China’s Ministry of Finance (MoF) has recently announced a comprehensive local debt swap programme amounting to 12 trillion yuan (US$1.67 trillion) of special bond quotas over the next few years, an initiative by which it expects to enhance local government bond issuance in November and December.

However, the market is still waiting for a fiscal stimulus package to improve employment and restore consumer confidence. Therefore, the equity market will continue to be volatile in the short term before further stimuli are announced.  

Last week, during a press conference held by the MoF after the NPC Standing Committee meeting, China revealed the details of the latest local debt swap proposal.

Beijing plans to add a 6-trillion-yuan special local government bond quota dedicated to debt swaps between the central and local governments over the period of 2024 to 2026, assigning 2 trillion yuan per year.

In addition, another 4-trillion-yuan special local government bond quota for debt swap is granted over the coming five years starting this year, or approximately 800 billion yuan each year.

Furthermore, the debt of 2 trillion yuan for shantytown renovation due in 2029 and subsequent years will be repaid.

“The first three measures (6 trillion + 4 trillion + 2 trillion) are expected to translate to a 12-trillion-yuan debt swap programme for the next five years (2024 to 2028), which is at the similar level of the first debt swap of 12.2 trillion yuan from 2015 to 2018, and higher than the previous three rounds between 2019 and 2023, which were below 2 trillion yuan,” says Iris Tan, senior equity analyst at Morningstar Research.

The amount of the country's “hidden” local government debt, according to the plan, is projected to decrease to 2.3 trillion yuan by 2028. This will be a significant drop from the 14.3 trillion yuan at the end of last year, as indicated by official data.

“The plan helps reduce the default risks on the LGFVs [local government financing vehicles] and alleviate local governments’ interest expense burden to some extent, therefore, marginally helping local governments’ fiscal status, which has been under stress in recent years,” says Vivian Lin Thurston, a portfolio manager for William Blair’s Emerging Markets Growth Fund at William Blair.   

“Local government bond issuance is likely to speed up in November and December, after the upward revision of the special bond quota,” Morningstar’s Tan notes. “And in the short term, the fiscal easing will increase investors’ risk appetite and boost market confidence. We also expect the PBoC [People’s Bank of China] to inject liquidity to support upcoming increased government bond issuance for the rest of 2024 and 2025.”

However, although the short-term financial burden will be reduced, Tan adds, the total debt, including the operating and hidden debt of LGFVs, is still high, indicating debt repayment pressure is still challenging in the near term.

The recent stimulus emphasizes debt management and risk prevention, Chinese banks point out, in contrast to the large-scale infrastructure investments of 2008, suggesting that future economic policies may prioritize sustainability, risk management, structural reforms and high-quality development.

“However, this is not a fiscal stimulus package that the market expected, in terms of supporting consumption, working down unfinished projects, improving employment and restoring consumer confidence,” Thurston states. “In my view, these remain the key areas that the Chinese government need to address to jump-start the economy and stimulate the recovery.”

Against this backdrop, Chinese equities, according to Thurston, are expected to trade on policies with continued volatility in the short term as the market awaits further potential fiscal stimulus.

“With recent share price action also seemingly pricing in a more aggressive policy stimulus, especially in light of the US election outcome,” James Wang, head of China strategy at UBS Investment Bank Research, argues, “we see the potential for a pullback and believe that a 5% to 10% decline could present a more attractive entry point for investors.”

Yet the MoF hints that there will be more room for fiscal policy support in 2025, targeting consumption, a national dual focus (on major strategic and key security capacity projects), a special bond issuance quota and the issuance of ultra-long special bonds.