Local Government Bonds: An Update and Frequently Asked Questions

Our analysis of China’s local government bonds published on June 16 has generated a number of questions from clients and the policy community. In this follow-up note, we address the most frequent inquiries we have received, and update our dataset of local government bond issuance through early July. Based on our expectations for how placement bonds should be reflected in TSF totals, aggregate loan growth in June should be in line with or slightly stronger than May levels, since placement bond issuance fell marginally last month.

Posted August 1, 2017
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A Closer Look at China’s Local Government Bonds

China’s financial reforms are often confusing, even for seasoned observers of the system. Nothing in recent years, however, has topped the complexity and consequent misunderstanding associated with China’s local debt restructuring and refinancing plans. Original Ministry of Finance-led plans to cap China’s local government debt in late 2014 gave way to a compromise to permit limited volumes of provincial bond issuance to refinance maturing debt. As the economy continued flagging, expansion of local bond issuance volumes was permitted, rising over 6.8 trillion yuan since May 2015. As is typical of any rapid fundraising effort, there has been little clarity provided on the uses of these bond proceeds at the local level.

To provide additional perspective on this important debt restructuring and refinancing effort, we analyzed all 1,525 local government bond issues reported since the inception of this program, and sorted them by province. This note summarizes our findings and implications for China’s credit growth, fiscal position, and the aggregate impact on debt restructuring for China’s localities.

Key insights include:

Debt replacement limited: Only around 24% of local government bonds are directly replacing older legacy local government debt. These “placement” issues only totaled 792 billion yuan in 2015 and 831 billion yuan so far in 2016. Loan levels, or aggregate total social financing (TSF) levels, should be adjusted higher by these volumes when computing total credit growth. The remainder of the bond issues should probably be considered a form of on-budget fiscal expansion.

Provincial distinctions matter: There are widespread provincial disparities in bond issuance, which do not necessarily correspond to past credit expansion. Many provinces appear to be using local government bonds to fund new investment rather than refinancing legacy debt.

Stock of local debt still needs to fall: Most of the refinancing benefits from local bond issuance have already been overwhelmed by the expansion of credit in 1Q 2016. As a result, there is no substitute for more active recapitalization efforts for banks and slower, more sustainable credit growth.

Posted August 1, 2017
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Q2 2016 China Macro Data Recap

On the surface, China’s Q2 macroeconomic data revealed remarkably few changes in the economy from earlier this year, with GDP growth unchanged at 6.7% y/y. Warranting a closer look, in our view, are the outsized contributions of financial services and real estate to China’s economic output, as well as the decelerating credit impulse provided by China’s banks, which suggests weaker activity growth ahead in the second half.  We also evaluate some surprising data releases, including China’s $13.4 billion increase in its foreign exchange reserves in June despite market pressure for the currency to depreciate, as well as the sharp divergence of state-led and private sector investment trends in 2016.

Posted August 1, 2017
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