Strengthening Subnational Debt Financing and Managing Risks

The Chinese budget law prevents
subnational governments from borrowing. However, Subnational
Governments (SNG) borrows indirectly off-budget, through
Urban Development and Investment Corporations (UDIC). There
are various estimates on the off-budget liabilities, with
one estimate having the liabilities at more than 30 percent
of Gross Domestic Product (GDP). This paper provides a
discussion of more reform options for China, anchored with
cross-country experiences and lessons. The way forward is to
develop regulatory frameworks that can expand SNG and UDIC
market access and debt financing, while strengthening
subnational fiscal discipline, managing default risks,
promoting capital market development, and supporting
macroeconomic management and a stable financial system. The
paper is organized as: section two presents fiscal rules and
framework - ex ante regulations for subnational debt issuing
and procedures. Section three discusses what to do when a
subnational government becomes insolvent - ex post system.
Section four is devoted to developing regulatory frameworks
for UDIC, which may require a debt restructuring system
different from a system for direct debt of SNG. Ex post debt
restructuring for UDIC may also differ from the existing
bankruptcy code in China for corporations due to the
fundamental difference between a public entity and a private
corporation. Section five focuses on strengthening debt
management capacity of SNG particularly with respect to
liquidity and refinancing risks. Section six focuses on
managing fiscal risks of land financing, given its prevalent
use in China. Section seven discusses the development of a
competitive and diversified subnational debt market. Section
eight concludes with suggested reform options.