Large-scale debt swap eyed to boost economy

China is likely to approve a debt swap program worth trillions of yuan as the beginning of a broader plan to decisively forestall any downward economic spiral, economists and policy advisers said.

The debt resolution program — set to be the biggest of its kind in recent years — reflects policymakers' priority not only to stimulate short-term growth, but also to proactively tackle major structural challenges, opening the door to further substantive policy support, they said.

The policy focus for the coming quarters should include further addressing local governments' delayed payments to businesses, acquiring idle housing and helping struggling real estate developers overcome difficulties, they said.

The economists and advisers added that by alleviating debt pressures facing local governments, the debt swap plan will improve corporate performance, reinvigorate business expectations and serve as an important stepping stone to economic stabilization.

Noting that this approach is as essential as direct demand stimulus, Robin Xing, chief China economist at Morgan Stanley, said, "Resolving the debt issue is a critical step in stopping a key deflationary downward spiral."

Xing added that the debt swap program would go beyond merely reducing interest payments. "It can improve the liquidity and balance sheets of local businesses (as local governments honor payables), but more fundamentally, restore stability in the regulatory environment and thus business expectations."

He estimated that the debt swap program will be no less than 6 trillion yuan ($843 billion) over multiple years, with the central government taking over some local debt burdens, and added that this year may see a 2 trillion yuan supplementary fiscal package for local debt resolution and bank recapitalization.

Finance Minister Lan Fo'an said on Saturday that the Finance Ministry plans to increase the debt limit by a large scale at once and replace the hidden debt of local governments, without disclosing the specific size of the plan.

The market is waiting for the Standing Committee of the National People's Congress, the country's top legislature, to convene in late October or early November to approve the specifics of the plan.

Sheng Zhongming, a research fellow at the CF40 Institute, which is affiliated with the China Finance 40 Forum think tank, said that a debt swap would convert high-cost and structurally complex implicit debt into more sustainable low-cost and standardized government bonds, reflecting a policy orientation of securing this year's growth target while tackling persistent structural problems.

China must confront the key structural issues of local debt risks, outstanding government payments to businesses, real estate concerns and the recapitalization needs of banks, Sheng said, which will require at least 10 trillion yuan in additional public funds over several years in order to be effectively addressed.

Wang Yiming, vice-chairman of the China Center for International Economic Exchanges, suggested leveraging central government funding to address local governments' overdue payments to businesses that accumulated during the COVID-19 pandemic.

To further address the real estate downturn, a feasible solution could be establishing a special fund, financed by fiscal funds, to acquire housing stock and convert it into government-subsidized rental housing for new urban residents, said Wang, who also serves as a monetary policy committee member of the nation's central bank.

Li Daokui, director of Tsinghua University's Academic Center for Chinese Economic Practice and Thinking, said it is imperative to address the situation in which local governments face extremely tight cash flows while banks are flush with liquidity.

Li suggested that local debt at least equivalent to 20 percent of the country's GDP, or around 30 trillion yuan, should be replaced with longer-term treasury bonds.