MNI: PBOC Eyes CNY1 Tln Liquidity Tool For Local Gov't Debt

The People’s Bank of China is considering a new tool to provide at least CNY1 trillion in liquidity for lenders to roll over or swap debt raised by local-government funding vehicles, which have become a potential source of financial-system instability, policy advisors and bank officials told MNI.

Chinese policymakers have accelerated plans to derisk local-government debt since a call for action at July’s Politburo meeting, with 26 provinces announcing plans to issue CNY1.26 trillion in refinancing bonds, amid speculation that the Ministry of Finance will provide a quota for debt swaps, prompting short-term LGFV bond prices to surge. (See MNI: China To Launch Debt Swaps To Address Implicit Liabilities)

This month’s announcement by PBOC Governor Pan Gongsheng of preparations for emergency liquidity lending to local governments could herald a new debt-disposal tool, such as a special purpose vehicle to purchase a portion of the swapped or extended debt, or a relending facility similar to those offering funding to small businesses and property projects at 1.75%, an advisor told MNI.

RISKY DEBT

LGFVs have expanded rapidly since their creation in 2009 to finance infrastructure, but local governments’ ability to repay the off-balance sheet debt has weakened as revenue from land sales has declined. LGFV debt totalled over CNY50 trillion at the end of 2022, with CNY3 trillion of bonds set to mature annually from 2024-2026, according to China Chengxin Credit Rating Group,

An LGFV analyst told MNI that bank loans account for about 70% of the debt and that lenders also hold most of the CNY14 trillion in bonds, a driving factor behind the central bank’s sense of urgency to “dispose of the bomb.”

A special tool would allow lenders to extend short-term, high-interest LGFV debt into longer-term cheap loans, to buy the newly issued low-yield bonds and to swap the maturing liabilities with other banks, the analyst said, noting that some state-owned institutions have already started the process.

State-owned lenders have in some cases provided new 20-year loans at 4.5% to swap maturing debt incuding shadow-banking credit at 6%, an official at a commercial bank said. However, he warned that this process would hurt lenders’ profits, worsen asset quality and pressure already insufficient capital. Small banks could face significant risk should they participate in the debt restructurings, the official cautioned.

FINAL FEAST

The rally in short-term LGFV bond prices has also been supported by a recent unpublished State Council order for a dozen local governments not to default on the instruments before the end of 2024, and for large banks to help, including the debt raised via shadow banking channels, the analyst said.

The bank official confirmed the order and said top policymakers insisted on a market-orientated process to avoid adding pressure to lenders, noting that the restructuring could bring fresh risks if made too aggressively by the local governments.

The advisor warned the rally in LGFV debt is set to stall, as it becomes clearer that officials aim to prevent risk and curb the creation of new hidden debt. This will mean stricter control of LGFVs, and eventually their full exposure to market mechanisms, prompting a sharp drop in returns on the instruments, he said. (See MNI: China To Tighten Grip On Finance Despite Deleverage Shift)