Understanding PSL in one article

After more than a year, PSL has made a comeback, with a scale reaching its third highest in history. What is its impact on the market?

On January 2nd, the central bank disclosed on its official website that in December 2023, the net increase in mortgage supplementary loans for the National Development Bank, China Exim Bank, and China Agricultural Development Bank was 350 billion yuan, with a year-end balance of 3.2522 trillion yuan.

Huatai Securities pointed out in a previous report that the "Three Major Projects" have been mentioned multiple times in recent important meetings, and PSL is a suitable tool for providing financial support, with the dual functions of "quasi-fiscal + loose monetary policy."

Reviewing the historical period from 2015 to 2018, PSL played an important role in the monetization of shantytown renovation, effectively boosting real estate sales and investment, significantly reducing inventory, and promoting economic recovery, while also driving credit expansion for microeconomic entities.

Looking ahead to this round of PSL operations and impact, Huatai Securities predicts that there may be multiple rounds of PSL injections in the future, and there is still room for PSL interest rates to decrease. As a quasi-fiscal tool, PSL will provide financial support for the "Three Major Projects," stimulate investment growth, help expand credit for microeconomic entities, and improve economic growth expectations. As a structural monetary policy tool of the central bank, it also reduces the need for reserve requirement ratio cuts and has a relatively limited impact on the overall bond market.

What is PSL?

In terms of specific concepts, according to Huatai Securities:

PSL (Pledged Supplementary Lending) is one of the structural monetary policy tools of the central bank. The PSL tool was established in April 2014, and its initial purpose was to provide long-term and stable funding sources at appropriate costs to support shantytown renovation through the National Development Bank.

Since October 2015, the recipients have expanded to include the National Development Bank, China Agricultural Development Bank, and China Exim Bank, and the purposes have expanded to include loans for shantytown renovation, major water conservancy projects, and RMB "going global" projects.

In terms of specific operational processes, Huatai Securities pointed out:

The central bank injects PSL into policy banks, and policy banks use these funds to provide special loans for shantytown renovation to local governments, providing financial support for shantytown renovation. After obtaining the funds, local governments provide monetary compensation to residents in shantytown areas through monetization of shantytown renovation.

Local governments can obtain income from land sales through demolition and use it to repay policy bank loans. Policy banks use this repayment to repay the PSL issued by the central bank, ultimately forming a closed loop of funds.

It is worth mentioning that PSL has dual functions of "quasi-fiscal + loose monetary policy":

On the one hand, PSL funds are targeted and only support specific projects through policy banks, including shantytown renovation, underground pipe gallery construction, major water conservancy projects, etc., which have the characteristics of fiscal policy;

On the other hand, PSL is equivalent to the central bank injecting base currency, which has a targeted easing effect. Moreover, PSL has a generally longer term, up to 5 years, and belongs to medium- to long-term liquidity injection.

Looking back at the development of PSL, the scale of PSL has experienced growth, decline, and then a rebound, while the PSL interest rate has been continuously lowered:

From 2015 to 2016, the scale of PSL grew significantly. From January to March 2018, the average monthly increase in PSL reached 100 billion yuan. In 2019, as the shantytown renovation cooled down, the monthly increase in PSL scale significantly declined and turned into net repayment since May 2019. From September to November 2022, the central bank restarted PSL operations, and the PSL balance rose again. The PSL interest rate has been continuously lowered from the initial 4.5% to the current 2.4%.

A Review of the Two Historical Phases of PSL's Rise

1. From 2015 to 2018, PSL supported shantytown renovation, and the balance grew rapidly

According to Huatai Securities, PSL played an important role in the monetization of shantytown renovation:

After the 4 trillion yuan stimulus package following the 2008 financial crisis, shantytown renovation was fully launched. From 2008 to 2013, due to the funding issues of local governments, physical relocation was the main approach for shantytown renovation. After 2014, as economic growth slowed down and the pressure to stabilize growth increased, the real estate inventory accumulated rapidly. The central bank introduced PSL loans, which allowed the government to obtain sufficient funding to support the monetization of shantytown renovation, helping to reduce real estate inventory. Since then, monetization has gradually replaced physical relocation.

