China’s US$195 billion debt splurge has less bang than you might think

China’s burst of local bond issuance is supposed to fund roads, affordable homes and other infrastructure developments that will help support its flagging economy. But there do not seem to be enough projects around to spend the money on.

Provincial authorities had by the end of September already raised 92 per cent of the 1.35 trillion yuan (US$195 billion) worth of special infrastructure bonds that the central government has targeted for the entire year.

The bonds, which are separate to provincial authorities’ budgets, are part of an attempt to counter the economic slowdown by financing projects from railways to environmental facilities and affordable homes.

But analysis of bond data by Bloomberg News shows that about 42 per cent of the total special bonds sold since August are earmarked for “land reserves,” which means compensating farmers for property acquisition or preparing the acreage for future development.

In short, the economic boost of the debt creation will be less immediate than if it was used to build motorways or redevelop substandard housing straight away.

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“Land reserve bonds are favoured because local officials do not have enough projects in the pipeline when they’re being asked to speed up spending,” said Nie Wen, a Shanghai-based economist at Huabao Trust Co.

“The direct impact on investment is limited. If other funding channels for local governments remain tightly controlled, special bonds alone won’t be enough to restore growth.”

The sudden surge in such debt sold into the market has also had an indirect crowding-out impact: yields on other forms of government bonds have risen, in turn pushing up those on corporate debt.

As China seeks to buffer the domestic economy and shield it from the trade war with the US, the difficulties around the bond programme heighten the chances the nation will just increase indebtedness without stoking growth.

Tax cuts, infrastructure spending and other fiscal stimulus measures are playing an increasing role in the efforts of Chinese policymakers to prevent the world’s second-largest economy from slowing further.

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But data released last week showed that the impact of government spending had yet to kick in, with infrastructure investment sliding to the slowest growth since early 2014.

“Boosting spending in infrastructure will definitely have to rely on government” and special government bonds are an important source to replenish funding for that, said Li Peijia, a senior analyst at the Bank of China’s Institute of International Finance in Beijing.

China started to issue special bonds in 2015 to finance projects from motorways to environmental facilities and affordable homes. Policymakers decide an annual quota in March each year. That has swollen over the years as local authorities grapple with worsening financing conditions as well as increasing downward pressure on the economy.

The spending is seen by some as a turbocharger in boosting investment, as it stays outside the official budget deficit, and it can leverage additional bank loans and even private capital in infrastructure projects.

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“Infrastructure investment growth will likely rebound in the fourth quarter, but it won’t be a big recovery” unless the central government increases its budget deficit and local authorities find alternative financing channels for off-balance-sheet lending, according to a report last week from China International Capital Corporation analysts led by Chen Jianheng.

This year the issuance of special bonds had a slow start amid attempts to clean up the nation’s finances. So when in late July the government told officials to pick up the pace, it led to a flood of hasty selling, and caused an “obvious substitution impact” on bank loans and corporate bonds, the PBOC said last week when it added the debt to its measure of total credit supply.

The slump in net corporate bond sales in September to 8.7 billion yuan from 338 billion yuan in August was “mainly due to the crowding-out effect from the surge in local government bond issuance on private sector financing” according to Lu Ting, chief China economist at Nomura International in Hong Kong.

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The impact of land reserve bonds is limited as is their effect on investment data, according to a report by the fixed-asset research team at China Merchants Bank in mid September.

“Land preparation isn’t included in the calculation of fixed-asset investment,” meaning the biggest share of government special bonds – land reserve bonds – cannot lift the headline investment growth number, analysts wrote in the report.

In addition, the long process from preparing land to initiating a project indicates the bonds will probably not influence local infrastructure investment immediately.

“To some extent special bonds can supplement local fiscal strength, and we can’t overlook their effects on stabilising and lifting overall investment spirits”, said Liu Peiqian, Asia strategist at NatWest Markets in Singapore.

“We expect infrastructure investment growth to rebound moderately toward the end of the year, but it won’t be back again to the double-digit growth of the past.”