A DRAFT document circulated by China’s Ministry of Finance on local government debt proposes letting them issue bonds to replace borrowings taken through opaque financing vehicles, according to people who have seen the draft.

    If such issuance were to be allowed, it could require a massive expansion of the country’s fledgling municipal bond market.

    Regulators are struggling to manage a massive US$3 trillion in outstanding local government debt, much of it raised by local government financial vehicles (LGFVs) to finance infrastructure and real estate projects.

    This lending was originally encouraged by the Central Government to stimulate the economy and offset the impact of the 2008/2009 global financial crisis.

    Earlier this month, China cut local governments’ ability to use LGFVs for future fundraising, as these have been since widely criticized for facilitating a rash of irresponsible borrowing and investment that now is a drag on growth.

    Two people with direct knowledge of the draft document said that the Central Government wants to precisely measure the amount of local government debt currently outstanding, classify it, and assign responsibility for it to appropriate government bodies.

    The draft is not yet policy but has been distributed to officials to seek opinions. Formal rules are expected to be published in a few months, the people familiar with it said.

    The draft says local governments will be permitted to issue U.S. style-municipal bonds to replace existing debt, among other repayment channels.

    China’s current quota for the muni bond market remains extremely small at 109.2 billion yuan (US$17.84 billion) for all of 2014.

    The Ministry of Finance said in the draft that it aims to publish official rules on how to clear local government debt off the books by the end of 2014, the sources knowledgeable about it said.

    According to the sources, the draft says local finance bureaus must report their debt to the ministry before Jan. 1, 2015, together with estimates of their ability to repay and their plans for doing so.

    The draft proposes a grace period, during which time local governments will be permitted to use existing channels to raise money to fund projects under construction. (SD-Agencies)