Markets Autumn 2009 Vol.1 No.3

Figure 13: Local government bond issuers (as of end-May 2009)

Note:
Source:The Beijing, Shanghai, Henan (second issue) and Guangxi bonds were auctionedon 25 May 2009.
Nomura Institute of Capital Markets Research, based on Ministry of Finance data

Figure 14: Local government bond syndicate
Book-entry government bond syndicate (List A)
1 Industrial & Commercial Bank of China
2 Agricultural Bank of China
3 Bank of China
4 China Construction Bank
5 Bank of Communications
6 China CITIC Bank
7 Industrial Bank
8 Bank of Nanjing
9 China Galaxy Securities
10 Guotai Junan Securities
11 Ping An Securities
12 CITIC Securities
13 BOCI Securities
14 Guohai Securities
15 China Life Insurance
16 China Postal Savings Bank
Special institutions (on a par with List A)
National Social Security Fund

Source:Nomura Institute of Capital Markets Research, based on Ministry of Finance data

Launch of Local Government Bonds in China

142) Underwriters
Local government bonds are issued by inviting members of the book-entry
government bond syndicate to bid for them by auction (List A) (Figure 14). The
syndicate therefore consists of 17 financial institutions: nine banks, six securities
companies, one insurance company and one special institution (the National Social
Security Fund). Apart from BOCI Securities, all the institutions are based in China.
However, although BOCI Securities is a non-Chinese financial institution, the factthat it is ultimately owned by Bank of China, a China-based company, means that, to
all intents and purposes, all the members of the local government bond underwriting
syndicate are based in China.

3) Investors
Once the bonds have been underwritten, they trade on either the interbank bondmarket or the stock exchange markets (Shanghai and Shenzhen). According to the
Ministry of Finance, RMB111,730mn of the RMB111,800mn in local government
bonds already issued is traded on the interbank bond market, with only RMB70mn(two out of 26 issues, namely those issued by the Xinjiang Uyghur Autonomous
Region and Anhui Province) being traded on the stock exchange markets. Similarly,
the trading value of the 22 issues (worth a total of RMB94.9bn) listed and traded on
the markets by 22 May 2009 was RMB37,920mn. Of this, RMB37,861mn was tradedon the interbank bond market and RMB59mn on the stock exchange markets7.
50.3% of the government bonds traded on the interbank bond market are owned bycommercial banks, 33.9% by special clearing members 8 , and 5.4% by insurancecompanies. We therefore assume that local government bonds have a similarownership structure, with the majority being owned by commercial banks.

4) Contribution to economic stimulus measures
According to a report by China's National Audit Office on the state of progress in
implementing the economic stimulus measures 9 , 94% of the central government
budget for 335 new projects in 18 provinces (including municipalities andautonomous regions) had been disbursed as of end-March 2009 but only 48% of thelocal government budget. Of the RMB24,859mn planned total investment in the 335
projects, RMB8,669mn is due to come from central government, RMB6,894mn fromlocal government, and RMB9,296mn from bank loans and companies' own capital10.

7

8

9
10

This information on the issue amount and trading value of local government bonds as of
22 May 2009 is also from the above Ministry of Finance press release.
These include the People's Bank of China, the Ministry of Finance, the policy banks, thestock exchanges and China Government Securities Depository Trust & Clearing Co. Ltd.
Published on 18 May 2009.
According to a National Audit Office announcement at a State Council press conference
on 27 May 2009.

15 Nomura Journal of Capital Markets Autumn 2009 Vol.1 No.3

Whereas central government is expected to have contributed RMB100.0bn from its
budget for 2008 Q4 (Oct–Dec) and RMB130.0bn for 2009 Q1 (Jan–Mar), making a
total of RMB230.0bn, local government is expected to have contributed RMB170.0bn.
The intermittent issue of local government bonds since the end of March 2009 has
helped local governments to raise the funds they need to meet their target.

IV. Challenges and prospects
1. Responsibility for redeeming local government bonds
As we have said, the issue of local government bonds following the promulgationof the 1994 Budget Law, special regulations and approval by the State Council has
been a milestone in the history of China's bond market. The Chinese government also
pursued an aggressive fiscal policy 10 years ago after the Asian currency crisis of
1997, when, from 1998 to 2004, the central government issued construction bonds andlent the issue proceeds to local governments to invest in national projects to stimulatedomestic demand. However, although the central government bore the cost of(re)paying the principal and interest on the bonds, the money it lent to local
governments from the proceeds was not included in either its own or their budgets. As
a result, the resulting central government debt was not recorded as a fiscal deficit. We
therefore assume that the Ministry of Finance was very much aware that this issue of
construction bonds 10 years ago not only involved a distinction between the issuer
and the user of the funds but also blurred the locus of responsibility between the two,with the central government finding itself having to bear the increased cost and risk.
It was therefore careful to ensure that, although it will issue the local government
bonds on behalf of all local governments, this will only be after the issues have been
properly approved and budgeted, and both the NPC and the local people's congresses
have debated and ratified them. However, the low-cost public housing projects and the
public welfare and basic infrastructure projects in rural areas for which the issue
proceeds are intended will not necessarily generate a high return. Therefore local
governments may find themselves without the funds needed to redeem the bonds. If
that happened, it is by no means clear whether they would be expected to bear all the
responsibility for redeeming the bonds or whether the central government would
assume the responsibility. In particular, prefecture- and county-level governments will
face interest charges on public welfare projects as they will be lent the money by theprovince-level governments above them. Investors may assume that these local
government bonds are tacitly guaranteed by the central government because the
Ministry of Finance has issued them on behalf of local governments. However, if
there is any problem with redemption, investors and other market participants will
have to find out where the responsibility for redemption lies.

