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On August 12, a media outlet learned from a third-party urban investment research institution, Modern Consulting, that by the end of July 2024, the total market size of urban investment bonds was 16.07 trillion yuan. The agency estimated that the maximum maturity size would be 529.813 billion yuan, which would occur inAugust 2024,followed bySeptember 2024andMarch 2025。

Municipal investment debt is an important part of local government hidden debt and has attracted much attention from industry and academia.

History

"Urban investment" is a general term for all types of urban construction investment companies across the country. From the establishment of the first urban investment company in 1992 to the present, the development of urban investment companies can be roughly divided into three stages.

 The first stage: 1992-2007, from scratch.

Founded in 1992, Shanghai Urban Construction Investment and Development Corporation (the predecessor of Shanghai Urban Construction Investment (Group) Co., Ltd.) is the earliest urban investment company.

At that time, urban investment companies were actually mainly established jointly by local finance departments and "Construction Committees" (Construction and Management Committees, mostly the predecessors of Construction Bureaus). The company's capital was contributed by the finance department, and the project funds, except for the fiscal appropriations, mainly came from bank loans guaranteed by the finance department.

Like many state-owned enterprises of that era, the company team and government agencies often did not distinguish between management and operation, with one team having two names.Therefore, in nature it mainly belongs to a non-profit institution or a state-owned company that undertakes some government functions. It is a special market operating entity with government nature.

In the planned economy era, all funds for urban construction were provided by the government.However, with the advancement of reform and opening up, local governments need more and more funds to invest in infrastructure construction, and fiscal investment alone cannot meet the funding needs of urban construction. With the establishment of urban investment companies, coupled with policy support, they can issue bonds and raise funds with government credit as the background and corporate legal person as the main body, and can also borrow from international banks, policy banks, and commercial banks to support the construction of public facilities.

For example, in the year of its establishment, Shanghai Urban Construction Investment and Development Corporation issued China's first municipal bond with a scale of 500 million and a term of 5 years in accordance with the central government's supporting policies for the Pudong New Area.After that, it also obtained loans from domestic and foreign banks including the World Bank, the Asian Development Bank, and the China Development Bank.

Following Shanghai, Chongqing, Guangdong and other provinces and cities also established urban investment companies one after another. The original intention of establishing urban investment companies in various places was to serve as government investment and financing platforms to raise funds for public construction.

The origin of urban investment determines both its close relationship with local governments and its business characteristics: it is often engaged in infrastructure construction, land consolidation, public utilities, affordable housing and other businesses. Most of these projects have a certain degree of public welfare or quasi-public welfare nature, with large investments, long cycles and low profits, but they play an important role in promoting economic growth or serving economic development.

There has always been another view that the emergence of urban investment and financing companies is because the tax-sharing reform in 1994 weakened the financial resources of local governments, which forced local governments to incur debt by establishing urban investment and financing companies.The earliest municipal investment company was established in 1992, earlier than the introduction of the tax-sharing system, so the tax-sharing system was not the direct cause of the emergence of municipal investment companies.

Early municipal investments were financed with government guarantees, a relatively single source of funding, no distinction between government and business, and an operating model that was primarily about borrowing new money to repay old debts. There were many problems and huge risks involved.

The Budget Law (Old) and Guarantee Law (Old) promulgated in 1994 and 1995 respectively no longer allowed the government to provide guarantees for urban investment companies. At that time, urban investment companies were mainly responsible for fundraising and construction tasks, and did not have their own assets. Therefore, once the government was prohibited from providing guarantees, it would be difficult for such companies to survive, and they would either close down or plan for transformation.

Between 1994 and 2008, urban investment companies began to explore transformation for the first time, with the following directions as the main focus:

First, through the transfer of franchise rights, the existing infrastructure can be revitalized, such as the transfer of limited-term operation rights of roads and bridges;

Second, it changes from a mere financing entity to an investment and financing entity, and begins to own its own assets;

Third, the business scope has gradually expanded from infrastructure to public services. In addition to being responsible for the entire construction cycle of the project, it also leads the operation of the project after completion;

Fourth, the project operation can obtain relatively stable cash flow. The municipal investment companies no longer mechanically borrow new money to repay old debts, but begin to try to establish their own debt repayment mechanism.

