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What is the “special debt” used by China to stimulate its economy?

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The Chinese government is running out of money with Covid-19, with tax breaks and a slowdown in real estate dragging revenues down while spending continues to rise to pay for economic stimulus and contain virus outbreaks. One option Beijing has to fill the void is to sell special sovereign bonds, a rarely used financing tool it last dusted off in 2020 to help revive the economy without inflating the budget deficit. Before that, they had been employed during the Asian financial crisis of the 1990s and to help launch China’s sovereign wealth fund in 2007.

1. What are special sovereign bonds?

Unlike ordinary government debt, special bonds raise funds for a certain policy or to help solve a particular problem. They are not part of China’s official budget and are therefore not included in deficit calculations. The State Council, China’s cabinet, can propose the sale of these bonds, which then only requires the approval of a standing committee of the National People’s Congress, which usually meets every two months, rather than the entire legislature, which only meets once a year. . This means they can be issued more flexibly than ordinary bonds, which must be budgeted and approved by the annual NPC session.

2. Why use this tool now?

China has a gross domestic product growth target of around 5.5% for this year, but with Covid shutdowns and a housing crisis, economists say the government is nowhere near achieving it. President Xi Jinping notably hopes to fuel a faster recovery by spending trillions of yuan on infrastructure projects. Financing this type of stimulus through the budget will be difficult, however, given the fall in tax revenues this year. Some of the financing will come from China’s state-owned development banks, such as the China Development Bank and the Agricultural Development Bank of China, which have received an additional 800 billion yuan ($120 billion) line of credit to provide loans for infrastructure investments. Special sovereign bonds could be an additional source, given that some have been used for this purpose in 2020. Wang Yiming, adviser to the central bank’s monetary policy committee, highlighted special national bonds as an option. More likely, the notes could be used to bridge the fiscal gap and fund stimulus measures announced by the government in May, analysts at Australia & New Zealand Banking Group Ltd say. Betty Wang and Xing Zhaopeng.

3. How were these bonds used before?

Some 1 trillion yuan worth of tickets were sold in 2020, at the start of the pandemic. Unusually this time, the Communist Party’s all-powerful Politburo decided to sell the bonds and the NPC gave the official go-ahead at its plenary session in May. Some 700 billion yuan from that sale was transferred to local governments to support their Covid control efforts and infrastructure investments, according to a finance ministry report. The rest went into the central government’s general public budget to subsidize local epidemic-related spending, it says. Before that:

• In 2007, 1.550 billion yuan of special government bonds were issued to capitalize China Investment Corp., the sovereign wealth fund. Proceeds from the bonds were used to purchase foreign exchange reserves from the People’s Bank of China, and those funds then went to CIC. Some of the bonds worth about 950 billion yuan will mature in the second half of this year, according to data compiled by Bloomberg.

• During the Asian financial crisis, China sold 270 billion yuan of special government bonds – at the time the country’s largest bond issue – to raise capital for its major state banks and help offset losses from non-performing assets.

4. How could bonds affect financial markets?

An increase in the supply of bonds would lower security prices and drive up yields. The issuance in mid-2020 helped push the yield on China’s 10-year government bonds up more than 20 basis points in about three weeks, to a nearly six-month high. At the time, liquidity conditions were tight due to a deluge of local government bond supply before special debt hit the market and the central bank’s cautious approach to monetary easing, partly to avoid fueling asset bubbles. The situation is different now. Interest rate cuts and other central bank easing measures mean the country’s banks have plenty of cash they can use to absorb any additional bond supply. In addition, local governments – which issue their own special bonds used primarily for infrastructure investment – have been ordered to sell off nearly all of this year’s 3.65 trillion yuan quota of debt by the end of the year. end of June. This should leave room for the market to absorb new debt issuance in the second half of 2022.

5. How much do we talk?

Jia Kang, a former director of a research institute at the Ministry of Finance, said the 1 trillion yuan sold in 2020 could serve as a “benchmark” for policymakers when deciding how much to issue this year. Others think it could be more. Larry Hu, head of China economy at Macquarie Group Ltd., estimated that this year’s Covid outbreaks in China have likely caused a budget shortfall of 1 trillion to 2 trillion yuan. A sale of this size could contribute 1 to 2 percentage points to gross domestic product growth given the additional financial boost it will give local governments to spend, he estimated, adding that the impact on the financial market should be “limited”.

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