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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