Fifth, we will carry out institutional reforms, gradually separate government and enterprises, and politics and administration. Local urban investment platforms will be gradually transferred to the State-owned Assets Supervision and Administration Commission and managed as state-owned enterprises.

 The second stage: rapid expansion from 2008 to 2013.

The real development of municipal investment began in the second half of 2008.

In response to the financial crisis, China launched a 4 trillion yuan fiscal stimulus. 4 trillion yuan is the total scale, 1.18 trillion yuan is borne by the central government, and the other 2.82 trillion yuan is raised by local governments.

However, the old Budget Law does not allow local governments to directly borrow money. In order to raise matching funds, regulators began to relax restrictions on municipal investment companies’ borrowing.

Encouraged by policies, various regions began to compete to establish urban investment platforms, and commercial banks also announced their active support for national key projects and infrastructure construction. As a result, urban investment entered a period of accelerated expansion.

In 2009, the issuance scale of municipal bonds reached 430.49 billion yuan, a year-on-year increase of 274.3%.

While urban investment companies are expanding rapidly, illegal borrowing and disguised guarantees are common.

In June 2010, after it was clarified that urban investment and financing platforms could serve as financing platforms for local governments, the State Council began to introduce regulatory policies for urban investment and financing platforms in order to control risks.

However, since the main partners of municipal investment companies at this time are commercial banks and the most direct impact is also on commercial banks, the regulatory focus of this round of rectification is bank credit, without too much involvement of "non-standard" and bond financing channels.

At that time, various regions were still carrying out large-scale infrastructure construction, followed by the construction of affordable housing and the transformation of shanty towns. Local governments had a strong demand for financing.

For the government, on the one hand, the government's financing needs are only increasing and not decreasing, and on the other hand, it is required to reduce funding sources such as bank loans, which has led to changes in the financing structure of urban investment companies.The proportion of credit funds from commercial banks declined rapidly, but the scale of bond financing from non-bank institutions increased significantly. Shadow banking began to expand rapidly and became an important source of funds for urban investment platforms.

For banks, first of all, municipal investment companies have "municipal investment faith" - the market believes that municipal investment companies will not default in the bond market. Even if there are repayment risks in the short term, the government will eventually provide a guarantee, and municipal investment companies will still be high-quality borrowing targets for financial institutions.Secondly, non-standard assets can provide higher returns than market-based financing. Finally, it can “adjust” the balance sheet.

The above-mentioned reasons have jointly led to the coincidence between local government financing platforms and commercial banks. Banks have provided a large amount of funds to local government financing platforms through various non-standard financing methods, promoting the vigorous development of non-standard financing.

From the data, we can find that from 2010 to 2013, the proportion of commercial bank credit in the debt structure of local governments that are responsible for repayment dropped from 74.8% to 50.8%, while the issuance scale of municipal bonds increased from 406.25 billion yuan to 1.4 trillion yuan (annual compound growth rate of 50.3%). Compared with 2010, the debts that local governments are responsible for repayment, guarantee and may bear certain rescue responsibilities increased by 62.2%, 14.1% and 159.9% respectively.

 The third stage: Rectification has accelerated since 2014.

The previous round of regulation of urban investment and financing companies was mainly aimed at bank credit, with the aim of preventing illegal borrowing and disorderly expansion of urban investment and financing companies’ credit.

However, while reducing the credit funding sources of urban investment and financing companies, no new funding channels were provided. What is most critical is that both financial institutions such as commercial banks and non-bank institutions such as securities companies and insurance companies regard urban investment and financing companies as high-quality customers that enjoy implicit government guarantees. Therefore, all parties have formed a "combined force" intentionally or unintentionally, providing urban investment and financing companies with a large amount of non-standard financing.

While enjoying the financing convenience brought by non-standard financing, urban investment companies also breed risks, such as impacting bank asset quality, maturity mismatch, nesting, evading supervision, forming capital pools and affecting macro-control.

In order to strictly control local government debt risks, the rectification of urban investment platforms has begun to accelerate.

