HTSC: Localized debt is the "main event" of incremental policy

This week's three major events affecting the market (U.S. election, Federal Reserve FOMC meeting, Standing Committee of the National People's Congress) have concluded one by one. After the dust settles, there are still many uncertainties to be revealed. The overall macro visibility remains low for the time being, but the tail risk of the economy has decreased, and the economic cycle is improving. Our comments on this press conference of the Standing Committee of the National People's Congress are as follows:

1. The necessity of fiscal stimulus?

We previously mentioned that under the circumstances of blockages in the transmission mechanism of monetary policy + local government fiscal gaps + increasing pressures from the "three guarantees," fiscal policy is a tool to reduce tail risks in the economy and is also where demand-side increments lie. With the U.S. election settled, external demand uncertainty has increased, necessitating more internal demand to hedge against it, hence the market has greater expectations for this press conference.

2. Debt resolution is unsurprisingly the focus

From the final information of the press conference, it is unsurprisingly focused on debt resolution, supplementing and refining the information from last month's fiscal press conference.

(1) Resolving existing debt: The local government debt limit is raised by 6 trillion + 800 billion will be arranged annually from new local government special bonds for five consecutive years + 2 trillion of hidden debts due for shantytown renovation after 2029 will still be repaid according to the original contract = it is expected that before 2028, the total amount of hidden debts that local governments need to digest will decrease from 14.3 trillion to 2.3 trillion.

(2) Strict control of new debt: "Budget constraints will be stronger, and not adding hidden debts will be treated as an 'iron discipline.' Government expenditures and investment projects not included in the budget arrangement are not allowed to be implemented," and "supervision and accountability will be stricter."

(3) Regarding the operating debt of financing platforms: Financial regulatory authorities have already researched and formulated policy measures to support local debt resolution, with the Ministry of Finance actively cooperating.

As for the incremental policies that the market is more concerned about, the press conference only "teased" some information that was already expected:

(1) Regarding this year's budget: Arranging for central units to pay profits + strengthening expenditure management + the budget stabilization fund can be utilized to ensure fiscal balance this year, with no temporary issuance of government bonds to fill the gap.

(2) Continuing to plan the next fiscal policy, "teasing" several known pieces of information: ① Real estate tax policy: in the approval stage, landing soon; ② Debt replacement work: to be launched soon; ③ Issuing special government bonds to supplement the core Tier 1 capital of large state-owned commercial banks: accelerating progress; ④ Stockpiling and acquiring existing commercial housing: policies are being researched and formulated in cooperation with relevant departments, which will be a focus in the future.

(3) Next year's fiscal policy will be "more powerful": ① Actively utilize the available deficit space; ② Expand the scale of special bond issuance, broaden the investment fields, and increase the proportion used for capital; ③ Continue to issue ultra-long-term special government bonds to support "two 重"; ④ Increase efforts to support "two new," expanding varieties and scale; ⑤ Increase the scale of central government transfers to local governments and strengthen efforts in key areas such as technological innovation and people's livelihoods.

Overall, the numbers announced in this systematic debt reduction plan at the press conference are basically within market expectations. There is some positive incremental information regarding "hidden debts in housing renovation" and "operational debts of financing platforms," but the discipline regarding "budget constraints," "investment projects," and "accountability" is clearer, and the overall net effect remains to be observed. Additionally, regarding incremental stimulus, details were not disclosed, focusing mainly on expectation management, leaving some room.

3. What is the significance and role of debt reduction as a focus of this press conference?

It is necessary to make some distinctions:

(1) The disclosed debt reduction quota mainly corresponds to the "national hidden debt balance calculated after individual project identification and hierarchical review," which may more closely relate to current interest-bearing debts (such as bank loans, etc.). The operational debts and wage expenditures that have been widely discussed in the market may not be included. The direct impact of this part is to save interest expenses; according to the Ministry of Finance's calculations, it can save about 600 billion yuan in interest expenses over five years, with a direct pull on GDP of about 0.1 percentage points annually.

(2) More attention should be paid to the impact on the "soft environment" and proactivity of local governments. "Freeing up resources originally used for debt reduction," "freeing up policy space originally constrained by debt reduction pressures," and "freeing up time and energy originally used for debt reduction and risk management" are more substantive impacts. However, the press conference also mentioned that "budget constraints are stronger" and "regulatory accountability is stricter," so the selection of investment projects is expected to remain tight. On the other hand, we need to closely monitor the potential positive impacts brought by local government KPI orientation and policy consistency assessments; the final net effect still needs observation. With financial support and incentive orientation, the synergistic effect will be better.

