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    This time China tries fiscal stimulus

    It has been an eventful weak in China due to the release of key economic data and moves by Beijing to restructure the liabilities of local governments. The latter is being considered by some as sign that Beijing is using both major policy avenues available to it, as it slaps some fiscal stimulus on top of monetary policy loosening. In theory, this should inject some much needed fuel in China’s stalling economy.

    Earlier this week the finance ministry announced that local governments, who are massively indebted, would be allowed to swap some of their crippling high-interest debts for cheaper-to-finance bonds. China did this by tripling the quota for bond sales by local governments to 1/1.5 trillion yuan, with local media reporting (the Economic Observer) that this is just the first tranche and the total amount with be closer to RMB3.5 trillion, which isn’t massive but it’s certainly a start.

    Why is this important?

    Short answer, China has a massive local government debt issue. Estimates of how much they owe are nearing 40% of GDP and the structure of this debt is unclear. In China, local governments can only borrow with the permission of the finance ministry, thus they seek out off-balance sheet lending. This makes the exact size of their debt burdens and interest payments uncertain, but both are very large.

    The decision to refinance to lower yield bonds significantly reduces this debt burden for local governments (the ministry estimates they will save 40-50bn yuan in interest payments this year), and while it reduces the amount creditors will receive, they are likely happy to swap that would-be capital for the security of these lower-yielding bonds.

    Will it work?

    Reducing the debt burden of local governments should theoretically free-up some cash, but this one event isn’t going signal a massive push for infrastructure spending from local governments. Instead, we consider this as a step in the right direction by using fiscal policy to support growth, alongside the PBoC’s loosening of monetary policy. It’s also another step towards eliminating the reliance of local governments on back-door funding, as it opens up the front door. As for how mush stimulus this move will provide, China’s fiscal deficit is expected to reach 2.7%, up from 2.1% last year.

    What effect does this have on the FX market?

    There are no direct implications of these moves on the global FX market. We wouldn’t expect to see much of a reaction from the yuan, as it is being over showed by moves in the US dollar and fears about the health of China’s economy; fears which wear exasperated this week by the released of soft industrial production and retail sales figures for February. Overall, looser fiscal and monetary policies support our call for CNY to gradually weaken against the US dollar.


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