Photographer: Tomohiro Ohsumi/Bloomberg

China Local Government Debt Surge Boosts Focus on PBOC Help

A surge in China’s local-government debt pile is drawing focus to the central bank’s role in avoiding a credit crunch as policy makers seek to develop a municipal-bond market.

Provincial authorities estimated they had 16 trillion yuan ($2.6 trillion) in liabilities in a review earlier this year, the China News Service said April 25, citing a Ministry of Finance official -- a 47 percent jump from June 2013.

With liquidity in the bond market being restrained by capital flowing out of China, a slowing economy and a booming stock market, the challenge for officials will be to ensure demand as they restructure local finances. The central bank is considering expanding its Pledged Supplementary Lending program in part to encourage banks to buy local government bonds, according to people familiar with the matter.

One of its new tools to boost liquidity, the PSL last year was used to channel credit to shantytown redevelopment. Other options for People’s Bank of China Governor Zhou Xiaochuan include broad monetary easing and direct purchases of municipal bonds in the secondary market.

‘Many Roles’

“Zhou Xiaochuan has always been a key figure promoting China’s municipal bond market,” said An Guojun, an associate professor with the Institute of Finance and Banking at the Chinese Academy of Social Sciences in Beijing. “The central bank has many roles to play in aspects of market infrastructure.”

An expansion of the PSL program would also help improve dilapidated housing and fund the “One Belt, One Road” project to invest in regional Asian infrastructure, said the people familiar with the matter, asking not to be named as the talks were private. Banks may be allowed to use more assets as collateral for PSL, including local-government bonds, they said.

Local governments are planning to sell more than 1.7 trillion yuan in municipal bonds this year, up from 400 billion yuan in 2014. Premier Li Keqiang’s government has turned to fostering a transparent municipal debt market as a more stable structure for provinces and cities than the off-balance sheet vehicles they expanded during a record credit boom from 2008.

Unconventional Policy

The PBOC is discussing adopting unconventional policies including making direct purchases of local government bonds from the market, Market News International reported Monday, citing unidentified people. Previous reports from the Wall Street Journal and Bloomberg News indicated officials were considering letting banks use the notes as collateral for loans from the central bank.

The PBOC and Ministry of Finance didn’t reply to faxes sent Monday seeking comment on plans to support the municipal bond market or upcoming sales.

Purchases of securities would expand the PBOC’s balance sheet, similar to how the U.S. Federal Reserve grew its assets in recent years as it took on mortgage securities in an effort to shore up the American housing market. While the PBOC isn’t allowed to buy government bonds at Ministry of Finance auctions, it can do so in the open market.

China’s interest-rate swaps declined to the lowest level since 2012 Monday on speculation of such help. Any measures would add to monetary easing that has included two interest-rate reductions and two cuts to bank’s required reserve ratios in the past six months.

Breaking Habits

In a bid to break regional governments’ habit of borrowing off their balance sheets, policy makers last month announced a program that will convert as much as 1 trillion yuan of such debt into municipal notes this year. Finance Minister Lou Jiwei said March 27 the limit may be expanded.

The increased provincial debt figure is “an indication of the scale of the debt burden, and the need for the debt-for-bond swap program to expand in order to ease the pressure on local government debt repayment,” said Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong.

In an initial stumble in the debt fix, Jiangsu province, which was to issue 64.8 billion yuan of general notes on April 23 to swap for debt maturing this year, has delayed its sale. Domestic corporate debt sales in China slumped 11.1 percent so far this year to 2.34 trillion yuan, according to data compiled by Bloomberg.

Capping Debt

China announced plans in October to cap the amount of debt local governments can take on, and said all borrowings by provinces and cities will need to be within a certain quota set by the State Council -- China’s cabinet -- and approved by the National People’s Congress -- its national legislature.

Including contingent liabilities, local governments had 17.9 trillion yuan of debt responsibilities in June 2013.

China’s total government, corporate and household debt load debt was $28 trillion as of mid-2014, according to McKinsey & Co. It’s equal to 282 percent of the country’s total annual economic output.

“Measures to contain the debt growth were not very effective,” said Shi Lei, a Beijing-based head of fixed-income research at Ping An Securities Co., a unit of China’s second-biggest insurer. “This is likely to prompt targeted supporting measures from the PBOC.”

— With assistance by Xin Zhou, and Helen Sun

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