By Kevin Yao
BEIJING (Reuters) - A stand-off between China's central bank and finance ministry could delay the creation of a local government bond market, illustrating a potential roadblock to Beijing's broader reform agenda: bureaucratic turf wars.
Sources say the dispute is over who would manage fiscal deposits, including funds raised by local government bond sales in a reform the State Council this week said was a priority for 2014, and that it has implications for other fiscal reforms.
Currently the People's Bank of China manages most of central and local government deposits, which hit 3.7 trillion yuan (349.72 billion pounds) at the end of April, up 20 percent from a year ago.
A proposed revision of the budget law removes a clause that the central bank is the official manager of treasury funds and would give the finance ministry the power to control them, triggering an outcry from some lawmakers and academics.
The revised law, which was submitted to parliament in April but not approved, would also lift the ban on bond issuance by local governments.
"The parliament may hold another session soon, but my judgment is that the law won't be approved in the near term," said an influential economist who was involved in drafting the law and spoke on condition of anonymity.
"It's definitely unfavourable for China's economy if we don't allow local governments to issue bonds. But they can only do experiments before the budget law is revised."
Some lawmakers, including former vice central bank governor Wu Xiaoling, have said the revisions could make the government budget less transparent and fuel official corruption.
Sources familiar with the issue said parliament did not approve the law mainly because of the dispute between the PBOC and Ministry of Finance, which is pushing for the revisions.
For the PBOC, managing the deposits allows better control of money supply and improves policy efficiency. But that limits the ability of the finance ministry and local governments to use the funds.
To get around this, an estimated 60,000 "special fiscal accounts" have been set up, holding about 1.4 trillion yuan. The ministry issued a document last year to legalise such accounts, making the issue more complicated, the sources said.
There are signs of compromise between the central bank and finance ministry, the sources said, but passage of the law could still be dragged into the second half of 2014. Media have said the parliament could debate the revised law again in June.
Officials at both the central bank and finance ministry declined to comment on the issue over the phone, and questions sent via fax were not answered.
PILOT PROGRAMME
Analysts say a fully fledged municipal bond market is still some way off given China needs to reform its fiscal system.
Under a pilot programme, six local governments can sell bonds directly, but analysts say repayments are still handled by the central government and so carry implicit state guarantees.
On Wednesday, the Finance Ministry expanded the programme to another four governments, and made it clear local governments would be responsible for repaying their debts.
The ministry said on Thursday that the 10 local governments would sell a total of 109.2 billion yuan of bonds this year.
"This is part of market-based reforms, suggesting that we need to revise the budget law urgently because you cannot always conduct experiments," said Zhao Xijun, deputy head of the Finance and Securities Institute at Renmin University in Beijing and an advisor to the government.
"Fiscal reforms will help sort out the central government's spending obligations and give them more power on revenues, but the system will not be the same as in the West."
The ban on local government debt sales is meant to be a restraint on their borrowings, but they have got around the regulations by using local government financing vehicles (LGFV).
Official data shows local governments owe about $3 trillion (1.78 trillion pounds) - equivalent to a third of China's gross domestic product - much of it raised through financing vehicles.
The bond pilot is tiny compared to actual financing needs. The ministry has set a quota of 400 billion yuan for the programme in 2014, up from 350 billion yuan last year.
"They are unlikely to expand it to nationwide before the approval of the revised budget law," said Li Heng, an economist at Minsheng Securities in Beijing.
Beijing has pledged to improve budget management and have the central government assume more spending obligations, but on condition that local governments have more sustainable tax revenues and constraints on spending.
Slowing economic growth has cut into revenues, making it less likely that Beijing will take over spending obligations from local governments any time soon.
"Fiscal reforms in China are very difficult and face strong resistance," said a former central bank researcher who declined to be named.
(Editing by John Mair)