Legislators halted plans on Tuesday to allow local governments to issue bonds directly, as policymakers increase their scrutiny of regional debt risks and call for improved fiscal management at the local level.

The latest revision to the Budget Law removes a clause, introduced in a previous draft amendment in November, which would have allowed local authorities to sell bonds directly within an approved quota.

Instead, local governments are forbidden from issuing bonds unless otherwise regulated by the law and the State Council. The central government will continue to sell bonds on their behalf.

“Considering the rapidly growing scale of local debt, attention must be paid to the accompanying problems and potential risks,” said Hong Hu, deputy director of the Law Committee of the National People’s Congress.

“Direct bond issues by local governments still lack transparency and proper monitoring, and declining revenue is threatening their debt repayment abilities,” said a statement from the NPC.

Figures from the National Audit Office showed local debt of 10.7 trillion yuan ($1.68 trillion) by the end of 2010, in which local governments are responsible for 70 percent of the debt repayment.

In 2009, the Ministry of Finance started issuing bonds on behalf of local governments, and the budget for this year will be 250 billion yuan. But as the debt repayment was still guaranteed by the Finance Ministry, it is considered to be similar to national debt.

Ye Yanfei, deputy head of the statistics department of the China Banking Regulatory Commission, said the new move will barely affect the repayment of current loans made to local governments through financing vehicles.

“It only restricted governments’ bond issuance in the open market and didn’t block other channels for them to collect capital. In addition, repayment of all these loans currently relies mostly on projected revenue instead of local government debt.”

In the long term, however, the change might affect the repayment of loans. People previously expected that using money collected through bond issuances could prevent defaults of such loans, he told China Daily.

“The new order made it clear that the governments must try their best to reduce their liabilities and thus balance their budgets, which means they must not only reduce bond issuances, but also reduce indirect borrowing from commercial lenders,” Ye added.

However, some experts expressed concern that the cancellation of direct debt issuance will put local authorities under greater financial strain.

Jia Kang, director of the Finance Ministry’s Fiscal Science Research Center, said the move does not reflect the actual requirements under current economic conditions.

“It is imperative to open the bond market to local governments as a proper financing channel. It is also a chance to prevent further hidden debt and prevent risks,” Jia wrote on his micro blog.

But now that the door is closed, local governments will face increasing fiscal constraints from decreasing land sale revenues and increasing expenditures on people’s livelihoods, said Xiang Songzuo, chief economist of Agricultural Bank of China Ltd.

“Expanding financing channels for local governments and letting them be responsible for their own debt repayments is a basic direction of China’s fiscal reform, and that should not be changed,” Xiang said.

Xiang suggested that more developed areas such as Beijing and Shanghai should be allowed to directly issue bonds.

China’s outstanding external debt totaled more than $751 billion by the end of March, the highest amount since 1985, adding to concerns over whether rising external debt may undermine China’s fiscal position and cause it economic harm.

According to data released on Tuesday by the State Administration of Foreign Exchange, its total debt increased 8.1 percent from $695 billion three months earlier. The proportion of short-term debt rose to a record high of 74 percent, well above the international alert level of 25 percent.

SAFE said the increase in short-term debt is closely related to the rapid development of China’s foreign trade.

“The ratio of short-term debt to foreign exchange reserves stood at 15.75 percent, far below the globally recognized warning line of 100 percent,” it said in March.

By Wei Tian and Wang Xiaotian