Opinion Leader Zhang Ming
On October 24, 2023, the Chinese government announced the issuance of an additional 1 trillion national debt, and the funds raised from the issuance of national debt were all allocated to local governments through transfer payments to focus on supporting post disaster recovery and reconstruction and improving disaster prevention, mitigation and relief capabilities. The government work report of the 2024 NPC and CPPCC pointed out that it is planned to issue ultra long term special treasury bonds for several consecutive years from this year, specifically for the implementation of major national strategies and security capacity building in key areas. This year, 1 trillion yuan will be issued first. On April 23, 2024, the Ministry of Finance expressed its support for the central bank to gradually increase the purchase and sale of government bonds in open market operations and enrich the monetary policy toolbox. In an interview, the head of the relevant department of the Central Bank said that China's central bank can conduct treasury bond trading in the secondary market as a liquidity management method and monetary policy tool reserve. The above series of events have received high attention from all walks of life, which means that the Chinese government may significantly increase the issuance scale of government bonds in the future, and the People's Bank of China will take buying and selling government bonds in the secondary market as a normal operation in the future.
The author believes that under the current situation, the Chinese government has significantly increased the issuance of treasury bonds with different maturities, which has at least five meanings as follows.
One of the significance of increasing the issuance of national debt is to help provide sufficient funds for the implementation of more expansionary fiscal policies.
At present, the most prominent contradiction of China's macro-economy is still insufficient aggregate demand, with a significant negative output gap. As of March 2024, the year-on-year growth rate of CPI is only 0.1%, and the year-on-year growth rate of PPI has been negative for 18 consecutive months, which is a clear evidence of the negative output gap. Under the complex external environment and the impact of the three-year epidemic, so far, the balance sheets of both enterprises and households are in the process of repair, the expectations and confidence in the future are still low, and the motivation for actively leveraging investment and consumption is not strong. In this context, the effect of expansionary monetary policy is not good, and we must rely on expansionary fiscal policy to actively create demand. However, due to the slowdown of economic growth and the structural adjustment of the real estate industry, on the one hand, the national tax revenue is not satisfactory, and on the other hand, the local government debt has been high. Therefore, to provide financial support for more expansionary fiscal expenditure, the Chinese government will increase the issuance of national debt.
At present, the Chinese government has two convenient conditions for increasing the issuance of national debt. First, there is ample room for issuing national debt. The ratio of China's central government debt to GDP is less than 30%. At present, it is more than 100% in the United States and more than 200% in Japan; Second, the cost of issuing national debt is relatively low. At present, the yield of China's 10-year treasury bonds is only about 2.3%, far lower than the 4.5% of the United States.
The second meaning of increasing the issuance of national debt is to help successfully prevent and resolve the risk of local government debt.
To be fair, even with the implicit debt of local governments, the debt burden of the Chinese government is not too high in the world. For example, according to IMF estimates, the ratio of China's full-size government debt to GDP is about 100% - 110%, significantly lower than that of Japan and the United States. But the problem with China's government debt lies in its unreasonable structure. If the implicit local government debt is included, the central government debt with low cost and long term only accounts for one fifth of the Chinese government debt, while the local government debt with high cost and short term accounts for four fifths. This is just a mirror image relationship with the United States. Among the US government debt, four fifths are government bonds and one fifth are municipal bonds. In particular, among Chinese local government debt, the proportion of provincial government debt with relatively low cost and relatively long term is very low, while the proportion of local government debt in third and fourth tier cities with relatively high cost and relatively short term is very high. In other words, the problem of Chinese government debt is not the total amount but the structure. The unreasonable structure leads to the double mismatch of yield and maturity of Chinese local government debt.
Therefore, in order to successfully prevent and defuse the risk of local government debt, in addition to making the financial rights and powers of the central and local governments more balanced through the reform of the fiscal and tax system, in terms of increment, this means that in the future, we should increase the issuance of high-grade bonds such as national debt and provincial government general debt, and reduce the new borrowing scale of third and fourth tier cities. In terms of stock, In the future, there may be more large-scale replacement of existing debt. For provinces with strong financial strength, it may be enough to issue additional provincial bonds to replace the debts of third and fourth tier cities. However, for some provinces with poor financial strength, the Chinese government may have to issue bonds to replace the local local government debts in the future. By issuing lower cost, longer term national debt and provincial general debt to replace the high cost, short-term local government debt, the Chinese government can successfully resolve the risks associated with local debt. Of course, in this process, how to strengthen financial discipline and curb moral hazard is crucial.
The third significance of increasing the issuance of national debt is to help provide new collateral to China's financial system and promote the bottoming out and recovery of the financial cycle.
