China Considers Doubling Its Local Bond-Swap Program

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Chinese policy makers are considering plans to as much as double the size of a clean-up program for shaky local government finances, according to people familiar with the discussions.

In what would be the second stage of the program, a further 500 billion yuan ($81 billion) to 1 trillion yuan of local-government loans would be authorized to be swapped into bonds issued by provinces and cities, the people said, asking not to be named because the talks are private. The first stage of the bond swap, currently under way, is 1 trillion yuan.

An expansion would signal officials are confident in the template they’ve crafted for reducing risks from a record surge in borrowing that local authorities took on to fund a glut of investment projects. The complex process -- which includes inducements for banks to buy new, longer-maturity, lower yielding bonds -- is alleviating a funding crunch among provinces that had threatened to deepen the economy’s slowdown.

“It’s solving the cash-flow issue at the local governments and ensuring that infrastructure projects this year aren’t delayed,” said Nicholas Zhu, a Beijing-based senior analyst at Moody’s Investors Service, referring to the initial 1 trillion-yuan program. He said any additional quota probably would be for debt swaps in 2016.

Stocks Gain

Chinese stocks extended gains after the news, with the Shanghai Composite Index up 4.7 percent. The yield on 10-year government bonds rose for a sixth day as demand for sovereign notes has been hurt by the increase in municipal debt issuance.

Attempts at a fiscal fix coincide with monetary easing that has seen the central bank lower benchmark interest rates, cut the amount of deposits banks need to set aside as reserves, reduce money-market rates and inject cash directly to selected lenders. In the latest step, People’s Bank of China recently pledged supplementary lending to some banks, Reuters reported Monday, citing unidentified people.

Jiangsu province delayed a note sale in April, raising concern there wouldn’t be sufficient demand. Since banks, the main potential buyers, were allowed to use such notes as collateral at the central bank, the sales have been smooth. Shandong on Friday sold 10-year notes at close to yields on sovereign debt and Jiangsu on Monday sold bonds in private placements.

“The initial success of the first batches of bonds, especially the lower-than-expected yields, may have encouraged the Finance Ministry to expand the swap,” said Ding Shuang, chief China economist at Standard Chartered Plc in Hong Kong. “Additional swaps, if confirmed, can show China’s handling of the local government debt problem will be faster than previous expectations.”

Possible Expansion

The up-sized plan needs State Council approval, according to the people. The Finance Ministry didn’t immediately respond to a faxed request for comment. Finance Minister Lou Jiwei had previously said that the swap program could be expanded.

Lou is grappling with ways to rein in local governments’ largess without accelerating an economic slowdown.

A 1994 law banned regional authorities from issuing bonds directly, spurring the birth of thousands of local government financing vehicles to fund infrastructure projects. The LGFVs typically used state-owned resources and assets such as land as collateral to set up companies that allowed provinces to borrow from banks.

Local-government obligations may have reached 25 trillion yuan, bigger than the size of the German economy, according to estimates from Mizuho Securities Asia Ltd. That compares with the figure of 17.9 trillion yuan as of June 30, 2013 given by the National Audit Office.

Fiscal Transition

Lou initiated a crackdown last year on the off-balance-sheet financing, plans that collided with the economy’s slowdown and a new imperative set by President Xi Jinping to shore up the economy amid a weakening job market.

“The timetable of fiscal transition was too aggressive, and the economic slowdown has been faster than expected, so the government relaxed its rules,” said Zhu at Moody’s.

By reducing debt-servicing costs for local authorities, policy makers are helping them sustain spending that’s crucial to shoring up growth. A gauge of manufacturing today suggested that the fiscal loosening, along with monetary easing by the central bank, has helped arrest a deterioration.

“Beijing does not want to push the investment vehicles to the default corner, so something has to be done,” said Tao Dong, chief regional economist for Asia excluding Japan at Credit Suisse Group AG in Hong Kong. “The debt-swap scheme is an innovative policy. It probably can manage to kick the can down the road.”

— With assistance by Steven Yang

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