Economic Observer: Exploring the Path of China's Debt Restructuring

How to develop debt reduction? What are the specific paths for market-oriented debt reduction? The answer may be revealed soon.

On the morning of November 4th, the 12th meeting of the Standing Committee of the 14th National People's Congress held its first plenary session at the Great Hall of the People in Beijing. The meeting reviewed the State Council's proposal to increase the quota for local government debt replacement of existing hidden debts. On behalf of the State Council, Minister of Finance Lan Fo'an provided an explanation. Xu Hongcai, Deputy Director of the Financial and Economic Committee of the National People's Congress, reported on the review results of the proposal.

With the surge in global economic uncertainty and the complex and changeable Sino-U.S. relations, it is urgent for China to properly resolve the pressure of local debt.

In mid-October, the Ministry of Finance announced a series of policy measures at a press conference held by the State Council Information Office, including increasing efforts to resolve local debt, raising the issuance quota of special government bonds, and increasing the capital of state-owned banks. Against this policy backdrop, on October 28th, the People's Bank of China innovatively launched a market-based buyout reverse repurchase tool to provide short-term liquidity support through market operations.

Wen Bin, Chief Economist at MINSHENG BANK, believes that this combination of policies and innovative tools effectively enhances the stability of the financial system while adopting "market-oriented debt reduction."

Attention is focused on a robust and upcoming fiscal incremental policy— the Ministry of Finance and the central bank are exploring new paths for "market-oriented debt reduction," with fiscal and monetary policies working in coordination to achieve a dynamic balance between debt management and economic growth.

Fiscal Action: Policy Combination for Developing Debt Reduction

At the press conference held by the State Council Information Office on October 12th, "debt reduction measures" were announced by the Ministry of Finance as the first incremental policy and described as "the largest support for debt reduction in recent years."

The second, third, and fourth incremental policy measures from the Ministry of Finance include issuing special government bonds to support state-owned large commercial banks in replenishing their core tier one capital, enhancing these banks' risk resistance and credit issuance capabilities to better serve the development of the real economy; utilizing local government special bonds, special funds, tax policies, and other tools to help stabilize the real estate market; and increasing support and protection for key groups.

Data shows that in 2023, the Ministry of Finance arranged for over 2.2 trillion yuan in local government bond quotas. Since 2024, the Ministry of Finance has arranged 1.2 trillion yuan in debt limits to support local resolution of existing hidden debts and to settle government arrears to enterprises, with the scale of the new policy expected to exceed 2.2 trillion yuan.

According to the press conference on October 12th, "as of the end of 2023, the balance of hidden debts included in the government debt information platform nationwide has decreased by 50% compared to the baseline figure in 2018." Galaxy Securities analyzed that this large-scale debt reduction should be controlled within 7.5 trillion yuan, primarily resolved through government debt replacement, while the remaining hidden debts will be addressed through other means.

In addition, many institutions predict that the total scale of fiscal stimulus to be announced by the Ministry of Finance will reach 10 trillion yuan. Such funds will not only be used for debt replacement but will also increase infrastructure investment, support technological innovation, and promote green transformation to further expand the growth space of the Chinese economy The core of the 10 trillion yuan scale is a debt resolution plan for local government implicit debts that may reach 6 trillion yuan. Some researchers believe this debt resolution plan will be implemented over three years. As pointed out by Galaxy Securities, the 6 trillion yuan debt resolution scale in the next three years will mainly be used to fill the gap in debt repayment sources caused by the decline in land revenue. Based on the recent decrease in land transfer income, the 6 trillion yuan replacement scale may be a reasonable level, mainly considering that government fund income has been the primary source of repayment for special bonds and urban investment bonds.

This debt resolution plan also emphasizes strengthening the budget management system, with the Ministry of Finance strictly controlling new implicit debts and promoting the transparency of local government debts. In the future, there will be a strengthened management of local debt limits to ensure that debt management is achieved within a standardized framework.

It is noteworthy that data from the Ministry of Finance shows that from January to September, the national government fund budget revenue was 30,861 billion yuan, a year-on-year decrease of 20.2%, with state-owned land use rights transfer income down 24.6%. To cope with the decline in land finance revenue, local financial departments need to continuously explore diversified income sources while increasing the proportion of non-tax revenue and issuing special bonds. However, due to the weak recovery of the real estate market, the support of land finance for local government spending has significantly weakened, making it a core challenge for local finances to fill this revenue gap.

