China's Revised Budget Law a Credit Positive, to Boost Local Bond Market

The National People's Congress amendment of China's (Aa3 stable) budget law on 31 August will improve the transparency, supervision and management of local government borrowing, says Moody's Investors Service.

The passage of the new budget law, which will take effect January 1, 2015, marks its first revision in 20 years and is a key milestone in the implementation of the broader fiscal reform agenda in China.

The amendments -- in addition to improved information flow and greater regulatory oversight -- will discourage riskier forms of borrowing and reduce the overall cost of capital for local governments.

Moody's notes that the new law clearly sets out criteria and restrictions on local government debt issuance, and says that the State Council will determine which local governments can borrow and how much.

Only the 31 upper tier governments -- which include provinces, autonomous regions, and four special municipalities -- will be permitted to borrow under the new framework. These entities will be permitted to issue only bonds because of the greater level of disclosure that is required as compared to bank loans and other forms of borrowing.

Moody's also notes that the law's enhanced disclosure requirements will improve transparency and discourage local governments from the riskier forms of borrowing that have proliferated in recent years.

This will help to mitigate the systemic risk that has built up in the current system of indirect borrowing through local government financing vehicles (LGFVs), where the legal obligation for the debt is often clouded.

Moreover, greater disclosure associated with bond issues will allow investors to better assess and price risk, which will in turn allow local governments to issue debt for longer maturities and at lower interest rates.

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