China Announces $1.4 Trillion Program to Address Local Governments’ Hidden Debt

AsianFin -- China has announced a 10 trillion yuan ($1.4 trillion) program to refinance local government debt, as part of broader efforts to support a slowing economy and address new risks following Donald Trump's reelection.

The country will raise the local government debt ceiling to 35.52 trillion yuan, enabling the issuance of six trillion yuan in additional special bonds over the next three years to replace hidden debt. Authorities later confirmed that local governments would also have access to an additional four trillion yuan in special bond quotas over five years for the same purpose.

The plan, which was submitted by the State Council, China’s cabinet, and approved by the Standing Committee of the National People’s Congress on Friday, is in line with the higher end of economists' forecasts as China seeks to manage financial risks and support economic growth. This marks the first time since 2015 that the debt ceiling has been raised in the middle of the year.

China’s Finance Minister Lan Fo’an described the debt swap as a "major policy decision," taking into account both domestic and international developments, the need for stable economic and fiscal operations, and the actual conditions of local governments.

Following the announcement, the offshore yuan extended its losses, falling 0.6% to 7.1891 per dollar, while the yield on 10-year China government bonds dropped to its lowest point since September.

Lan estimated that the debt swap could save around 600 billion yuan in interest payments over the next five years, with the savings to be redirected towards boosting investment and consumption. As of the end of 2023, outstanding hidden debt stood at 14.3 trillion yuan.

In the third quarter, China’s economy grew by just 4.6%, the slowest pace since March of the previous year, raising concerns about Beijing's ability to meet its annual growth target of around 5%. The slowdown prompted policymakers to adopt more supportive measures, including interest rate cuts and support for the stock and real estate markets.

This shift in policy since late September sparked a historic rally in the stock market and led global banks like Goldman Sachs to raise their forecasts for China’s $18 trillion economy. However, Trump’s reelection victory has intensified calls for China to implement stronger policies to stimulate domestic demand, particularly in light of potential export declines due to his tariff threats.

Morgan Stanley economists have praised the move to address local governments’ hidden debt as a “critical” step to breaking a deflationary cycle and deemed it equally as important as direct demand stimulus. However, some analysts argue that fiscal measures aimed at boosting consumption would have a more immediate and direct impact on economic growth.

Initial signs suggest that the latest measures may be yielding results, with home sales showing their first increase of the year in October, alongside improvements in both the manufacturing and service sectors.

At last month’s press conference, Lan stressed the importance of addressing local government debt. Meanwhile, the parliamentary session has reviewed proposals to raise local governments' debt issuance limit, allowing for the restructuring of existing hidden debt.

Local governments have faced severe financial strain in recent years, as the real estate downturn has weakened a major revenue source, while pandemic-related expenditures for Covid-19 controls added further burdens.

According to an IMF report, China’s local government debt had already swelled to 22% of GDP by the end of 2019, significantly outpacing revenue growth needed to service that debt.