Municipal debt will hinder financial reform in China

Subject

China's local government debt bailout.

Significance

China's local governments issued 734 billion renminbi (118 billion dollars) last month, accounting for some 35% of total bond issuance. A 1-trillion-renminbi local government debt-swap programme was introduced in March, under a pilot initiative announced in August 2014, and expanded last month by another 1 trillion renminbi. A slowdown in investment and an increasing use of bank loans by local governments to roll over debt may now have forced the central government to act boldly.

Impacts

• Falling fiscal revenues, policy targets and the legacy of the 2008-09 fiscal stimulus will increase the supply of municipal bonds.
• State-owned commercial banks under the direction of the PBoC will mop up excess supply.
• Slower investment and lending puts pressure on central government to accelerate infrastructure investment and public-private partnerships.
• The PBoC will further adjust bank reserve ratios downwards if the slowdown in investment persists.
• Shifting away from short-term loan financing will shrink bank margins and slow down interest rate reform.