C&B Notes

China’s Backdoor Bailout of Local Governments

As has been well-documented, China’s debt (particularly bank loans) has exploded since 2008 as China eased lending restrictions and promoted infrastructure and real estate projects to stimulate the economy.  This debt largely ended up on local government balance sheets, which are struggling under the strain of failed projects and a lack of cash flow available to service the debt.  What was originally local indebtedness is becoming a national balance sheet burden.

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 recapitalize the provinces after years of unsustainable borrowing and investment…

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 characterize 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.