Despite the decline in revenue, fiscal expenditure in the first three quarters increased by 2% year-on-year, indicating a "steady progress" orientation in current fiscal policy. Government spending in social security, education, agriculture, forestry, water conservancy, and other areas remains strong, reflecting the positioning of fiscal policy as "moderately strengthened, improving quality and efficiency." This expenditure structure helps stabilize the economy and safeguard social livelihoods.

According to Wen Bin's analysis, with multiple funding sources supplementing, local government financial resources are relatively sufficient, ensuring fiscal expenditure. Firstly, the Ministry of Finance stated it would allocate 400 billion yuan from the local government debt balance limit to supplement local government finances; secondly, the issuance of additional national bonds in 2023 is accelerating, and ultra-long-term special national bonds are also being gradually issued; thirdly, the National Development and Reform Commission indicated that next year’s 100 billion yuan central budget investment plan and 100 billion yuan "dual heavy" construction project list have also been issued according to procedures.

As the U.S. election approaches, global market expectations for future policy directions are becoming increasingly uncertain, and RMB assets may face certain pressures. Macro policies need to be prepared in advance to respond. Through fiscal stimulus plans, further reduce dependence on external environments and enhance endogenous growth momentum.

In the face of reduced revenue and local government debt pressure, support short-term economic growth through special bonds and large-scale fiscal expenditure. Future fiscal expenditure may still focus on infrastructure (including new infrastructure), social security, and regional development to stabilize growth, promote employment, enhance the debt-bearing capacity of local governments, and achieve "development-driven debt resolution."

Central Bank Efforts: Innovative Tools for Market-oriented Debt Resolution

In the current context of weak domestic demand, slowing exports, and rising local debt pressure in the Chinese economy, the Ministry of Finance and the central bank have chosen a "market-oriented debt resolution" path. This design aims to avoid the inflation risks brought by the direct monetization of fiscal deficits and gradually resolve debt issues through market mechanisms. This path may partially draw on the ideas of Modern Monetary Theory (MMT), balancing the price discovery mechanism, allowing market interest rates to play a guiding role in resource allocation, thereby indirectly supporting economic growth through market means On October 28, the central bank announced the launch of a market-based buyout reverse repurchase tool. Unlike traditional reverse repurchase operations, this tool does not require a short-term repurchase but provides liquidity through monthly operations with a term not exceeding one year. This approach alleviates the concentrated maturity pressure of local government debt while avoiding the inflation risks that may arise from large-scale monetary injections.

The buyout reverse repurchase tool employs a market mechanism of interest rate bidding and price discovery, guiding financial institutions to set their own prices based on funding needs. This operation avoids the burden of direct balance sheet expansion by the central bank and creates conditions for reducing local government financing costs in an environment of declining market interest rates. Through market-based interest rate regulation, the central bank flexibly injects liquidity into the market without changing the total amount of funds, helping local governments find a balance between debt repayment and development.

Although the buyout reverse repurchase may draw on MMT ideas to some extent, it differs from direct monetization. MMT advocates for direct monetization of debt, with the core idea that government spending should not be strictly limited by debt but should rely on how effectively inflation and economic resources are managed. In contrast, China prefers to manage the debt burden through market-based methods, providing short-term liquidity through open market operations while maintaining the stability of the price discovery mechanism.

Wen Bin pointed out that this approach avoids the risk of "de-virtualization" caused by monetary policy easing while enhancing the risk control capability of financial markets.

Wen Bin believes that this "market-based debt management" method does not directly monetize fiscal deficits but gradually adjusts the debt burden through a market-based interest rate mechanism, indirectly supporting the real economy.

Liu Chenjie, a global macro hedge fund manager at Wangzheng Capital, also noted that the implementation of MMT requires the economy to have strong supply capacity and production efficiency; otherwise, large-scale monetary supply may lead to funds "de-virtualizing." In China, despite the ongoing downward pressure on the economy and declining industrial profits, caution is still needed regarding MMT-style deficit monetization to avoid excessive liquidity flowing into the capital market, which could trigger financial risks.

"The design of the buyout reverse repurchase tool, by injecting liquidity in the short term rather than through large-scale balance sheet expansion, maintains the flexibility of monetary policy while meeting liquidity needs," Liu Chenjie stated.

