Shanghai to auction 40 billion yuan of deposits in step toward muni bond market

[SHANGHAI] Shanghai's municipal finance bureau said on Tuesday it would auction 40 billion yuan (US$6.40 billion) of 6-month deposits in February, in what traders said would be the first such move by a local government in China.

The auction would be a step forward in the development of the country's municipal bond market that would wean local governments off their dependence on external financing vehicles.

Local governments have been able to resell deposits of their own money held in commercial banks since 2013 in search of higher returns; in December, for example, Beijing sold a few tranches through a unit of China International Capital Corporation.

In the past, these deposits were basically controlled at the central government level, which heavily restricted local governments from using them to support their budgets, because their budgets were not independent.

But bond traders consider the Shanghai auction a first in terms of purpose and design because of its implications for budget management for China's legions of local governments suffering under heavy debt loads incurred during a sloppy stimulus spending spree that began in 2009.

In addition to the managerial presence of the central bank, the collateral for the issue will be government bonds, and this and other details mimic the way the central government managed bond auctions on behalf of localities in the past.

The announcement was made in a joint statement with the local branch of the central bank.

The bonds would be auctioned together by the Shanghai city finance office and the Shanghai headquarters of the People's Bank of China (PBOC).

Joint auctions by the central Ministry of Finance and the People's Bank of China have been one of the main ways for the Chinese authorities to manage government finance in the past, but this is the first time that the model is being used for a local government deposit auction, traders said.

In order to allow local governments to issue debt directly, those governments have to have some sort of assets or revenue streams under their direct control. "Granting local authorities the power to auction debt in the same way as the central government means that China has made a crucial step in letting local governments become financially independent eventually," said a senior trader at a major Chinese state-owned bank in Shanghai.

China wants to gradually build up a local government bond market modelled after the US municipal market, he added.

China amended its budget law last August to allow local governments to issue debt directly for the first time.

In the follow-through steps, the State Council, the cabinet, in a document published last October banned the local government financial vehicles (LGFVs), the previous main channel for them to raise money, from issuing new debt.

The finance ministry then ordered all local governments to report their LGFVs' debt by January, encouraging localities to use a Public-Private-Partnership (PPP) model to help fresh fundraising, among other channels, to raise funds.

Analysts have said all these moves will require letting local governments manage their finances independently. "The Shanghai auction is the first move towards the direction," said the trader.

China experimented with allowing local governments to issue municipal bonds last year, with a small quota at 109.2 billion yuan for all of 2014. Shanghai has already issued bonds directly under the pilot programme.

Economists have expected the quota will surge as China moves towards using the muni bond market to replace the fundraisings by LGFVs, with some estimating it would exceed 1 trillion yuan in 2015 alone.

REUTERS