The watershed was the "Opinions of the State Council on Strengthening the Management of Local Government Debt" (Guo Fa [2014] No. 43) issued by the State Council on October 2, 2014.

Of course, this does not mean that banks and non-bank institutions were allowed to circumvent supervision and provide funds to urban investment companies.But the significance of Document No. 43 lies in “blocking the back door and opening the front door”.

Subsequently, the National Development and Reform Commission, the Ministry of Finance, the China Securities Regulatory Commission and other departments successively issued relevant normative documents to implement Document No. 43, requiring further clarification of the boundaries between local governments and financing platform companies, and once again emphasizing that local governments must issue local government bonds within the limits approved by the State Council when raising debt.

On January 1, 2015, the new Budget Law came into effect, providing a legal basis for solving the problem of "implicit guarantees" of financing platform debts:According to the law, local financing platform debts do not constitute government debts.

Against the backdrop of the central government’s governance of financing platform debts, local financing platforms began to gradually separate from government financing functions, and platform companies gradually transformed towards marketization.

While strictly controlling the expansion of local government debt, regulatory authorities have also expanded local government funding sources through public-private partnerships (PPPs) and government investment funds, and adopted debt swaps and other methods to reduce local government debt interest burdens, optimize debt maturity structures, and reduce interest costs. According to data released by the National Audit Office, a total of 12.2 trillion yuan of stock government debt was swapped from 2015 to 2018.

On April 27, 2018, the People's Bank of China and other departments jointly issued the "Guiding Opinions on Regulating the Asset Management Business of Financial Institutions" (the "New Asset Management Regulations") to limit maturity mismatch and non-standard assets, regulate the asset management industry, and prevent risks.

In July 2024, a document called Guofa [134] began to circulate online. It has three main points:

It is particularly emphasized that the above-mentioned Document No. 134 is only a rumor on the Internet and it is impossible to judge whether it is true or not, but some provinces and cities have indeed completed non-standard replacements, which may be a pilot project.

Regardless of whether Document No. 134 is true or false, considering the debt-reduction ideas in recent years of "strict control of new additions, replacement of existing stocks, lowering interest rates, early repayment, and non-standard replacement", as well as the support of 1.56 trillion special refinancing bonds, 1 trillion special treasury bonds, and 55 billion ultra-long-term treasury bonds, the repayment pressure of urban investment companies has been significantly alleviated, and the probability of sudden debt default risks has been greatly reduced.

Risks of municipal investment

Against the backdrop of turbulent international political and economic situation, economic structural transformation, shifting economic growth rate, and increasing pressure on local fiscal revenue and expenditure year by year, the debt risks accumulated by many urban investment platforms have gradually been exposed, and operating pressure has increased significantly.

A "Minutes of the Kunming Urban Investment Experts Meeting" circulated on the Internet in May 2022 and the 20-year extension of Zunyi Road and Bridge's 15.6 billion loan in December sparked public attention.

Since 2021, urban investment financing policies have once again entered a tightening cycle. Coupled with the decline in general public budget revenue and land transfer fees in most provinces in 2022, the debt repayment capacity of local governments has weakened. Since 2023, the number of non-standard default incidents of urban investment has increased significantly, reaching 181 cases, a record high, involving a total of 97 urban investment companies.

However, there has been no public default on the standardized debts of municipal investment companies, especially those issued in the open market.

From the perspective of provincial distribution, the default incidents of municipal investment companies are mainly concentrated in 12 provincial regions, with the top four provinces being Guizhou, Shandong, Yunnan and Henan. In order to adhere to the bottom line of no systemic risk, local governments have actively taken various measures to resolve debt risks.

Although the number of default events has increased year-on-year, the risks of municipal investment companies are still within controllable range. The reasons are as follows:

First, although the total debt stock is large, there are a large number of high-quality assets corresponding to it.

It is estimated that by the end of 2023, the scale of interest-bearing debt of urban investment companies nationwide will be approximately 64 trillion yuan, of which approximately 25% will be in the form of bonds and the remaining 75% will be in non-bond form.

