Giving credit where it's due in the debt market

Another problem for credit rating firms is local governments' reluctance to share information. In some cases, the larger domestic credit rating agencies such as Dagong have declined to provide ratings when they couldn't get the required data from prospective issuers.

Another major rater, China Chengxin International Credit Rating Co Ltd. (CCXI), an affiliate of Moody's Investors Service Inc, has said it has "less share" of the government-related bond business.

"We are more conservative towards this sector," said CCXI President Ma Li.

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The heated competition means that national regulations covering the credit ratings market are crucial, said Liu Qiao, a finance professor at the Guanghua Management School of Peking University.

Liu said that in addition to the private sector, the academic community should be involved in drawing up criteria for ratings.

Liu's research team has devised a framework to gauge local governments' repayment ability and tested it with seven cities so far. But he also acknowledged the difficulty of finding cities that are willing to share information.

Despite initiatives from the private sector and academia, experts said it's still critical to have a "top-level design", making information disclosure mandatory for local governments.

The Ministry of Finance annual work report indicated that "institutional design" is already on the government's agenda.

The report discussed a series of related reforms, such as increasing budgetary transparency by requiring comprehensive reporting and disclosure of all revenue and expenditures; fiscal plans spanning several years, including three-year projections; introduction of accrual accounting and reporting of local government debt in budgets.

For example, accrual accounting, as an alternative to cash accounting, measures the performance and position of a corporate or government entity. Accrual accounting recognizes economic events regardless of when cash transactions occur. So when a government signs a contract with a developer, for example, the value is classified as a liability of the government, even though it hasn't yet made any cash payment.

These reforms, analysts said, are crucial to strengthening the fiscal prudence of local governments, whose true liability positions will be immediately exposed to higher authorities, acting as a bar to lavish spending by local officials who leave the debts to their successors.

But these reforms take time to materialize, and consistency is a problem because there are various rating standards practiced now, people familiar with the matter said.

Guan Jianzhong, chairman of Dagong, suggested that taking a laissez-faire approach to credit ratings can't work, because it will create a conflict of interest: Governments will choose firms that give them high ratings.

"A possible solution is to let the Finance Ministry pay (ratings fees) for local governments. Two or three firms could be introduced to conduct ratings.

"Most important, certain criteria should be adopted to limit the number of participants," Guan said.