Municipal debt market takes big step forward

The Finance Ministry will set annual quotas for each government that can't be rolled over to subsequent years. The municipal bonds will be rated, with the 10 local governments to disclose basic information on the bonds, including their fiscal and economic conditions and indebtedness.

"This is still far from a genuine municipal bond market, because the quota, maturity and structure are still dictated by the central government," said Li.

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According to the Finance Ministry, 40 percent of the bonds will have a term of five years, 30 percent of seven years and the remaining 30 percent of 10 years.

Investors will probably demand higher yields because the local authorities will repay the debt themselves. But Li said it is still too early to make any further assumptions about pricing until the local governments hire underwriters to start selling the debt.

Separately, the nation's top economic planner, the National Development and Reform Commission, said in a statement on Tuesday that China will create a financing system for local governments under which municipal bond sales will be a "major" funding source.

Financing vehicles, which are set up to borrow on local governments' behalf to skirt laws that ban direct borrowing, will be phased out.

These changes in the bond market will provide new opportunities for credit rating agencies such as China Chengxin and Dagong Global Credit Rating Co Ltd.

Dagong Chairman Guan Jianzhong said that the government should limit competition in the ratings sector to avoid the "mistakes" Western ratings agencies made that contributed to the 2008 financial meltdown.

Those agencies have been criticized for underestimating the risks of many structured finance products such as mortgage-backed securities, in part because they were competing for business from issuers, which typically pay for the ratings.