“Cities and townships must give up their unorthodox borrowing.” –Bloomberg News 2-5-15

The only way for new financings nationally, and within cities, counties and townships will be mostly through bond markets.

Bonds are becoming rapidly out of favor. This window of finance is closing quickly and in some cases is closed and impossible for now.

Negative reflections from the international bond markets are smothering new offering chances for China. -Roger

“China’s economy has peaked on most all fronts and is now in a consolidation and sell-off mode. The government is straining mightily to cover the sinking numbers but more and more of them are popping to the surface in the media. GDP is still claimed at +7.5%, which is their public target number. It is difficult to estimate since so many measures of Chinese economics are hidden or exaggerated. I would suspect a fair number for 2015 will be near +3%. The numbers one can check that are difficult to manipulate are domestic electricity consumption, imports of energy products along with imported grain demands and iron ore.

Gold and silver numbers are impossible to discover. We did recently learn that domestic China gold sales for physical product were running +$50.00 above the USA paper markets’ prices.  China is number one in the world for mining gold and number two for silver. To our knowledge, export of precious metals is not permitted. The government has encouraged domestic retail consumers to buy and hold physical gold and silver for a secure and protective asset base. Meanwhile, the amount of general market imports into China is lower and Chinese internal domestic demand for many commercial products is falling.

The nation of Australia is under terrible duress right now as their country is highly dependent upon export of mining materials to China. They mostly import iron ore, lead, zinc, and some others. The huge Aussie iron ore producers have been exporting billions tons of material and these orders have fallen off drastically. – Roger

“Close the back door, open the front door.” That’s the official slogan used to describe China’s most ambitious reform of government finances in two decades, to be introduced later in 2015. The aim is to wean badly indebted local governments—tens of thousands of cities, counties, and townships—off their dangerous reliance on off-balance-sheet financing and backdoor borrowing, from both banks and the unregulated shadow finance sector. Funds to support China’s rapid urbanization—to build infrastructure, keep pension programs solvent, and more—will come from a vastly expanded, newly legalized local bond market. Roger: This is nearly impossible to control as 40% of ALL DOMESTIC CHINESE LOANS ARE OFF THE BOOKS IN BLACK MARKETS. THEY ARE UNTAXED AND FREQUENTLY OFFER VERY HIGH INTEREST RATES.

“The development of a local bond market … is a real milestone,” says Debra Roane, senior credit officer at Moody’s Investors Service. “Once local governments start issuing debt in their own name, it will be clear that they are responsible for it, and that will ultimately lead to more prudent decision- making. They will stay away from riskier projects.” Roger: Who is going to buy the local bond paper of these small villages, towns, counties, and cities? I doubt prudence is on their minds. They need the cash.

Ever since China’s last major fiscal reform in the mid-1990s, when then-Vice Premier Zhu Rongji restored control of public finances to the national government, local governments have faced a dilemma. They receive only about half of China’s total tax revenue, while they must pay for 80 percent of all government expenses, including schools, roads, and health care. The local governments are banned from borrowing directly from banks and from issuing bonds.

As a result, a vast, unregulated industry has sprung up in what many call local government finance vehicles. Some 10,000 of these for-profit finance companies raise funds for local needs. They also have enabled local authorities to commit acts of apparent folly. The finance companies, with the implicit backing of local governments, bankrolled entire new city districts that now sit largely empty. “This has led to a very opaque and risky situation, with unclear accountability,” Roane says. “It’s not clear who is responsible for all this debt.”

China’s officially stated deficit is about 2 percent of its gross domestic product. That’s a fiction, says Chen Long, China economist at researcher GavekalDragonomics in Beijing, because it doesn’t include any of this indirect local borrowing. Add it in and the deficit rises to about 5 percent of GDP, Chen estimates. The National Audit Office found that as of 18 months ago, local debt—including indirect borrowing—totaled 17.9 trillion Yuan ($2.86 trillion), up +63 percent since the end of 2010, much more than the 40 percent expansion of the economy.

“This has led to a very opaque and risky situation. … It’s not clear who is responsible for all this debt.”—Debra Roane, Moody’s

For all future infrastructure projects, local governments will have to split liabilities into separate categories. The first group will include true public welfare projects, important but not self-supporting, such as a school, bridge, or sewer system. These efforts will be formally recognized on local government balance sheets and funded through the new bond market, says Louis Kuijs, chief China economist at the Royal Bank of Scotland in Hong Kong.

Money borrowed to build commercial structures—hotels, office buildings, or high-end apartment towers—will be hived off and classified as corporate debt, Kuijs says. Policymakers also seek to draw private investment into a third category of revenue-producing public works, such as city water systems. China’s State Council has announced that promotions for local officials and bank officers will be tied to their efforts to control local debt.

In 2009 the Ministry of Finance started a small pilot program to see how a local bond market would fare. Its development has been tightly controlled, and yields haven’t been determined by the market. Buyers of the 1.2 trillion Yuan in bonds have been almost exclusively state-owned banks that hold these securities to maturity. “Local banks are owned by the local governments, so they can tell them to buy bonds. Because the amounts are so small, the banks have been willing to buy. But that’s not sustainable,” says Chen of GavekalDragonomics, who estimates the market must grow 10 times its present size to meet the needs of localities. “In the future, when they want to sell a lot more, then it will become much harder [to find buyers].”

The plan to end local reliance on indirect borrowing comes as cities and counties are increasingly cash-strapped. Amid a real estate slump, sales of land, a main source of local financing, contracted by -21.5 percent in the fourth quarter, a sharp reversal from the +40.3 percent growth in the first three months of 2014. If regulators do clamp down on the local government financing companies, cities and townships will face a severe fiscal crunch, hurting China’s already cooling economy.

“Later this year, when the slowdown hits its nadir, there will be backsliding,” predicts Andrew Polk, senior economist at the Conference Board’s China Center for Economics & Business. “They say they want to close the back door. Instead, they will probably close it a few inches but then have to reopen it.”  The bottom line: China may have to develop a robust local bond market to reduce cities’ reliance on indirect borrowing.” –Bloomberg News 2-5-15 Bloomberg.net Roger: China does not have the experience in managing a hard depression. The amount of debts both domestically and internationally is going out of control. I think China has produced a massive bubble and we all know how Bubblemania ends!