Wen Bin pointed out that through buyout reverse repurchase operations, the central bank injects safe assets into the financial system, enhancing the risk appetite of financial institutions and thereby supporting financing for the real economy, reflecting a certain effect of monetary creation supporting economic growth.

It is evident that the central bank achieves a balance between the effectiveness and stability of policies through more refined selection of repurchase targets and market operations.

Wang Yongli, former vice president of Bank of China, noted that the boundary between monetary policy and fiscal policy is becoming increasingly blurred, and the trend of their integration is becoming more apparent. This phenomenon is also viewed by some as a manifestation of MMT. He stated that the positive effects of MMT have strict applicability conditions; within the applicable scope, the benefits outweigh the drawbacks, while exceeding the applicability conditions may lead to more drawbacks than benefits.

Market-Based Debt Management: A Recipe for High-Quality Development

The uniqueness of this debt management plan lies in the collaboration between the Ministry of Finance and the central bank, leveraging the combined effects of fiscal and monetary policies to achieve a balance between debt management and economic growth For example, the Ministry of Finance is promoting the phased replacement of local debt through special bonds and special government bonds, while the central bank is providing liquidity support. The special government bonds provided by the Ministry of Finance will supplement the capital of large state-owned banks, ensuring they have sufficient funds for debt replacement and encouraging banks to support local governments under market conditions. The central bank, on the other hand, provides liquidity for local bonds through reverse repos, thereby reducing the transmission of debt risks.

In the view of market participants, the exploration of this debt reduction path has seen innovations from both the Ministry of Finance and the central bank in multiple areas.

For instance, adjusting the debt burden through market interest rates: the central bank's market-oriented tools allow local debt to be financed at market interest rates, which not only reduces the impact of implicit debt but also promotes transparency in debt.

Market analysis generally predicts that the fiscal stimulus plan, sized at 10 trillion yuan, will include structural arrangements, focusing on the dual role of special funds and local debt replacement. Although the Ministry of Finance has not officially announced the total scale, it has clearly stated at the press conference of the State Council in October that it will increase the intensity of debt replacement and support local government debt management through special funds. This structural innovation not only aids economic growth but also provides positive fiscal support for local governments within a regulated debt management framework.

More importantly, the collaboration between the central and local governments effectively prevents systemic risks. The special government bonds from the Ministry of Finance and the liquidity injections from the central bank can reduce the risk of concentrated local debt maturities and promote market-oriented resource allocation. Wen Bin pointed out that the new tools introduced by the central bank and the Ministry of Finance's intensified debt reduction policies have sent positive signals to both the stock and bond markets. Through market-oriented liquidity management, this policy combination is expected to provide a bottom support for the market in the fourth quarter. The reverse repo operations are expected to stabilize bond market interest rates and reduce liquidity fluctuations caused by concentrated debt maturities. In addition, ample liquidity and an increase in financial institutions' risk appetite will help enhance investor confidence and support the stock market.

The 14th National People's Congress Standing Committee will hold its 12th meeting from November 4 to 8. Wen Bin believes that specific plans and details for "significantly increasing the debt quota to support local resolution of implicit debt" may be revealed at that time. Considering that it takes time for the fiscal budget to be adjusted and implemented, the new debt quota may be issued as early as the end of the year and put into use next year.

China is actively exploring a market-oriented debt reduction path, and the innovative collaboration of fiscal and monetary policies may provide new solutions for debt management, not only helping to cope with internal and external pressures but also aiming to promote high-quality development, making it a good prescription for "debt" reduction.

Author of this article: Ouyang Xiaohong, source: [Economic Observer](https://mp.weixin.qq.com/s?__biz=MjM5OTExMjYwMA==&mid=2670299968&idx=1&sn=3e0ca13a83a3978677e41186b7c4a93b&chksm=bdc9186c1c0c63f2645ef1117bd2bfd5328b22065b01505f0ecd87c76d09675aa71231a63d45&mpshare=1&scene=23&srcid=1104PGCFBsSqqRrm9VFhgOVS&sharer_shareinfo=81243ceac14b908b812d09cd963fb0b5&sharer_shareinfo_first=f82817 128ec5369683e61d3df19be848#rd), Original title: "[Chief Observation] Exploring the Path of China's Debt Transformation"