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 A consensus is forming in financial markets that the People's Bank
of China (PBOC) is behind the curve with its monetary easing.
China's money supply grew at is slowest pace on record in April
while HSBC said in a report on Tuesday that real monetary conditions
in March were the tightest since 2009.
That makes fiscal stimulus even more important in reviving the
economy but the worry is that local governments will not be able to
spend enough as they have yet to refinance their debts.
To bolster the recovery, the government has projected a 10.6 percent
increase in spending this year and the largest budget deficit since
2009.
Beijing hoped that a quadrupling of the municipal bond market would
provide a channel for local governments to refinance expensive debt,
creating more room to spend.
But not a single municipal bond has yet been issued this year.
Jiangsu province is set to auction the year's first municipal bond
on May 18 after a one-month delay that was widely blamed on a lack
of buying interest from banks already struggling from falling
interest rates and rising non-performing loans.
On Friday, highlighting these fears, the Ministry of Finance, the
central bank and the banking industry watchdog jointly urged banks
not to cut off funding to local government-backed construction
projects facing a funding shortfall.
In the meantime, the central government may have to spend far more
itself to make up for local governments' inability to do so, sources
and analysts suggest.
NEW STRATEGY
The root of the problem is China's $3 trillion pile of local
government debt, mostly raised at high rates through off balance
sheet "local government financing vehicles" (LGFVs).
To rein in this borrowing, Beijing has banned local governments from
raising funds through LGFVs but freed them to issue on balance sheet
municipal debt in a strategy dubbed "closing the back door, opening
the front door."
But with just 400 billion yuan in 2014, there are concerns that the
municipal bond market is too small to do the job.
"If China stops local governments from borrowing through the
existing illicit channels, but doesn't open up new ones, then the
spending supported by this borrowing will stop," wrote Chen Long,
China Economist at economic consultancy Gavekal Dragonomics back in
January when the new policy was announced.
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Local government spending is projected to rise 10.2 percent and
account for a significant portion of this year's overall 10.6
percent increase in government spending.
However, such projections may prove unrealistic as municipalities
battle slowing revenue from land sales -- a big portion of their
budgets.
"As of March 2015, land revenue has fallen 30 percent, worse than
assumed in the budget," wrote Julia Wang, China Economist at HSBC in
a research note on May 7.
"The implication of weaker-than-expected revenue growth is that the
government may be forced to scale back expenditures to keep the
fiscal deficit in check."
In late April the finance ministry highlighted these concerns,
telling local governments to "urgently" issue new municipal bonds to
cover funding shortfalls.
The central government, meanwhile, may have to step in with
additional fiscal stimulus and incentives to entice banks to buy
municipal debt.
For one, the PBOC will soon offer cheap loans backed by the
newly-issued municipal debt with the aim of spurring demand.
The central government also has plenty of firepower left, including
1.7 trillion yuan of fiscal deposits, Wang added.
But mobilizing funds and getting projects off the ground will take
time, which means the economy could be in for a rough few quarters
yet.
($1 = 6.2050 Chinese yuan)
(Editing by Nachum Kaplan and Jacqueline Wong)
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