First of all, although the scale of 64 trillion is large, urban investment companies are not 100% engaged in public welfare or quasi-public welfare businesses. According to rough estimates, about 50% are still operating businesses with good cash flow.

Secondly, urban investment companies usually control better local state-owned assets and resources, corresponding to a large number of high-quality assets.

Finally, even if all 64 trillion is included in the broad government debt, China's government debt ratio (broad government debt/GDP) in 2023 will be lower than 100% (110 trillion/126 trillion), which is still relatively controllable. During the same period, the debt ratio of the United States was 121.7% and that of Japan was 261%.

Second, the growth rate of municipal investment bonds has slowed down significantly, and the cost of borrowing has entered a downward channel.

In 2023, the growth rate of interest-bearing municipal bonds will drop to 11.5%. The main reasons are that since October 2023, special refinancing bonds have been issued in a concentrated manner, which has driven up the repayment scale of municipal bonds, and many provinces are in a net repayment state; on the other hand, the approval of the issuing end has tightened, and the overall issuance scale of municipal bonds has declined.

After the beginning of 2024, there were signs of warming in the issuance of municipal bonds, early debt repayments fell from the peak, and issuance gradually increased, but it is expected that the policy orientation of "transforming existing stocks and controlling incremental growth" will not change throughout the year, and the growth rate of debt scale may enter single digits.The implementation of debt reduction policies has strengthened market expectations, and the financing costs of municipal investment companies in various provinces are also decreasing.

Third, after the introduction of a package of debt reduction measures, the debt structure and maturity structure have been continuously optimized.

The debt side of the bond-issuing urban investment companies includes bank loans, bonds, bills and other financing. Overall, bank loans account for more than 60%, bond financing accounts for more than 20%, and the bonds issued by provincial and municipal urban investment companies account for about 45% in total. In addition, about 55% of urban investment bonds are issued by district, county or park-level urban investment companies, and the debt structure is relatively stable.

The maturity structure is mainly composed of long-term debt, with the ratio of long-term debt to short-term debt being approximately 80:20. This maturity structure is more in line with the business attributes of urban investment companies.

The real risks come from two aspects:

The first is the risk of technical default.The main reason is that urban investment companies and local governments did not do a good job of liquidity management, and the principal and interest of matured debts were not repaid on time on the due date, but the principal and interest of the bonds will still be repaid in the end.However, technical default will affect the credit of urban investment companies or local governments in the open market, increase financing costs, or even lose the open market financing channels;

On the other hand, during an economic downturn, technical defaults will amplify market panic, bring disturbances to the bond market, and even spill over to the capital market.In the short term, the liquidity pressure of municipal bonds is stillBecause 2023-2026 corresponds to the cycle of bond market expansion, with the concentrated maturity of debts, the amount of maturing debts each year is not low.

The second is the risk of deterioration in the balance sheet of urban investment assets due to the prosperity of the land market.Although all parties have repeatedly made it clear that municipal investment debt is not local government debt, against the backdrop of an "asset shortage," the strong "belief in municipal investment" will be difficult to break in the short term.

Debt reduction measures

First, provincial-level supervisors should clarify the management responsibilities of governments at all levels.

Municipal investment bonds may not be government bonds, but the purpose of establishing municipal investment bonds is to finance urban construction and carry out investment and financing management on behalf of the government, so the management responsibilities of local governments must be clarified.

The entity responsible for debt repayment can be the central government or provincial government, but it should preferably not be a municipal or county government.On the premise of insisting that the province bears overall responsibility, we must also be more refined and gradually establish a more accurate debt risk monitoring and prevention mechanism based on cities, districts and counties.

Second, strengthen policy coordination and further improve liquidity management.

Looking back at previous financial crises, the most direct cause of financial crises is unexpected debt defaults. When market confidence is fragile, both standardized and non-standard debts must be properly managed for liquidity.

The stock of municipal investment bonds accounts for about 30% of the total stock of the credit bond market. The default of municipal investment credit bonds will not only worsen regional credit risks, but may also be transmitted to the entire municipal investment credit bond market.