(3) The market is more concerned about the operational liabilities of local government financing vehicles, which correspond to corporate arrears and wage benefits. The press conference clarified that these liabilities will mainly be resolved through "financial support" from "financial management departments," with the Ministry of Finance playing a "cooperative" role. This part is more meaningful from an incremental perspective, as it is beneficial for improving the balance sheets of residents and enterprises and enhancing the local business environment, which is significant for economic circulation. Attention should be paid to whether the central bank will introduce corresponding policy tools; after cash flow improvement, the spending willingness of the real sector becomes more important.

(4) Additionally, debt reduction is beneficial for "improving the quality of financial assets, enhancing credit issuance capacity, and benefiting the real economy," but this requires a recovery in financing demand from the real sector as a foundational condition.

(5) Finally, attention should be paid to the expansion of the use of local debt; if it can be used for land acquisition, it will help alleviate some pressure on local financing vehicles acquiring land.

4. How to understand this press conference and the subsequent policy rhythm?

From the current point of view, the necessity of fiscal policy is still beyond doubt, but its urgency may have decreased. First, after the combination of financial policy measures, the increase in the local government bond limit by 400 billion this year, and the acceleration of 2.3 trillion yuan in existing funds, the economy has shown certain signs of stabilization. The financial and real estate sectors have directly contributed to GDP growth, which may have basically met the policy intensity required to achieve this year's goals; second, after the U.S. elections, under the influence of inflationary pressures and staff negotiations, the specifics of tariff implementation, such as the extent of tariffs and whether they will penetrate taxation, remain unclear, and the impact on growth may still need to be assessed; third, there may be greater uncertainty in the Trump era, necessitating some policy space.

Therefore, waiting for the subsequent Central Economic Work Conference and next year's Two Sessions aligns more with the tendency for policy discretion. We have a few judgments regarding the future policy rhythm:

First, in response to potential tariff risks, domestic policies may increase counter-cyclical adjustments and stimulus efforts, and this expectation has not changed significantly. The incremental part currently anticipated by the market (a deficit rate of over 3.8% next year + continued issuance of special government bonds, etc.) may have already become a relatively lower limit.

Second, due to the uncertainty of tariff policies, the cycle of this policy response may be relatively prolonged. The uncertainty factors include the timing and extent of tariff implementation, as well as whether they will penetrate taxation, and even possible subsequent trade negotiations.

Third, in terms of rhythm, several key nodes to pay attention to in the future include: ① The Politburo meeting and the Central Economic Work Conference in December—preparing for a series of policies before Trump's inauguration; ② The Two Sessions—responding to tariff advancements after Trump's inauguration; ③ The actual timing of tariff implementation and possible trade negotiations.

Fourth, the Trump 2.0 era may bring greater uncertainty, necessitating some policy space.

5. What is the market impact of this press conference?

Fundamentals: Fiscal policy has a certain short-term stimulating effect, and the external export rush effect may coincide with the year-end stability growth and the positive start of next year, potentially reinforcing short-term data resonance, with short-term growth readings expected to experience a small pulse. In the medium term, the uncertainty of external demand is increasing, viewing domestic policy space with a lower limit mindset, but the net effect and elasticity should not be overestimated. More incremental stimulus remains to be revealed and needs to rely on economic circulation transmission.

Regarding prices, the landing of several factors this week has caused some disturbances in the supply-demand gap. Externally, under the expectation of increased tariffs, the decline in exports has caused demand disturbances, while methods to avoid tariffs, such as going abroad, may lead to idle internal production lines; internally, in response to external uncertainties, domestic industrial policies also need to be more proactive, and support from the supply side remains necessary, indicating that price inertia may be relatively stronger, especially for commodities. From this perspective, a larger internal demand offset may be needed.

Therefore, the characteristic of the economy operating in waves currently shows no change, and the visibility of macro policies next year remains low, necessitating continuous attention to the impact of external environments and internal policy discretion. Slightly positive for the stock market. The policy game may not be over, and the response period may be further extended. With liquidity remaining loose, thematic opportunities are more active than cyclical varieties, benefiting domestic demand varieties relatively more. The two ends may be more dominant—focus on "large" targets related to the government and "small" targets that better match the early characteristics of household consumption recovery.

On the bond supply side, the issuance volume announced at this press conference has not exceeded our previous expectations, but the issuance pace has not been disclosed in detail, only mentioning "the work on hidden debt replacement will start soon" and "regional quotas will be issued as soon as possible," etc. The probability of starting within the year is relatively high, and we need to pay attention to subsequent announcements from the Ministry of Finance. The situation of significantly increased supply of interest rate bonds in the coming period remains unchanged.

