China’s local governments are accelerating the pace of borrowing for infrastructure investment, a move that could help lift economic growth while also putting pressure on financial markets.
(Bloomberg) — China’s local governments are accelerating the pace of borrowing for infrastructure investment, a move that could help lift economic growth while also putting pressure on financial markets.
Provincial governments sold the most amount of special bonds in more than a year this month, according to Bloomberg calculations. And with Beijing setting a September deadline for the regions to issue their remaining allocation for the year, analysts are expecting a boost to debt supply next month.
That, in turn, would result in a possible liquidity squeeze and prompt the need for more monetary policy easing steps.
Local governments have issued nearly 520 billion yuan ($71.4 billion) worth of special bonds, which are mainly used to finance infrastructure projects, in August. That’s more than double the amount sold in the previous month and is the highest since a record 1.36 trillion yuan in June 2022.
After a relatively slow start, provinces are now heeding a call made by China’s top leaders at a key July meeting to speed up bond issuance and make use of the funds raised. Beijing is betting that an increase in infrastructure investment would help offset the plunge in property and private business investment, bolstering economic growth.
Liquidity is tightening as banks mop up the notes, putting pressure on the People’s Bank of China to increase cash in the financial system, either by cutting banks’ reserve requirement ratio or interest rates, according to analysts.
“Monetary policy usually coordinates with spikes in local bond issuance to maintain stable interbank liquidity,” said Zhou Guannan, an analyst with Huachuang Securities Co. With even more local bonds likely to be issued in September, another RRR reduction to offset the impact on liquidity can’t be ruled out, she said.
The tighter liquidity has already contributed to a selloff in one-year sovereign bonds, with yields rising 20 basis points from this month’s low. Money markets are also reflecting the stress, with the seven-day repo rate at more than 40 basis points above the equivalent policy rate — that’s the biggest gap since 2021.
Finance Minister Liu Kun said Monday local governments aim to issue all of this year’s 3.8 trillion yuan quota of new special local bonds by the end of September, vowing to “reasonably accelerate” fiscal spending in the coming months.
That means provinces need to sell about 700 to 800 billion yuan worth of the notes in September, according to Bloomberg calculations based on debt sold so far this year.
Debt-Swap Bonds
Aside from those plans, Beijing is also considering allowing local governments to sell bonds to help repay off balance-sheet debt, much of which is owed by their financing vehicles. Bloomberg News previously reported that provinces will be allowed to tap unused quota from previous years to raise about 1 trillion yuan in 2023 for a swap.
Standard Chartered Plc. analysts forecast the size of the debt-bond swap may be even bigger, possibly in a range of 1.44-2.59 trillion yuan. If it hits the high end of the range, monthly net issuance would be 87% higher than the average seen in the first eight months of 2023, analysts including Becky Liu wrote in a note Tuesday.
That “may lead to some indigestion” in the markets, they said. The PBOC is likely to cut the RRR to “alleviate liquidity pressures if needed,” they added, although a reduction in the central bank’s one-year policy rate will likely only happen in the fourth quarter.
The PBOC has lowered that one-year medium-term lending facility rate twice this year, most recently a surprise reduction earlier in August.
After raising the funds, local governments will need to find quality infrastructure projects to invest in, something that’s become more challenging in recent years as urbanization in China increased.
In a recent survey by Guosheng Securities Co., a combined 70% of credit managers at banks said they observed the infrastructure project pipeline was unchanged or fell slightly in the third quarter from a year ago, and another 15% said the reserve contracted sharply, the brokerage’s analysts including Yang Yewei wrote in a Monday note.
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