Fiscal Policy: A Shift in Direction and Level

Key Points:

1. Finance is the "real deal" to address the "urgent need", so the market pays high attention to fiscal policy;

2. There has been a directional shift in fiscal thinking. Possibly due to policy processes and other reasons, specific numbers were not provided at this press conference, but sincerity was expressed, leaving room for expectations;

3. In terms of usage, it is no longer just infrastructure, mainly including four aspects: debt conversion + bank capital injection + real estate + people's livelihood.

4. The next focus will be on the meeting of the Standing Committee of the National People's Congress, which may provide further answers in terms of numbers, focusing on expectation gaps.

5. Impact on the economy: Resolving tail risks, facilitating economic circulation, and helping achieve this year's goals.

6. Market impact: Overall positive impact on the stock market, with commodities showing a positive response. The short-term impact of the 10-year government bond is slightly negative, neutral to slightly positive if it rises above 2.2%; long-term central deleveraging increases long-term interest rate supply, steepening the yield curve. Short-term urban investment bonds benefit from supply contraction and financing pressure, with medium-term focus on urban investment transformation and differentiation.

Specifically:

Under the influence of factors such as weakening marginal economic data, local government debt pressure, and the urgent need to boost market confidence, recent political meetings have set the tone, with a series of policies such as monetary, NDRC, etc., being rolled out. The market's core focus has always been on fiscal matters, and today's fiscal press conference provided some specific information.

1. Why is the market currently highly focused on fiscal policy? Firstly, from the perspective of the positioning of various functional departments, financial policy mainly plays a positive role in stabilizing the market and expectations. The NDRC leans towards supply, considers demand, focuses on unified deployment and implementation, while finance is the incremental demand side. Secondly, in terms of policy effectiveness, there are bottlenecks in the transmission mechanism of monetary policy, while the advantage of fiscal funds reaching the real economy directly is more prominent. Thirdly, in terms of targeting, fiscal policy is more "targeted". The current main economic problems are the increasing pressure on local government fiscal deficits, the "Three Guarantees", etc., and fiscal measures are the "real deal" to address the "urgent need".

2. This press conference provided some incremental information, but on one hand, it may be constrained by processes, etc., without specific numbers, and on the other hand, many incremental policies are still under study, with uncertainties remaining, but showing sincerity and leaving room. The core focus points are as follows:

(1) "China's finance has enough resilience. By taking comprehensive measures, it can achieve a balance between revenue and expenditure and achieve the annual budget target." In the current situation of fiscal shortfall, it implies the need for new funds to make up for it. It has been clarified that "the central finance has allocated 400 billion yuan from the limit of local government debt balance to supplement the comprehensive financial resources of local governments", which constitutes incremental funds; still under study is the "larger debt space and deficit increase space for central finance", the specific scale may await the announcement of the Standing Committee of the National People's Congress, but "larger" is emphasized, providing a certain expectation space. In addition, the profits turned over by the central bank, central enterprises, and state-owned enterprises could also be possible ways to supplement the budget（2）In terms of usage, it is no longer just about infrastructure, mainly including four aspects: debt conversion + bank capital injection + real estate + people's livelihood.

① Regarding local debt conversion, the focus is on the follow-up efforts, with plans to "significantly increase the debt limit in one go", specific details will be announced later. The significance of local debt conversion is not only to alleviate debt risks, but also to help facilitate economic circulation.

② The process of bank capital injection has entered the decision-making stage, to be carried out through the issuance of special national bonds.

③ In the real estate sector, the focus is on allowing special bonds to be used for land reserves and the acquisition of existing commercial housing, as well as allowing affordable housing subsidy funds to be used to absorb existing housing stock. This to some extent addresses the issue of missing projects in special bonds, and if implemented effectively, it will have a certain significance in stabilizing housing prices.

④ People's livelihood is extensively mentioned, with the main funding possibly relying on "the central government's significant debt space and deficit increase space", specific stimulus effects are subject to further calculation.

⑤ There is also an important piece of information: "Currently, the issuance of national bonds is accelerating, with the gradual issuance of ultra-long-term special national bonds. In the next three months, a total of 2.3 trillion yuan of special bond funds can be arranged for use across the country." This part does not count as incremental funds, but the speed of previous usage was relatively slow. The scale of 2.3 trillion yuan is not small, and it is the main source of funds to support economic stabilization within the year. In addition to the broadening of the use of special bonds, which can be used to stabilize the real estate sector, it also plays a certain role in stabilizing expectations and growth.