Regarding the bond market, fiscal and monetary policies will continue to exert force next year, improving the asset-liability balance of micro entities, and macro liquidity is likely to remain loose. The core contradictions in the fundamentals need to be resolved, corporate financing demand has not yet recovered, and production capacity is still in the process of de-stocking. Supportive monetary policies will not change, and the bond market will not enter a bear phase. However, compared to the stock market, the issue for the bond market is that the "starting point" is too high, with many unstable factors in institutional behavior. The stock market, as a competitive asset, will divert funds, leading to increased volatility. Currently, the yield on ten-year government bonds has dropped to around 2.1%, which is historically a very low level. Even if there are one or two rate cuts next year, considering the current stable growth policy intentions, fiscal supply, and stock market diversion, it will be difficult to drive long-end rates down significantly. The probability of a steeper curve shape is higher. We judge that the low point for ten-year government bonds next year may struggle to break through 1.8%-1.9%, and it will be difficult to break above 2.3-2.4%. The long-term trend is not over, but the characteristics of a volatile market are more pronounced.

What is the impact on credit bonds?

(1) Large-scale debt replacement will significantly alleviate the refinancing pressure of urban investment bonds, benefiting medium- and short-term urban investment bonds. According to the meeting, a total of 10 trillion yuan will be used to resolve hidden debts, including 4 trillion yuan (in the form of special bonds, 800 billion yuan * 5 years) + 6 trillion yuan (in the form of special refinancing bonds, 2 trillion yuan * 3 years). In addition, the hidden debts for shantytown renovation maturing in 2029 and beyond, amounting to 2 trillion yuan, will still be repaid according to the original contract, alleviating local liquidity pressure and significantly boosting market confidence in urban investment bonds. Combined with previous market news and the mention at the October 12 press conference of arranging a certain quota of special bonds and large-scale debt replacement each year, the overall situation is relatively in line with debt resolution expectations.

Considering that the current package of debt resolution has been extended to June 2027 (basically consistent with the 2028 deadline for hidden debt replacement), medium- and short-term varieties are expected to decline more significantly. At the regional level, recent policy games and the stock-bond seesaw have led to significant adjustments in credit bonds, and it is expected that urban investment bonds in key debt resolution provinces and cities still have considerable room for spread decline.

In addition, large-scale debt replacement is often accompanied by the early redemption of some high-yield urban investment bonds. Combined with the continued tightening of financing policies under debt resolution, it is expected that the supply of urban investment bonds may become even scarcer (2) Long-term attention to platform transformation and differentiation, and pay attention to clarifying hidden debts and operational debts. According to the meeting, before the announcement of debt relief support, the total amount of hidden debts that local governments need to digest before 2028 is 14.3 trillion yuan (consistent with our previous estimate range of 10-15 trillion yuan, referring to the report "Shifting to a Volatile Market Mindset - 2025 Bond Market Outlook" published on November 4). However, this figure mainly reflects the scale of hidden debts audited before 2018. In addition to hidden debts, various platforms still have a large amount of operational debts (as of the end of June 2024, the outstanding interest-bearing debts of urban investment platforms totaled 58 trillion yuan). Some of the debts outside of hidden debts may still rely on bank loan extensions, interest rate reductions, and replacements for risk mitigation, so attention should be paid to the subsequent debt replacement process of regional supporting financial institutions.

In conjunction with Document No. 134 and Document No. 150, which have consistently emphasized the timeline of June 2027, we recommend continuing to monitor the disposal paths of existing debts of urban investment entities, the progress of business transformation, changes in equity transfers, and marginal changes in fiscal subsidies, to clarify whether the platform still maintains its "urban investment" essence or signifies "industrial transformation."

(3) From the perspective of debt relief, this meeting emphasized a fundamental shift in the approach to debt relief work: first, a shift from emergency handling in the past to proactive resolution now; second, a shift from point-based risk clearance to overall risk elimination; third, a shift from dual-track management of hidden debts and statutory debts to standardized and transparent management of all debts; fourth, a shift from focusing on risk prevention to balancing risk prevention and promoting development. The shift in the debt relief approach further expands the scope of debt relief, indicating the central government's emphasis on solving local debt issues, while also releasing signals for addressing local debt problems. Additionally, the shift from focusing on risk prevention to balancing risk prevention and promoting development may be related to the transformation of urban investment, so attention should be paid to the subsequent transformation processes of urban investment platforms in different provinces and cities.

(4) Regarding the impact on other enterprises, considering that hidden debts also include overdue payments, and the creditors of overdue payments are mainly construction and building materials companies, it is expected that the liquidity pressure on these companies will ease, and their subsequent performance is likely to improve. Therefore, local debt replacement can, to some extent, facilitate economic circulation, improve corporate cash flow, and even enhance the business environment. Continuous attention should be paid to the subsequent allocation quotas and uses of funds for debt replacement in various provinces.

Author of this article: Huatai Research; Source: Huatai Securities Fixed Income Research, original title: "Local Debt Relief is the 'Main Event' of Incremental Policies - Comments on the NPC Standing Committee Press Conference"