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Fitch: New Circular Pressures China Subnationals' Financing in Short-Term, Long-Term Positive
May 10, 2017 / 10:50 AM / 6 months ago

Fitch: New Circular Pressures China Subnationals' Financing in Short-Term, Long-Term Positive

(The following statement was released by the rating agency) HONG KONG/BARCELONA, May 10 (Fitch) The new Policy Circular No. 50 in China will put short-term pressure on Chinese local and regional governments (LRG) and their financing vehicles' (LGFVs) debt issuance, but reinforces the state's mechanism to bolster risk controls and prevent systemic risks, Fitch Ratings says. The agency views the regulation as positive, since it will increase the control LGFVs have over borrowings. According to a joint statement released on 4 May 2017 by six government agencies - the National Development and Reform Commission, the central bank, the Ministry of Finance, the Ministry of Justice and Securities and banking regulators - Chinese LRGs cannot provide any form of guarantee on the debts issued by their LGFVs. In addition, the central government will strictly prohibit attempts to provide debt financing to LGFVs through public-private partnerships. Fitch is of the view that the statement reiterates and elaborates on the framework under the new budget law, covered under Circular No. 43 and Circular No. 88. China's Ministry of Finance regularly issues policies and directives to restrict debt raising through LGFVs to control public indebtedness and reduce moral hazard. However, since LGFVs are critical for LRGs to achieve their economic and policy objectives, and more broadly, the country's general economic goals, LGFVs continue to increase their activities and debt outstanding. Fitch believes the new measures will improve the monitoring and supervision of LRG's indebtedness, enable authorities to rein-in potential systemic risks arising from LRG debt and put LRG financing on a more sustainable long-term path. However, it is too early to judge the effectiveness of the measures. The recent initiative follows and is consistent with the authority's series of substantial steps to regulate and usher in stringent supervision and higher transparency of LRGs' fiscal positions under a strategy dubbed "close back door, open front door" (see <a href="">"Latest Circular Positive for China's Local Government Finance and Muni Bond Markets", dated 4 February 2016). Notably, the statement reiterates that subnationals are prohibited from using expected land sales as sources of debt servicing for LGFVs or injecting public assets into LGFVs. The authorities will also set a clearer boundary between LRGs and their financing vehicles. Nevertheless, LGFVs will continue to play a critical role in rolling out local infrastructure investment and public expenditure, undertaking social economic policy mandates and supporting local economic development owing to the structural mismatches between LRGs' revenue and expenditure. Fitch expects LGFVs to gradually transform into local state-owned asset management and investment companies, and government service providers. As such, there may be several rounds of sector consolidation, with those with strong policy mandates benefiting while those with weak policy mandates eventually side-lined and closed. Presently, Fitch applies a top-down approach to rate LGFVs due to their strong policy role and close connection with LRGs. The agency also believes a default of a strategically important LGFV is likely to have a negative effect on the sector's funding costs. LRGs also have tools to assist troubled LGFVs in the absence of outright bail-out, such as capital injections and increased subsidies. However, the agency may widen notching on selected LGFVs or change its rating approach if the policy role of LGFVs is diluted. 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