The funding sources for shantytown renovation investment can be divided into four main parts: PSL, commercial bank loans, special shantytown renovation bonds, and public fiscal expenditure. Among them, PSL is the most important source of funding, accounting for the highest proportion among all funding sources. From 2014 to 2018, PSL accounted for a total of 57%.

From the role played by PSL in this phase, firstly, the real estate inventory was significantly reduced, driving real estate sales and investment, and the economy rebounded, leading to credit expansion for microeconomic entities:

After a strong round of monetization of shantytown renovation starting in 2015, residents' enthusiasm for home purchases was stimulated, which had a significant effect on real estate sales and investment, and the real estate inventory was greatly reduced, leading to a noticeable increase in housing prices in third- and fourth-tier cities;

With the advancement of real estate relaxation, the month-on-month sales of real estate continue to strengthen, and the growth rate of real estate investment has rebounded since hitting bottom in October 2015, indicating a gradual economic recovery.

From the perspective of credit structure, after the implementation of the Pledged Supplementary Lending (PSL) program, the year-on-year growth rates of long-term loans for residents and enterprises have bottomed out and rebounded, while the year-on-year growth rate of bill discounting has decreased, indicating an improvement in credit structure.

In addition, regarding the impact of monetary policy, Huatai Securities pointed out that the PSL, as a means for the central bank to inject base currency, to some extent reduces the necessity of reserve requirement ratio cuts, but has little impact on the bond market.

2. PSL Restart in September-November 2022

Due to the pressure of stabilizing economic growth and the negative cycle of the real estate market, the PSL program will be restarted in 2022. Huatai Securities stated:

On the real estate enterprise side, insufficient external financing and sales receipts lead to obstacles in land acquisition and construction, as well as a slowdown in construction and difficulties in project completion.

On the resident side, weak expectations for housing prices and concerns about delivery lead to a decrease in housing demand and early repayment of loans.

Real estate sales, land acquisition, construction, and project completion are all weak. Real estate companies are facing a wave of defaults, and the requirement of "guaranteeing delivery" by regulators requires financial support.

The restart of the PSL program will drive infrastructure construction, but there is no evidence to support the claim that it will guarantee project completion. However, the real estate sales and investment will remain sluggish, and the progress of project completion will continue to be slow. The credit growth rate and long-term loans for enterprises have shown improvement. In addition, the impact on monetary policies such as reserve requirement ratio cuts and the bond market is minimal.

What is the impact of this round of PSL restart?

After a year of suspension, the PSL program is restarted with an injection of 350 billion yuan, making it the third-largest monthly injection in PSL history.

Huatai Securities previously predicted that there may be multiple rounds of PSL injections in the future, and the scale of PSL may increase. The current PSL interest rate is 2.4%. Considering that the interest rate spread between PSL and Medium-term Lending Facility (MLF) is at a historically narrow level, there is still room for the PSL interest rate to decrease.

Against the backdrop of policy support for the "Three Major Projects," Huatai Securities pointed out that the PSL is a suitable tool to support the construction of the "Three Major Projects," especially for urban village transformation. Firstly, it has low costs, secondly, it has minimal impact on external balance, and thirdly, it was created for policy banks to provide infrastructure loans.

Regarding the impact of the PSL restart, Huatai Securities previously estimated:

If the scale of this round of PSL is 500 billion yuan, it may drive an investment scale of 13 trillion yuan; if the scale of PSL is 1 trillion yuan, it may drive an investment scale of 27 trillion yuan. The actual impact will depend on the leverage ratio of the projects and whether they can be used as capital, among other factors.

In terms of the impact on the bond market, it is still worth paying attention to in the medium term. The total scale of PSL's injection is important to consider, as the impact of small-scale injections is relatively limited. The effectiveness of PSL injections is also crucial in terms of improving investment, the economy, and the credit of micro entities. However, overall, the impact on the bond market is relatively limited.

This article is excerpted from the "History and Prospects of PSL Tools" by Huatai Securities. Analysts Zhang Jiqiang (SAC No. S0570518110002), Qiu Wenzhu (SAC No. S0570521050002), and Wu Yuhang (SAC No. S0570521090004).