BEIJING, Oct. 11 -- China's reform focus has recently shifted to fiscal reform, with particular focus on the containment of local government debt.

The State Council, on Wednesday, released a decision on reform of the budget management system, following the Budget Law revision on Aug. 31 and a State Council proposal on strengthening local government debt management on Oct. 2. On June 30, the government passed a plan to deepen fiscal reform that outlined the path of fiscal reform for the coming years.

The June plan cited three major areas of concern: better budget management, a rejigged tax system and alignment of fiscal spending with fiscal responsibilities.

"Under the new Budget Law, provincial governments will be able to issue municipal bonds, subject to limits set by the central government," said Zhu Haibin, J.P. Morgan China chief economist, on Saturday. "The new rules will reduce the investment role of local governments."

Local governments will no longer be involved in commercial projects--most notably commercial real estate--and existing projects will be sold off with the debt converted into corporate debt.

Cooperation between the government and private investors via public-private partnerships or franchises will finance some public projects in areas such as infrastructure, water supplies and water disposal.

Those public projects which have difficulty attracting private investment may be financed through local government bonds. It is clearly stated that local governments are no longer allowed to raise debt via corporate or financing platform entities.

Funding sources for local governments will change dramatically. Shadow banks and corporate bonds are out: local government bonds are in, for both existing and new debt. This will immediately cure the maturity mismatch risk for local government debt, as local government debt has a longer maturity. The interest burden will also be reduced: Yields on municipal bonds are close to treasury yields and much lower than bank lending rates or trust yields. In the long run, this could strengthen market discipline for local government borrowing, as municipal bonds tend to have stricter requirements on disclosure of fiscal balance sheets and monitoring than shadow banks.

In the new regime, debt will be a major factor in assessing local government performance. Local governments will be required to monitor new debt, debt ratios, liability ratios and overdue debt.

These measures could help contain fiscal risk and narrow the distorted incentives for local government officials, who once believed that growth was to their personal credit, but debt was a problem for their successor.