Overall, this press conference is basically within expectations. The "significant" scale of "blank space" is a certain positive for both stocks and bonds. The interpretation of the bond market is: the direction and tools are basically within expectations + no specific scale given + more focused on stability and people's livelihood rather than promoting credit expansion, the policy effects need to be verified, and the fundamental logic has not been reversed; the interpretation of the stock market is: the direction of central deleveraging is clarified + providing expectations of "significant" incremental growth + the not insignificant amount of stockpile to be implemented within the year + details on stabilizing real estate are helpful for stabilizing housing prices and expectations, etc.

3. The next focus will be on the meeting of the Standing Committee of the National People's Congress, which may provide further quantitative answers.

**Currently, the fiscal sector is facing significant challenges and needs to balance multiple factors: Firstly, under the requirement of "high-quality development", fiscal intensification is expected to be a systematic process, considering comprehensively the impact on expectations, the economy, and the market. "Stability", "risk prevention", and "systemic issues" may still be the main considerations. Secondly, the geopolitical situation remains complex, and the fiscal sector, as the "backbone", needs to reserve "ammunition", such as dealing with uncertainties like the U.S. election. Thirdly, the "aftereffects" of the large-scale fiscal and monetary stimulus in 2009 and 2016, such as rising house prices and increasing debt, are still fresh in memory, but this concern has significantly weakened.

However, the "central government's significant debt space and deficit increase space" leaves room for expectations. Apart from the scale itself, providing policy expectations that are not enough to further intensify, may have a more significant meaning for stabilizing the economy and expectations.

4. What is the impact of this fiscal press conference? Overall, it tends to be positive!

（1）On the main line, what impact does it have on the fundamental operating logic? Which logics have changed?We divide the challenges facing the current Chinese economy into three levels: First, the issue of transitioning economic drivers and economic transformation; second, non-economic factors such as geopolitical environment, social incentive mechanisms, confidence, etc., affecting the business environment under the pressure of fiscal deficits by local governments; third, short-term macro supply-demand imbalance, insufficient total demand, weak price signals. What problems does this policy solve?

The central government has ample room to leverage up + policy focus shifting to the demand side, which is conducive to avoiding the exposure of local debt risks, alleviating the problem of insufficient short-term economic total demand, and also conducive to improving expectations and confidence and other non-economic factors. Some problems at the third and second levels are expected to be temporarily improved.

However, some problems still require time to resolve, first, persistent issues; second, some non-economic factors, such as incentive mechanism issues, require time, and there is still considerable uncertainty in the geopolitical environment; third, industrial transformation is a major background of the times, requiring long-term efforts for industrial upgrading, which still takes time.

Therefore, after this press conference, the short-term logic of the economy may see some improvement, with a significant reduction in tail risks, but the strength to drive growth still needs to be strengthened.

(2) Impact on the economy? Resolving tail risks and smoothing economic cycles.

This fiscal direction is relatively diverse, with different impacts and timeliness in different directions, which need to be discussed separately:

① Debt-for-bond swap: Not incremental funds, weak pull, but reduces tail risks, helps smooth economic cycles. Debt-for-bond swap is a stock replacement, with low short-term incremental effects and pulling effects. It has a greater effect on reducing debt costs and risk prevention in the long term. After the debt pressure is reduced, it also helps to increase the enthusiasm of local governments, smooth economic cycles, and aims for the long term.

② Bank capital injection: Incremental funds, helping to enhance the support for real economy by financial institutions. In order to prepare for maintaining the net interest margin of banks, it helps promote bank credit lending, but the effectiveness requires the repair of real financing demand as a basic condition.

③ Real estate: Stock funds + incremental funds, relatively strong pulling effect, but the scale is expected to be small. Special bonds can be used for land reserves and acquisition of existing commercial housing, allowing affordable housing subsidies to be used to digest existing housing. To a certain extent, it solves the problem of special bonds lacking projects. If implemented properly, it can play a certain role. However, considering the current high inventory of existing commercial housing, it may take time from fund landing to stabilizing house prices, and demand-side policies need to be coordinated, with the repair of residents' willingness to buy houses as a basic condition. Under the tone of "strict control of increments," there will be a certain lag from house prices to investment.

