Authors of this article: He Jueyuan, Guo Bohao, Source: Securities Times

Original title: "Expectations for the "maximum effort" of localizing debt, possible restart of "debt substitution""

More than a year after the implementation of the comprehensive debt reduction plan, local governments continue to increase efforts to resolve the hidden debt stock (referred to as "local debt"). To ease the pressure of local government debt, the Ministry of Finance plans to "substantially increase the debt ceiling at one time to replace the hidden debts of local governments", which will be the most significant local debt measure in recent years. Finance Minister Lan Foan referred to it as a timely policy intervention.

From the perspective of addressing local fiscal pressures in certain regions, and promoting the transformation of more hidden debts from implicit to explicit, carrying out a large-scale hidden debt substitution is a necessary measure to deal with short-term risks and strengthen debt monitoring.

According to interviewed experts, the scale of the new round of debt substitution may reach 6 trillion to 10 trillion yuan. Local governments can restart the issuance of "debt substitution bonds", or continue to issue "special refinancing bonds" and "special new special bonds" to alleviate the risk of local debt default, helping local governments focus more energy and resources on economic development and ensuring people's livelihoods.

Large-scale hidden debt substitution to "alleviate pressure" on local governments

Since the beginning of this year, China's fiscal revenue growth has slowed down, and land transfer income has decreased, highlighting the tight balance of local fiscal revenue and expenditure. At the same time, the debt repayment pressure borne by some grassroots local governments remains high. In the first half of the year, many local governments explicitly mentioned in their budget execution report the difficulties in grassroots financial operations and the increased pressure to prevent and resolve risks. Under various influencing factors, this year, the pressure on certain regions in China to ensure the "three guarantees" has increased.

In the 'Report on the Implementation of the Budget in the First Half of 2024 and Suggestions for Work in the Second Half' issued by Anhui Province, it is clearly pointed out that some counties and districts have relatively weak financial resources, the situation of the 'Three Guarantees' operation is tight, a few counties and districts have heavy debt resolution tasks, and there is certain pressure on the stable operation of finance.

The essence of debt replacement is to 'exchange time for space,' that is, to transform high-interest, short-term debt into low-interest, long-term debt. Although it will not reduce the balance of existing implicit debt, it can effectively alleviate the pressure of concentrated short-term debt repayment.

Professor Wen Laicheng from the School of Finance and Taxation of Central University of Finance and Economics stated in an interview with Securities Times that currently, some local finances are in a dilemma, and the government cannot ignore the issue of enterprise arrears. Once the replacement funds are in place, it will effectively improve the operational conditions of local finance, thereby significantly reducing the risk of local government debt defaults or explosions within the next two years.

Since last year, the Ministry of Finance has arranged over 2.2 trillion yuan of local government bond quotas to support local debt, with more targeted at high-risk debt areas. The upcoming debt replacement funds will be of a 'relatively large scale.' He Daiyin, Director of the Finance Research Office of the Financial Research Institute of the Chinese Academy of Social Sciences, told Securities Times that this inventory implicit debt replacement is expected to comprehensively alleviate the debt and financial pressures of various provinces (autonomous regions, municipalities), allowing local governments to free up more energy and financial resources to promote development and benefit the people.

The replacement scale may reach 6 trillion to 10 trillion yuan.

There are various opinions in the market on how the most substantial debt-to-equity swap initiative in recent years will be implemented. To ensure a 'significant reduction in local debt pressures' in this local debt operation, interviewed experts and scholars told reporters that the estimated additional debt quota will be around 6 trillion to 10 trillion yuan.

With the help of large-scale debt replacement, more existing implicit debt will be made explicit, which will help future local governments monitor and manage debts. Wang Qing, Chief Macro Analyst at Orient Securities, analyzed to reporters that the one-time increase in the limit of local government debt may be around 10 trillion yuan, achieving the transformation of all existing implicit debts from implicit to explicit.

Wang Feng, a lecturer at the China Public Finance Research Institute of Shanghai University of Finance and Economics, also holds a similar view. He told reporters that based on the scale of urban investment bonds, the expected new debt limit is around 11 trillion yuan.

Wen Laicheng believes that the main goal of this round of implicit debt replacement is to prevent the possibility of large-scale defaults in the field of hidden debts such as local government bonds in the past two years. In short, its core purpose is to prevent the occurrence of explosion events.

He further pointed out that the scale of implicit debt replacement mainly depends on the amount of principal and interest of the local government's implicit debt due. From the actual situation, the total amount of principal and interest of local government bonds due each year is about 3 trillion yuan. Considering the principal and interest requirements that may need to be met during the replacement, it may be necessary to carry out implicit debt replacement of about 2 trillion yuan in scale each year. Taking into account the country's fiscal capacity for the year, if the replacement plan is implemented over three years, the total amount can reach around 6 trillion yuan.

"Debt Replacement" or restart

Looking back on previous local government debt exchanges, considering that the intensity of this local government debt exchange is "the largest in recent years" and will increase the debt ceiling, some experts point out that the form of this round of debt replacement may be similar to the first large-scale implicit debt substitution that began in 2015.

From 2015 to 2018, local governments issued a total of 12.2 trillion yuan in replacement bonds, replacing the stock government debt in non-bond form, effectively alleviating the risk of concentrated repayment of local government debt due. Tan Zhiguo, deputy general manager of China Investment Consulting Co., Ltd., told Securities Times reporters that the Ministry of Finance has clearly added new debt quotas specifically for the replacement of stock hidden debts, which can also be called "replacement bonds".

Several interviewed experts also pointed out that local governments may continue to issue "special new special bonds". Since the fourth quarter of last year, local governments have begun to issue a type of new special bonds that were neither disclosed "one case two books" (project implementation plan, financial audit report, and legal opinion), nor disclosed the specific investment direction of the fundraising project, with the fundraising funds simply described as being "used for local government investment projects".

Some market experts speculate that the "special new special bonds" are actually used to resolve the stock debt.

Regarding the upcoming new round of large-scale implicit debt replacement, Luo Zhiheng, chief economist at Yuekai Securities, pointed out that it can continue the current form of special refinancing bonds and "special new special bonds", or restart the issuance of "replacement bonds", the latter being more standardized and more in line with the actual use of bonds. But to fundamentally address the local debt problem, it is still necessary to suppress the generation of local hidden debts from the three dimensions of fiscal system, debt budget management, and urban investment transformation.

Editor/ping