The research bureau of the People’s Bank of China said the country’s local authorities should be allowed to go bankrupt to rein in excessive regional borrowing.
“China must have an example like the bankruptcy in Detroit. Only if we allow local state-owned firms and governments to go bankrupt will investors believe the central government will break the implicit guarantee,” Xu Zhong, the head of the agency, wrote in an article on the financial news website Yicai.
Xu referred to the largest-ever municipal bankruptcy, filed by the US city of Detroit in 2013 after local authorities failed to repay an $18 billion debt.
According to the official, China should eliminate central government control over the scale of local government bonds and responsibilities to issue and repay obligations must be laid on the county or a city, which uses these funds.
“Whether bonds can be issued, and at what price, must be examined and screened by the financial markets. There does not need to be worry about local governments chaotically issuing debt,” Xu wrote.
Last week, China’s National Audit Office pledged to dispel the “illusion” that Beijing would foot the bill for local government debt. At the same time, the central government should increase the limit for local government debt as general government debt is primarily used for poverty relief spending, while also controlling expenditure on new projects.
“Financial institutions must not provide financing to projects without a source of stable operating cash flow or that do not have compliant collateral,” the office said.
Concerns about eliminating support for local funding units have triggered a decrease in the issuance of local government debt. Local governments have sold 1.7 trillion yuan ($259 billion) worth of bonds onshore and offshore in 2017, marking a 23 percent decline from 2016’s level, according to Bloomberg estimates. Earlier this year, Fitch Ratings said the first bond defaults by Chinese LGFV were becoming more likely.
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