④ Livelihood expenditure: Incremental funds, moderate pulling effect, the effect may be relatively slow. Depending on residents' savings tendencies, residents need to be willing to use their income for consumption to exert economic pulling effects.

⑤ For the year, the 2.3 trillion special bonds can be arranged for use, plus NDRC's 200 billion project investment, which helps achieve the annual target. "In the next three months, a total of 2.3 trillion yuan of special bond funds can be arranged for use in various regions," although this part of the funds is not incremental, the scale is not small, plus an additional 400 billion debt limitCombining specific arrangements such as "two new", "two heavy", and "acquisition of existing housing", the NDRC's 200 billion project investment has a certain leverage effect. The resilience of the manufacturing industry since the beginning of the year and recent sales data for automobiles, home appliances, etc., also confirm its relatively fast driving effect. Direct subsidies can quickly stimulate corresponding categories of consumption and investment expenditure.

Therefore, in the short term, we expect that some additional + existing funds landing + stable real estate will provide a certain short-term boost to the economy, which may lead to a phase of stabilization, helping to achieve the annual economic growth target. Subsequent "larger-scale" incremental stimuli, more driving effects may be reflected in the next year and beyond.

From a longer-term perspective, the sustainability of economic stabilization needs to see more signals: ① Real estate needs to see stabilization of property price expectations; ② Consumption relies on income expectations improving, repairing consumption tendencies, reducing precautionary savings; ③ Local governments need not only financial resources but also "capable" incentive mechanisms and room for error; ④ Corporate profits need internal demand transmission to backend prices. We do not currently change the basic judgment of data running in a wave-like manner, but marginal positive changes need to be continuously monitored.

(3) Impact on the market? Stocks slightly positive, bonds showing differentiation.

Stock market: With the clear direction of central deleveraging + the expectation of "larger" increments + a considerable amount of pending funds to be landed during the year + stable real estate, all these factors contribute to stabilizing expectations and market sentiment. After the stock market valuation has entered a reasonable range, the market has entered the second phase, the stability growth policy verification period, requiring close attention to expectation differentials. This fiscal scale is left blank, but it expresses sincerity, leaving room for expectations, overall leaning towards positive. The commodity market has responded more positively to this press conference.

Interest rate bonds: Short-term logic at the fundamental level has improved to some extent + economic data may run in waves + possible supply pressure. In the short term, defense should be the main focus, but the long-term logic has not yet reversed.

At the fundamental level, market expectations of improvement do not equate to a change in the core contradictions of the fundamentals. Many non-economic factors and structural issues still require time. While there is a bottom for the economy, the upward momentum, especially sustainability, still needs to be verified.

On the supply side, on the one hand, special bond quotas and special national bond issuances may bring some incremental supply, but after the rush in August-September, the current pace of government bond issuance is faster than the same period in previous years. On the other hand, the coordination mechanism between the central bank and the Ministry of Finance can to some extent alleviate subsequent supply pressures.

In the short term, we reiterate that the 10-year government bond yield of around 2.2%-2.3% can be turned into a positive, and we recommend positioning on corrections. The main considerations are: First, in the context where the transformation of new and old economic drivers, corporate financing needs, supportive monetary policy, and allocation pressures remain unchanged, panic sentiment is more likely to provide opportunities in the medium term. Second, from a cost-effectiveness perspective, the 10-year government bond yield of around 2.3% is already cost-effective. Compared with history, in the second half of last year, the 10-year government bond repeatedly "bottomed out" at 2.5%-2.6%, and the policy interest rate has been reduced by 30BP compared to last year, with a greater reduction in LPR and deposit ratesFrom the perspective of the loan-to-deposit ratio, it is even at a relatively high level. We believe that if the 10-year government bond yield is adjusted to 2.3%-2.4%, factors such as the stock market and policies can be ignored for active intervention. The uncertainty in the stock market performance remains significant, affecting the extent of financial redemption, which is the biggest uncertainty factor going forward.

In the long term, the central government's inclination to leverage is clear, and long-term interest rates face supply pressure, but the magnitude is unknown. Considering the coordination between monetary and fiscal policies, long-term interest rates may trend downward and enter a volatile market, with an overall steep curve trend continuing.

