State Council would set quota system on debt, but only under strict conditions

China may allow local governments to sell municipal bonds under narrow parameters in a move to regulate their borrowing and reduce systemic risk.

Qualified provincial-level governments that win approval from the State Council, the country's cabinet, will be able to raise some of the funds needed for construction projects through bonds, if a draft amendment to the Budget Law is approved by the top legislature.

The draft amendment, which was submitted on Monday to the National People's Congress Standing Committee, sets strict conditions for such debt issues.

The scale of any debt issue must be within the quotas approved by the NPC as well as local legislatures. Debt proposals will only be approved if there is a stable revenue stream to cover repayments, and proceeds of such issues can't be used for current expenditures.

Except under these conditions, local governments may not issue bonds or provide a guaranty to any institution or individual.

Officials found to be directly responsible for illegal bond issues will be dismissed, the draft said.

It's the first time for the nation to formulate explicit rules and supervisory principles for local government bond sales.

The current Budget Law, which is some two decades old, bars most debt issues by local governments.

But governments at all levels have managed to raise funds in recent years through bank loans or via local government financing vehicles to pay for a plethora of infrastructure projects.

A survey by the National Audit Office found that as of June 30, 2013, local government debt and contingent liabilities surged to about 17.89 trillion yuan ($2.9 trillion), a 67 percent rise from the previous estimate of 10.7 trillion yuan at the end of 2010.

Much of this debt, especially that raised through LGFVs, poses a systemic risk because of its opacity, said Liu Jianwen, head of the Fiscal and Economic Law Research Center at Peking University.