Chinese policymakers will soon announce the guidance for the local government debt-to-bond swap programme. According to the Bloomberg, the plan will suggest that a large portion of China’s debt-to-bond swap programme will be done by targeted private placements. That is, local government bonds (LGBs) will be sold directly to existing creditors, formal and shadow banks to retire existing local government debt they have claims on in the form of bank loans, corporate bonds and shadow banking credit. There will be a cap on LGB yields at 30% above the yields of central government bonds (CGBs). At the time of writing, the yield on 5-year CGBs is around 3.25%, and so the cap is about 4.2%, which is well above the current yields on outstanding LGBs. Also reported by the Bloomberg, the incentive to the biggest creditor – commercial banks – to accept debt restructuring will be that LGBs will qualify as collateral for the PBoC’s various new liquidity and relending programmes, including standing lending facilities (SLFs), mediumterm lending facilities (MLFs) and pledged supplementary lending (PSL). There is no quantitative easing. This incentive may not be enough given the large LGB supply (CNY 1.6trn) in the pipeline. At some point, RRR cuts will likely beneeded to free up commercial banks’ liquidity for bond purchases. Furthermore, policy banks, with some relending support from the PBoC, will probably be asked to play a critical role in stabilising the borrowing cost of government bonds as well.The restructuring will certainly help mitigate liquidity risk at local governments, but analysts do not think that it is a panacea for either growth or overall financial market risk. First, a lower interest burden does not necessary entail easier access to new funding, which depends on how strictly the central government implements other elements of fiscal reform. Second, CNY16trn of debt will reportedly be recognised as formal local government debt. That is much less than the market perception (at least CNY20trn), and credit risk may therefore actually rise on the unrecognised part.
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