Credit bonds: This press conference emphasized resolving local debt risks through centralized replacement by the central government, further releasing a prudent signal for debt restructuring. Since the "comprehensive debt restructuring plan" proposed at the Central Political Bureau meeting in July 2023, measures such as the issuance of special refinancing bonds, the use of newly added special project bonds for debt restructuring this year, financial institutions' extension and interest rate reduction for non-standard replacement, have effectively reduced the debt slope, improved platform financing structure.

The large-scale hidden debt replacement proposed by the Ministry of Finance this time is the implementation of the requirement to clear hidden debts by 2028, and it also reduces the local government's debt burden, which is conducive to local governments in resolving existing debts, digesting overdue corporate accounts, alleviating pressure on urban investment platform debts, and continuing to drive economic growth through leverage in the future.

Looking at the experience of the three rounds of debt restructuring in history, the explicitization of hidden debts is a common method, and standardized debt management and risk prevention are common reasons, with the indispensable role of central top-level design. Looking at the three rounds of debt issuances for debt restructuring from 2015 to 2018 (12.2 trillion), the pilot project for county-level debt restructuring in 2019 (142.9 billion), and the special refinancing bond replacement for hidden debts from 2020 to 2022 (11.3 trillion), the explicitization of hidden debts has accumulated a lot of practical experience, all accompanied by a decrease in the interest spread of urban investment bonds and the alleviation of tail-end regional liquidity risks.

However, it is worth noting that the debt restructuring mentioned in this press conference mainly focuses on hidden debt replacement, while various urban investment platforms still have a large amount of operational debts outside of hidden debts (as of the end of June 2024, the total outstanding interest-bearing debts of urban investment platforms amount to 58 trillion yuan, including hidden debts and operational debts). The part of debts outside of hidden debts may still rely on bank extensions, interest rate reductions, and loan replacements for risk mitigation. It is important to pay attention to the subsequent regional financial institutions' debt replacement process.

Market impact:

(1) Large-scale debt restructuring is expected to significantly alleviate the refinancing pressure of urban investment platforms, benefiting short- to medium-term urban investment bonds. From a secondary valuation perspective, the "proposed large-scale replacement of local government existing hidden debts" will significantly boost market confidence in urban investment bonds. Considering that the comprehensive debt restructuring cycle has been extended to June 2027 (which is basically consistent with the 2028 deadline for hidden debt replacement), short- to medium-term varieties are expected to have a greater downward trend. At the regional level, the policy direction is more favorable for key debt-restructuring provinces and cities. Coupled with recent policy shifts and interest rate fluctuations driving more credit bond adjustments, it is expected that such provincial and municipal urban investment bonds still have significant room for further spread reduction.

(2) Long-term attention to platform transformation and differentiation, pay attention to clarifying hidden debts and operational debts. The press conference also mentioned "guiding localities to prudently resolve hidden debt risks and promote the transformation of financing platforms." The accelerated replacement of hidden debts can also be understood as reducing the debt burden of some transformation platforms and providing them with a time windowIn the long run, transitioning platforms may gradually clear infrastructure-related businesses, clarify their relationships with local governments, and ultimately decouple from local credit. The market may still return to fundamental pricing for such entities. Therefore, it is recommended to continue monitoring the disposal path of existing debts of urban investment entities, business transformation progress, equity transfers, marginal changes in financial subsidies, etc., to clarify whether the platform still maintains its "urban investment" nature or implies "industrial transformation".

(3) From the supply side, in the short term, due to the requirements of debt reduction, the supply of urban investment bonds may still struggle to pick up. However, the press conference also emphasized "easing local government pressure, freeing up more resources to support economic development". Considering the progress of urban investment platforms exiting the list as indicated by Document No. 150, the large-scale debt replacement is expected to accelerate the clearance of hidden debts, the process of platforms exiting the list may speed up, and even after exiting, they may still play a role in driving infrastructure investment. In light of recent signs of resumed construction projects in provinces such as Guizhou and Qinghai, Qinghai has restarted local bond issuances for project construction. In the long run, some core urban investment platforms in certain regions may still have the potential to drive investment to a certain extent, with more standardized sources and uses of funds expected. Pay attention to the subsequent process of "platform exit" and marginal changes in regulatory financing policies.

Risk Warning: Economic recovery falls short of expectations, fiscal quotas and timing are slower than expected.

Authors: Zhang Jiqiang (S0570518110002), Wu Jing (S0570520020001), Article Source: Huatai Securities Fixed Income Research, Original Title: "Huatai Fixed Income: Fiscal Policy - Change in Direction Level"