We have "special refinancing bonds", "contingent liquidity financial vehicles (SPV)", "bailout funds" and "debt conversion funds", but due to information, rights and responsibilities and other issues, when repayment risks are expected to occur, there are often problems such as untimely response, difficulty in obtaining liquidity tools, and high cost of bailout funds.

Third, establish debt limit redistribution, capital budget and debt budget systems.

Replacing high-interest, relatively short-term municipal investment debts with low-interest, long-term local government bonds will help reduce the scale of local hidden debts, alleviate the pressure on municipal investment companies to repay debts and pay interest, and narrow the repayment gap.

However, special refinancing bonds are mainly used to replace implicit debts, which will increase the balance of local government debt, and the scale of issuance is limited by regional debt limits.

This poses a problem: regions with larger remaining debt limits are mostly those with better economic development and relatively lower debt ratios, while regions with heavy debt repayment pressure and stronger demand for debt replacement may not have much remaining available limit.

Therefore, the central government needs to establish a debt limit redistribution mechanism, capital budget and debt budget system.

Fourth, improve corporate governance and enhance the asset-liability management capabilities and transparency of urban investment companies.

On the one hand, the financing function of urban investment companies must be stripped away. For government projects and special bond projects undertaken by urban investment companies, it is necessary to clarify whether they are investments or construction, and how the rights, responsibilities and debts are divided.

On the other hand, we need to improve the company system of urban investment companies, including independent directors. The idea of ​​hiring private entrepreneurs as independent directors, as mentioned in the market, can also be explored.

Fifth, clarify the rights and responsibilities of local governments and urban investment companies in assets and debts.

In most projects, the urban investment company either acts as the construction entity or the investment entity. In this case, the rights, responsibilities and obligations of the government and the urban investment company are relatively clear.

However, in some projects, the division of debt responsibilities between the municipal investment and government is not clear, which will affect the accuracy of the municipal investment balance sheet. In addition, when local governments use special refinancing bonds to replace existing debts, the debt relationship between local governments and municipal investment also needs to be clarified.

For example, when the government issues bonds, funds flow into urban investment companies. From the government's perspective, this is a change from implicit debt to explicit debt.

But from the perspective of enterprises, is the money from the government to the enterprises capital injection? Subsidy? Or is it a loan from the municipal investment company to the government? Will the municipal investment company repay it in the future? If the municipal investment company uses its own assets or funds to repay the debt owed to the public welfare project, will the government need to repay the enterprise in the future?

If the rights and responsibilities between local governments and urban investment companies are not clearly defined, it will be difficult to separate government and business, and even more difficult to break the "belief in urban investment companies."

Sixth, the transformation of urban investment companies should be adapted to local conditions, to the conditions of each enterprise, and to each enterprise’s own policy.

Each place has different resource endowments, and each municipal investment company has different asset-liability situations, business models, and areas of expertise, so the direction of transformation is naturally different.

For some small and medium-sized urban investment companies in counties and districts with a net outflow of population, can they also consider suspending interest and keeping their accounts payable? Higher-level units, policy banks or asset disposal agencies can intervene and work with local governments to study and explore closures, shutdowns and transfers?

In short, the transformation of urban investment companies needs to be based on their own actual conditions, and the support of local governments should also be based on actual conditions.

Summarize

Debt itself is not a risk. The key is whether the use of debt can form high-quality assets and stable cash flow, whether the debt maturity structure matches the cash flow, and whether the debt expenditure structure and utilization efficiency match.

Taking into account the downward pressure on the economy, when resolving the debt risks of municipal investment companies, it is particularly important to note that what is being resolved is debt risk. The debt scale is a component of debt risk, but debt risk is not equal to debt scale. Efforts should be made to avoid a strong contraction effect caused by a too rapid reduction in the scale of municipal investment debt when the decline in government fund revenue and expenditure drags down the growth rate of fiscal expenditure.

In the long run, both macroeconomic issues and municipal debt problems must be answered through in-depth reform.

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No.5824 Original first article | Author Jia Ming

About the author: Young economist. His research areas are behavioral and experimental economics, focusing on macroeconomics, political economy, and international relations.‍‍‍‍‍‍

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