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Five Things to Know About China’s Unusual Sovereign Bond Issue

The Chinese government took a rare and unexpected decision in October to issue 1 trillion yuan ($141 billion) of additional sovereign bonds in the fourth quarter to finance infrastructure spending, widening the budget deficit as a percentage of GDP for 2023 to a record high of 3.8%.

The announcement, which surprised economists and investors, has fueled debate about whether this heralds a change in the leadership’s approach to fiscal policy. Some analysts say the move suggests top policymakers have accepted that larger annual budget deficits as a percentage of GDP will be needed in the future, and that the central government will need to take a larger share of the fiscal spending burden to alleviate pressure on cash-strapped local authorities.

The State Council’s proposals won approval from the Standing Committee of the National People’s Congress (NPC), China’s top legislature, on Oct. 24. The funds raised will be passed on to local governments through transfer payments, and the central government will assume responsibility for repaying the principal and interest. Half of the proceeds, 500 billion yuan, will be allocated this year and half will be carried over into 2024.

The National Development and Reform Commission (NDRC) and the Ministry of Finance, along with other related departments, have established a working mechanism for the special treasury bonds, state broadcaster CCTV reported last week, citing a ministry representative. This will involve project reviews and budget allocation.

Here are five things you need to know about the additional government bond issuance.

What’s unusual about this issuance? 

The central government rarely issues special treasury bonds, which raise money to finance specific policies or projects. This is only the fourth time they’ve been used since reform and opening-up started in 1978. The first time was in 1998 during the Asian financial crisis, they were net used in 2007 during the global financial crisis, and then again in 2020 during the COVID-19 pandemic.

But this is the first time special treasury bonds will be included as part of the fiscal deficit. That decision means the budget deficit will now jump to 4.88 trillion yuan from the 3.88 trillion yuan approved by the NPC at its annual meeting in March. The increase will push the deficit-to-GDP ratio from 3% to 3.8%, only the third time that the shortfall will have exceeded 3%, and the highest percentage on record.

The increase in the deficit indicates that the government is pursuing “a more proactive and flexible fiscal policy and signals an intensification of policies to stabilize growth,” Guan Tao, chief global economist at BOC International (China) Co. Ltd., wrote in an Oct. 30 commentary.

What will the money be spent on?

Half of the proceeds, 500 billion yuan, will be used this year and half will be carried over into 2024. The money will primarily finance investment in eight major areas, including rebuilding disaster-hit areas, construction of key flood control projects and improving management of natural disaster emergencies, Vice Finance Minister Zhu Zhongming said at a briefing on Oct. 25.

The main beneficiaries will be North and Northeast China, regions that were hit hard by severe floods in the summer that exposed shortcomings in flood control and drainage, and emergency response capacity.

What impact will the bonds have on GDP growth?

Some analysts say that as real GDP growth this year is almost certain to meet the government’s target of “around 5%” set at the NPC meeting in March, the main aim of the bonds is to get the economy off to a good start in 2024.

Many analysts say the 500 billion yuan to be issued in the fourth quarter has come too late to have much influence on the quarter’s growth, especially as local governments will have to submit qualified projects for approval and come up with some funding themselves before the money can be spent.

Analysts at China International Capital Corp. Ltd. said that taking into account the progress of the projects, problems such as constraints on construction in northern China in winter and the impact of the fiscal multiplier — which measures the impact of changes in government spending on GDP — the bond issuance could boost fourth quarter GDP growth by an additional 0.4 percentage points to 5.6% year-on-year, bringing full-year GDP growth to 5.3%. They said in an Oct. 26 report that the impact of the policy will be reflected mainly in 2024 and may give annual GDP growth an additional boost of about 1 percentage point.

The bond issuance “is too late to change the fourth quarter’s growth trajectory meaningfully, but may be helpful in underpinning growth in early 2024,” UBS economists wrote in a note last month.

Does the deficit increase signal a change in China’s fiscal policy stance?

Policymakers have traditionally followed a conservative fiscal policy and have been reluctant to allow the official deficit-to-GDP ratio to exceed 3%. This level is seen as a “red line” that shouldn’t be crossed and has its origins in the Maastricht Treaty signed by European Community members in 1992. The pact requires the signatory nations to maintain deficit-to-GDP ratios at no higher than 3% and to not exceed government debt-to-GDP ratios of 60%. But many analysts say the government shouldn’t be bound by the 3% threshold, which EU member states breach regularly.

“There is no fixed, universal warning line for the fiscal deficit ratio,” Sheng Songcheng wrote in a commentary in the central bank-backed Financial News in 2016 when he was director of the statistics department of the People’s Bank of China (PBOC). “The level should be considered based on a range of factors including a country’s outstanding debt and its structure, its economic development situation, and interest rate levels.” The commentary that was republished last month by the China Chief Economist Forum on its WeChat account, noting that a threshold of 3% isn’t appropriate for China’s situation. Sheng is now an adjunct professor of economics and finance at the Shanghai-based China Europe International Business School.

PBOC Gov. Pan Gongsheng has also pointed out that central government debt is relatively low. In a speech to a forum in Beijing on Nov. 8, Pan said, “Overall, the debt level of the Chinese government is at the mid-to-lower level internationally, and the central government’s debt burden is relatively light.”

Does the special bond issuance signal a shift in the fiscal relationship between central and local governments?

Overhauling the fiscal and taxation systems in 1994 changed how fiscal revenue and spending responsibilities were split between central and local governments. It strengthened the central government’s control over money raised but placed the burden of spending disproportionately on the shoulders of local governments. In 2019 for example, the central government collected 46.9% of China’s fiscal revenue, while localities received 53.1%. However, the central government accounted for only 14.7% of fiscal spending, with localities accounting for the remaining 85.3%. That said, the central government’s transfer payments to local governments have eased their burden to some extent.

To fund their obligations, local governments set up financing vehicles that raised trillions of yuan of borrowing outside of the official budget system. But the growing debt is posing increasing risks to the country’s financial system and the sustainability of local government finances. That’s now put the issue at the top of policymakers’ agenda, and while the central government has insisted it won’t provide any bailouts, calls have grown for the central budget to take on more of the spending burden.

“China’s latest sovereign debt-issuance plan signals greater support from the central government in driving infrastructure spending and the economy and may mark the beginning of a shift towards the central government providing more fiscal support to local governments,” Fitch Ratings analysts wrote in an Oct. 27 report. “We view the programme as part of the Chinese government’s recent efforts to bolster the economy and ease refinancing burdens at local governments and their corresponding local government financing vehicles.”

Source: Nikkei Asia