China lets local governments sell bonds for the first time


China said it will let 10 local governments sell municipal bonds in an experiment to straighten out messy state budgets, a watershed move that would start the clean-up of the country's $3 trillion public debt problem.

The finance ministry said the governments in Shanghai, Zhejiang, Guangdong, Shenzhen, Jiangsu, Shandong, Beijing, Qingdao, Ningxia and Jiangxi will be part of a pilot program that allows officials to sell and repay their own debt.

Getty Images

In an earlier financial reform framework announced by the National Development and Reform Commission, municipal bonds were included as part of reform plans. Wednesday's announcement is the first detailed plan for implementing the program.

Read MoreWhy bonds are important to watch this week

This is a significant break from the past as under China's current laws, local governments are prohibited from borrowing from any parties.

Yet, the law has been ineffective in containing public debt levels as officials have skirted the rules by creating opaque financing vehicles that borrow on their behalf. A government audit published in December showed Chinese governments owe a total of $3 trillion.

Many experts say the only long-term solution to China's government debt problem is the creation of an active municipal bond market, a recommendation that Beijing appears to be taking on board.

What was behind China's bond auction failure?

The finance ministry said in statement on its website that local governments involved in this experiment would be responsible for repaying their own debt. This is unlike in the past when the ministry would sell bonds on behalf of local governments and was thus also responsible for repayments.

The value of bonds that can be sold must be within an annual limit decided by China's cabinet, the ministry said. Any government that fails to sell as many bonds as it is allowed to in a year cannot carry their unused quotas into the next year.

Read MoreEuropean bonds signaling trouble?

For 2014, China has said that local governments can sell 400 billion yuan worth of bonds, so the value of municipal bonds that the 10 governments can sell under this experiment is expected to count towards the 400 billion yuan limit.

The municipal bonds, which can either be sold via auctions or be underwritten by banks, must have maturities of five, seven and 10 years and sold in the proportion of 40 percent, 30 percent and 30 percent, respectively.

Further, local government bonds must be rated by ratings agencies and the prices of central government bonds must be used as the benchmark when pricing municipal bonds.

Read MoreFive bond marketrisks to worry about: Pimco

The launch of this new bond experiment comes at a time when China is trying to revise its budget law to allow governments to sell bonds. But the process, which has been frustrated in the past by fiscal conservatives who blocked any changes, is expected to be a long one.