China mulls plan to boost demand for local government debt
China’s central bank is considering extraordinary measures to boost credit flows to heavily indebted local governments, according to local media reports, as Beijing struggles to recapitalise the provinces after years of unsustainable borrowing and investment.
China’s local debt has surged since the 2008 financial crisis as regional governments borrowed to finance infrastructure projects in an effort to stimulate the economy. Economists have warned the debt poses a risk to the banking system.
China’s economy is growing at its slowest pace in six years, according to official figures. Policy makers want to enable local governments to maintain infrastructure spending to cushion the impact from a slowdown in the property and manufacturing sectors.
Some stock investors and media outlets have interpreted the bank’s plan to try to increase demand for cash-strapped local governments’ debt — by accepting it as collateral for loans to commercial lenders — as a form of quantitative easing.
However, economists say it is better understood as a targeted measure to boost credit flows to local governments struggling to refinance Rmb1.9tn in debt due to mature this year.
“From the details we know it’s probably wrong to characterise this as quantitative easing. It’s tempting to think that China would join everybody else, but the reality is that the Chinese central bank seems to be concerned about banks’ reluctance to buy local government bonds,” said Frederic Neumann, co-chief Asia economist for HSBC.
China’s finance ministry last month announced a plan for provincial governments to refinance Rmb1tn in maturing debt by selling bonds. The goal is to lower debt-servicing costs and extend maturities by converting short-term, high-interest bank loans to low-interest, long-term municipal bonds.
But this month at least two Chinese provinces were forced to postpone scheduled bond auctions due to insufficient demand from commercial banks. Allowing local bonds to be used as collateral would stoke demand for the paper.
Loans from China’s central bank to commercial banks would expand the People’s Bank of China’s balance sheet, increasing the base money supply.
But economists expect that increases in the money supply via the new PBoC lending facility would probably be offset by withdrawals via other tools such as reduced foreign exchange purchases, open market operations and the required reserve ratio.
Rather than quantitative easing, analysts say the programme is closer to the European Central Bank’s programme to provide cheap financing for banks under its “long-term refinancing operations”.
Under that programme, the ECB allowed banks to post even low-rated sovereign bonds from peripheral countries such as Italy and Portugal in exchange for loans of up to 36 months. But the ECB said it sterilised those extra liquidity injections through other channels, offsetting their impact on the overall money supply.
“This isn’t really about adding liquidity. It’s aimed at alleviating debt pressures on local governments and reducing financial risks,” said Zhang Bin, director of the global macroeconomy research department at the Chinese Academy of Social Sciences, a think-tank that advises the government.
Since February the PBoC has twice cut the amount of cash that banks must hold on reserve at the central bank. That increases funds available for lending and other investments.
The moves sent money market interest rates, which determine the cost of short-term borrowing for companies and banks, plunging. The benchmark seven-day repo rate closed at a 13-month low of 2.42 per cent on Monday, suggesting there is little need for further broad-based liquidity injections yet.
The People’s Bank of China did not respond to requests for comment on Tuesday.
Additional reporting by Ma Nan