Since the beginning of 2024, there has been a "fight" in China's macro financial data. On the one hand, real economic indicators such as consumption growth rate, manufacturing investment growth rate, export growth rate, industrial added value growth rate, and purchasing managers' index are generally recovering. On the other hand, financial related indicators are very sluggish. As of March 2023, the growth rate of M1 in the narrow sense was only 1.1% year on year, hitting a new stage low since January 2022. The year-on-year growth rate of new RMB loans will be - 46% and - 17% respectively in February and March 2023. The underlying reason for the fight between physical data and financial data lies in the significant mismatch between China's current economic cycle and financial cycle.
With the end of the COVID-19 epidemic and the fact of expansionary macro policies, China's economic cycle has been in the rebound stage. However, due to the structural adjustment of the real estate market, the decline of house prices and low trading volume, the bank loan market relying on real estate as the main collateral is not operating smoothly. The decline in collateral value or even the loss of collateral function is an important reason why China's financial cycle is still in a downward phase. In this context, a large-scale increase in the issuance of government bonds can provide new high-quality collateral for China's financial system, which will help ease the decline of China's financial cycle and promote its bottoming and recovery as soon as possible. Once both the economic cycle and the financial cycle rebound, it will not only consolidate the foundation of China's economic growth, but also help reduce the temperature difference between macro data and micro perception.
The fourth significance of increasing the issuance of national debt is to help the central bank restructure the basic currency issuance mechanism and improve the interest rate transmission mechanism.
From 1999 to 2011, China had a double surplus pattern between current account and non reserve financial account for 13 consecutive years, and foreign exchange reserves continued to soar, making foreign exchange reserves the only basic currency issuance mechanism at that time. In order to avoid excess liquidity caused by excessive growth of foreign exchange funds, the People's Bank of China has also had to issue central bank bills and increase the statutory deposit reserve ratio to offset. Before and after the 811 foreign exchange reform in 2015, as foreign exchange reserves stopped growing or even began to decline, the People's Bank of China had to find a new mechanism for issuing basic currency. The Open Market Liquidity Operation (OMO) of the Central Bank and various forms of refinancing (such as SLF, MLF, etc.) have become the new basic currency issuance mechanism. In most developed countries, the central bank's purchase and sale of government bonds in the secondary market is the dominant mechanism for issuing basic currency. Therefore, increasing the issuance of government bonds and normalizing the central bank's operation of buying and selling government bonds in the secondary market will help to integrate China's basic currency issuance mechanism with the international mainstream.
At present, one of the major problems of China's monetary policy transmission is that the transmission from short-term interest rates to long-term interest rates is not smooth. One of the important obstacles is that China lacks a perfect and flexible treasury bond yield curve. The yield curve of government bonds can show the market the exact pricing of the term structure, which helps to transmit short-term interest rate changes to long-term interest rates. Therefore, increasing the issuance of treasury bonds with different maturities will help improve China's treasury bond yield curve and smooth the transmission from short-term interest rates to medium and long-term interest rates.
The fifth meaning of increasing the issuance of national debt is to help promote the high-quality opening of China's financial market and the internationalization of RMB.
At present, China's financial market and the international financial market have been interconnected through a number of channels, such as Shanghai Hong Kong Stock Connect, Shenzhen Hong Kong Stock Connect, Bond Connect, Cross border Wealth Management Connect, QFII and RQFII, QDLP, etc. However, one of the key obstacles restricting the progress of China's financial market opening is the insufficient supply of high-quality bonds (such as national debt, CDB bonds and financial bonds issued by some banks) in the Chinese bond market. Therefore, increasing the scale of national debt issuance can provide foreign investors with financial products of larger scale and higher liquidity.
In addition, since 2018, the People's Bank of China has begun to increase the opening of the domestic financial market to foreign institutional investors as one of the important measures to promote RMB internationalization. Whether in the domestic RMB financial market or the offshore RMB financial market, the insufficient supply of high-quality RMB denominated financial assets has always been a major obstacle to the internationalization of RMB. Therefore, at the same time, increasing the issuance scale of RMB denominated treasury bonds in both the onshore and offshore markets will not only help the government finance, but also help to prosper the financial market, and also help promote the internationalization of RMB, which can be said to kill three birds with one stone.
After the outbreak of the conflict between Russia and Ukraine, the United States government and its allies froze Russia's foreign exchange reserves, which actually means that the US treasury bonds committed a targeted default on Russian sovereign investors. This weaponization of the US dollar has damaged the reputation of US treasury bonds as the safest financial asset in the world. In response, emerging market countries with large foreign exchange reserves will increase efforts to allocate new safe assets globally. China's national debt, as a high-grade bond issued by a large emerging market economy with medium to high speed growth, huge scale and excellent historical credit, has the potential to become an important global safe asset. The Chinese government should seize this opportunity to develop RMB government bonds into safe assets recognized by global investors as soon as possible. This is undoubtedly an important opportunity for RMB internationalization.
Note: This article was published in Fudan Financial Review
(The author introduces: Deputy Director of the Institute of Finance of the Chinese Academy of Social Sciences and Deputy Director of the National Laboratory of Finance and Development)