Launch of Local Government Bonds in China

16

2. Transfer payments
The issue of local government bonds is tied up with that of fiscal transfers from
central to local government. As we have mentioned, local government fiscal revenue
consists of transfers from central government as well as revenue from local
governments' own resources. However, as the fiscal position of local governments
seems to get weaker as one goes from the coastal regions to the central and westernregions, reflecting regional inequalities, transfers from central government are an
essential part of trying to achieve some degree of balance at a national level.
An analysis of each province's per capita fiscal revenue and transfers from central
government shows that, with the exception of coastal region municipalities such as
Beijing, Tianjin and Shanghai, transfers to the central and western regions as well as
the north-east tend to be more generous than those to the coastal regions (Figure 15).

Figure 15: Per capita local government fiscal revenue (as of 2007)
0

2,000

0

10

4,000

6,000

8,000

10,00012,000(RMB)
14,000Beijing City
Tianjin City
Hebei Province
Shanxi Province
Inner Mongolia Autonomous Region
Liaoning Province
Jilin Province
Heilongjiang Province
Shanghai City
Jiangsu Province
Zhejiang Province
Anhui Province
Fujian Province
Jiangxi Province
Shandong ProvinceHenan Province
Hubei Province
Hunan Province
Guangdong Province
Guangxi Autonomous Region
Hainan Province
Chongqing City
Sichuan Province
Guizhou Province
Yunnan Province
Tibet Autonomous Region
Shaanxi Province
Gansu Province
Qinghai Province
Ningxia Autonomous Region
Xinjiang Autonomous Region
20

Local government fiscal revenue

30

40

50

60

70

80

90

100
（%）

Transfers from central government

Reliance on central government financeSource:Nomura Institute of Capital Markets Research, based on data from FinanceYearbook of China and China Statistical Abstract

17 Nomura Journal of Capital Markets Autumn 2009 Vol.1 No.3

This is particularly true of the Autonomous Region of Tibet. The economic stability of
autonomous regions of ethnic minorities such as Tibet as well as of the autonomous
prefectures and autonomous counties in each province, where a large number of
ethnic minorities tend to live, is a key policy issue in China. At the same time,
however, these autonomous regions of ethnic minorities tend to be concentrated ininaccessible areas, even in the interior and the coastal regions. They therefore tend tolack their own sources of finance and have had to depend on generous fiscal transfersfrom central government (Figure 16).
Figure 16: Fiscal shortfall of autonomous regions of ethnic minorities(single fiscal year basis)(RMB100mn)
0-500-1,000-1,500-2,000-2,500Fiscal shortfall-3,000-3,5001978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006
(CY)

Source:Nomura Institute of Capital Markets Research, based on data from FinanceYearbook of China

Regional inequalities have developed in the 30 years since China adopted its "opendoor" policy in 1978, and we see little prospect of the central government being able
to wean the regions off its generous transfer payments in the foreseeable future.
Transfer payments are not just a matter of differences between local governments:
they also concern the distribution of fiscal resources between higher and lower levelsof government in the same region. Under China's general system of transfer payments,
they are derived by multiplying the difference between a region's standard expenditureand standard revenue by the transfer payment coefficient for that region. However, it
is debatable whether revenue and expenditure related to local government bonds
should be included in this formula.

Launch of Local Government Bonds in China

18

3. Possible purchases by foreign investors
Having just started in fiscal 2009, China's local government bond market is still in
its infancy. For bond investors, however, local government bonds are a newinvestment option. Foreign investors may be able to purchase the bonds as qualified
foreign institutional investors (QFIIs), although they will need permission from the
China Securities Regulatory Commission (CSRC) for those bonds traded on securities
exchanges. In this connection, foreign investors are unlikely to have forgotten the
ITICs (international trust and investment companies), set up in the 1980s as bases for
Chinese local governments looking to issue bonds and borrow money overseas, andsome of which collapsed and defaulted in 1998 and the years that followed.
We can expect China's local government bond market to continue to go through aseries of transformations and will continue to monitor its development.

【References】
Onishi, Yasushi, "Chuugoku Zaisei, Zeisei no Genjou to Tenbou" (Public Finance andTaxation in China), PRI Discussion Paper Series, No.04A‐26 (in Japanese).
CLAIR, Chuugoku no Chihou Zaisei Seido (Local Government Finance in China), July 2007
(in Japanese).
Jingu, Takeshi and Ri Suiyo, "Chuugoku Zaisei no Genjou to Kadai" (Public Finance in
China), Kikan Chuugoku Shihon Shijou Kenkyuu, 2007 summer edition, TokyoClub Foundation for Global Studies (in Japanese).
Tanaka, Osamu, Kenshou: Gendai Chuugoku no Keizai Seisaku Kettei (Economic Policy
Making in Modern China), Nihon Keizai Shimbunsha, 2007 (in Japanese).

19 Nomura Journal of Capital Markets Autumn 2009 Vol.1 No.3