PBOC may use new tools to prop up local govt bonds

Measures could include liquidity infusion through policy banks, say sources

The People's Bank of China, the central bank, is considering new monetary tools to shore up the local government bond market, which could see issuances of about 1.6 trillion yuan ($258 billion) this year, analysts said.

While the central bank may not directly purchase the bonds, it would still be present in the market with the targeted re-lending scheme, the sources said.

The PBOC may chose to inject liquidity through policy banks such as China Development Bank for debt swaps, Caixin magazine reported, citing an unidentified source.

That measure is separate from the widely expected Medium-term Lending Facility or Pledged Supplementary Lending, but in essence is targeted relending, with terms of longer than 10 years.

Last July, the CDB received a 1 trillion yuan PSL, allowing it to use loans as collateral to get funds from the PBOC. The funds were subsequently invested in social housing projects.

Last month the PBOC injected another $32 billion into the CDB, Caixin reported, which fueled expectations that last year's PSL game could replay, this time by extending the eligible collateral to local government bonds.

Ma Jun, chief economist at the central bank's research bureau, declined to verify the issue to China Daily, citing the sensitivity of the issue. He said such efforts would require cross-department coordination.

Ma last week denied that the PBOC would directly buy the bonds. Following his remarks, yields on bonds issued by policy banks rose by 10 basis points.

But the fact that he did not explicitly rule out the possibility of indirect purchases, fueled hopes of an "upcoming PSL".

The Finance Ministry had in March announced a 1 trillion yuan debt-for-bonds swap plan that would save local governments up to 50 billion yuan in interest payments a year.

However, Jiangsu province on April 23 delayed a 64.8 billion yuan bond issuance after failing to agree with banks on the issuance price.

This scenario could be repeated in other parts of China, because banks stand to lose money on low-yielding government bonds.

With an average money cost of 4 percent, commercial banks would lose 500,000 yuan to 2 million yuan for every 100 million yuan bonds they purchase, financial institutions estimated.

The bonds are also considered by banks as not liquid because they cannot be pledged for repos.

Wang Tao, chief China economist with UBS, said:" It is likely in the future that the PSL would be collateralized with local government bonds, or commercial banks may be able to use those bonds as collateral to access "on-lending" liquidity from the central bank.

"Fundamentally, we do not consider this to be materially different from how PBOC has managed China's base money supply in the past. The only difference is that the type of collateral used will now include new bonds once they are available, along with longer terms of liquidity provision," she said.

Wang said the expansion of PSL does not mean that China has run out of other means to increase base money supply, but the government chose to use PSL or other similar liquidity facilities due to a belief that they can deliver more targeted easing to desirable sectors.

Local governments also ramped up their own efforts to increase the appeal of their bonds. Authorities in at least five cities are accepting local-government bonds as collateral, Bloomberg reported on Wednesday, citing people familiar with the matter.

Governments require collateral when they deposit cash at competing commercial banks. Typically, only central government bonds qualify.

The Caixin report also said that officials at bank headquarters are unwilling to buy these bonds, but officials at local branches tried to persuade them out of concern over local governments' deposits, which is a main source of bank deposits.

Two researchers from the Institute of Finance and Banking under the Chinese Academy of Social Sciences said in an academic journal on Wednesday that the circumstance for issuing municipal bonds are far from mature, so the Finance Ministry should consider issuing special State treasuries instead.

Provincial authorities estimated they had 16 trillion yuan of direct debt by the end of 2014, a 47 percent jump from 18 months ago, an official with the ministry said earlier.

Debts falling due this year is estimated at 2.9 trillion yuan, or 4.2 percent of the country's GDP, the China International Capital Corp said in a recent report.

zhengyangpeng@chinadaily.com.cn