China’s local governments are intensifying their efforts to issue bonds, aiming to refinance hidden debt, a move that is further tightening the country’s already strained financial liquidity. Regional authorities are set to sell a record 1.69 trillion yuan ($233 billion) worth of bonds in the first two months of 2025. This unprecedented bond issuance is primarily focused on replacing off-balance sheet debt, with approximately 850 billion yuan allocated to this purpose.
This surge in bond sales has intensified the cash squeeze in the financial system, as banks scramble to absorb the newly issued securities. Meanwhile, money-market rates have spiked in recent weeks, as the People’s Bank of China (PBOC) has refrained from easing monetary policy and maintained tight liquidity conditions in a bid to stabilize the yuan.
The bond refinancing effort follows China’s approval in late 2024 of a plan to allow regional governments to swap as much as six trillion yuan of hidden debt, mostly accumulated by local government financing vehicles, over a three-year period. The initiative is designed to reduce the interest burden on local authorities. So far, the bond sales for this purpose have accounted for roughly 42% of the two trillion yuan quota set for the year.
Yuan Haixia, Executive Director at China Chengxin International Credit Rating Co., suggested that local authorities might be taking advantage of the pre-National People’s Congress window in early March to issue a large volume of these “swap bonds.” With the majority of local bonds held by banks, the pressure on banks to manage liquidity is mounting, Yuan added.
As the year progresses, government bond supply is expected to increase in line with China’s commitment to greater fiscal support. Vice Finance Minister Liao Min announced in January that the deficit-to-GDP ratio for 2025 will be higher, signaling continued fiscal expansion.
The ability of banks to secure funding at higher costs and purchase the new bonds will have significant implications for China’s broader money and bond markets. Recently, the seven-day interbank repo rate surpassed a broader market gauge during several sessions, an unusual occurrence given that borrowing between banks is typically cheaper.
In response, the PBOC has been draining funds through daily operations, widening the gap between the benchmark money market rate and the policy rate to the largest margin in four years. Although the central bank injected more liquidity on Friday, it did little to alleviate the ongoing market strain.
More than 60% of the debt-swap bonds issued by local governments this year have been long-term notes, with 20- and 30-year maturities. This reflects a strategic move by authorities to lock in favorable long-term financing terms while yields remain relatively low.
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