Zhang Ming is Deputy Director of the Institute of Finance and Banking, Chinese Academy of Social Sciences, Deputy Director of the National Finance and Development Laboratory, and Director of the China Chief Economist Forum
On October 24, 2023, the Chinese government announced the issuance of an additional 1 trillion yuan of government bonds, and all the funds raised from the issuance of government bonds will be arranged to local governments through transfer payments, focusing on supporting post-disaster recovery and reconstruction and improving disaster prevention, mitigation and relief capabilities. The government work report of the two sessions in 2024 pointed out that from this year, it is planned to issue ultra-long-term special treasury bonds for several consecutive years, which will be used for the implementation of major national strategies and security capacity building in key areas, and 1 trillion yuan will be issued this year. On April 23, 2024, the Ministry of Finance expressed its support for the PBOC to gradually increase the purchase and sale of treasury bonds in open market operations to enrich the monetary policy toolbox. The person in charge of the relevant department of the central bank said in an interview that the mainland central bank can carry out treasury bond trading in the secondary market, which can be used as a liquidity management method and a reserve of monetary policy tools. The above-mentioned series of events have received great attention from all walks of life, which means that the Chinese government may significantly increase the scale of treasury bond issuance in the future, and the PBOC will make the trading of treasury bonds in the secondary market a normal operation in the future.
In the author's view, under the current situation, the Chinese government has significantly increased the issuance of treasury bonds of different maturities, which has at least five meanings.
One of the implications of increasing government bond issuance is that it will help provide sufficient funds for a more expansionary fiscal policy.
At present, the most prominent contradiction in China's macroeconomy is still the lack of aggregate demand, and there is a significant negative output gap. As of March 2024, the year-on-year growth rate of CPI is only 0.1%, and the year-on-year growth rate of PPI has been negative for 18 consecutive months, which is a clear proof of the negative output gap. Under the complex external environment and the impact of the three-year epidemic, the balance sheets of both enterprises and households are in the process of repairing so far, and the expectations and confidence in the future are still low, and the motivation to actively increase leverage investment and consumption is not strong. Against this backdrop, expansionary monetary policy is not working well and must rely on expansionary fiscal policy to actively create demand. However, due to the slowdown in economic growth and the structural adjustment of the real estate sector, on the one hand, the national tax revenue is not satisfactory, and on the other hand, local government debt is already high, so it is necessary to provide financial support for more expansionary fiscal spending, and the Chinese government has become the meaning of the issue.
At present, the Chinese government has two convenient conditions for increasing the issuance of treasury bonds. First, there is ample room for the issuance of government bonds. China's central government debt-to-GDP ratio is less than 30%, and currently more than 100% in the United States and more than 200% in Japan. Second, the cost of issuing government bonds is relatively low. At present, China's 10-year government bond yield is only about 2.3%, far lower than the 4.5% in the United States.
The second significance of increasing the issuance of government bonds is that it will help to successfully prevent and resolve the risk of local government debt.
To be sure, even with the implicit debt of local governments, the Chinese government's debt burden is not too high globally. For example, according to IMF estimates, China's full-caliber government debt-to-GDP ratio is around 100%-110%, significantly lower than that of Japan and the United States. But the problem with China's government debt is that it is not structurally structured. If local government implicit debt is included, only one-fifth of China's government debt is low-cost, long-term central government debt, while high-cost, short-term local government debt accounts for four-fifths. This is a mirror image of the United States, where the U.S. government accounts for four-fifths of the U.S. government's debt, and municipal debt accounts for one-fifth. In particular, the proportion of local government debt in China is relatively low-cost and long-term, while the proportion of local government debt in third- and fourth-tier cities with relatively higher costs and shorter maturities is high. In other words, the problem with China's government debt is not the aggregate but the structure, which leads to a mismatch between yield and maturity of China's local government debt.
Therefore, in order to successfully prevent and resolve the risk of local government debt, in addition to making the financial power of the central and local governments more balanced through the reform of the fiscal and taxation system, in terms of increment, this means that in the future, the issuance of high-grade bonds such as government bonds and provincial government general bonds should be increased, and the scale of new debt borrowing in third- and fourth-tier cities should be reduced. For provinces with greater fiscal strength, the issuance of additional provincial bonds to replace the debt of third- and fourth-tier cities may be sufficient, but for some provinces with less fiscal strength, the Chinese government may have to issue government bonds to replace local government debt in the future. By issuing lower-cost, longer-maturity treasury bonds and provincial general bonds to replace high-cost, short-maturity local government debt, the Chinese government can successfully mitigate the risks associated with local government bonds. Of course, in this process, how to strengthen financial discipline and curb moral hazard is crucial.
The third significance of increasing the issuance of treasury bonds is that it will help provide new collateral to China's financial system and promote the bottoming out of the financial cycle.
So far in 2024, there has been a "fight" in China's macro-financial data. On the one hand, the growth rate of consumption, manufacturing investment, exports, industrial added value, purchasing managers' index and other real economic indicators are generally rebounding, on the other hand, the performance of financial-related indicators is very sluggish. As of March 2023, the year-on-year growth rate of narrow money M1 was only 1.1%, hitting a new low since January 2022. The year-on-year growth rate of new RMB loans was -46% and -17% in February and March 2023, respectively. The deep-seated reason for the fight between physical data and financial data lies in the significant mismatch between the current Chinese economic cycle and the financial cycle.
With the end of the pandemic and the fact of expansionary macro policies, China's economic cycle is already in a rebound phase. However, as the real estate market is in a phase of structural adjustment, falling house prices and sluggish transaction volumes, the bank loan market, which relies on real estate as the main collateral, has not functioned well. The decline in the value of collateral and even the loss of collateral function is an important reason why China's financial cycle is still in a downward phase. Against this backdrop, a massive increase in government bond issuance can provide new high-quality collateral for China's financial system, which will help mitigate the downturn in China's financial cycle and help it bottom out as soon as possible. Once both the economic cycle and the financial cycle pick up, this will not only strengthen the foundation of China's economic growth, but also help reduce the temperature difference between macro data and micro feelings.
The fourth significance of increasing the issuance of treasury bonds is to help the central bank reconstruct the base money issuance mechanism and improve the interest rate transmission mechanism.
From 1999 to 2011, China experienced a double surplus in the current account and non-reserve financial account for 13 consecutive years, and foreign exchange reserves continued to soar, making foreign exchange account the only base currency issuance mechanism at that time. In order to avoid excess liquidity due to excessive growth in foreign exchange holdings, the PBOC also had to offset them by issuing central bank bills and raising the statutory reserve ratio. Around the time of the 811 exchange rate reform in 2015, China's central bank had to look for a new base currency issuance mechanism as foreign exchange reserves stopped growing or even began to decline. The central bank's open market liquidity operations (OMO) and various forms of relending (e.g., SLF, MLF, etc.) became the new base money issuance mechanism. In most developed countries, central banks are the dominant base money issuance mechanism for buying and selling government bonds on the secondary market. Therefore, increasing the issuance of treasury bonds and normalizing the operation of the central bank in the secondary market will help bring China's base currency issuance mechanism into line with the international mainstream.
One of the major problems with the transmission of China's monetary policy from short-term to long-term interest rates is the lack of a well-developed and resilient treasury yield curve. The Treasury yield curve can show the market exactly how the term structure is priced and can help transmit changes in short-term interest rates to long-term interest rates. Therefore, increasing the issuance of treasury bonds of different maturities will help improve China's treasury bond yield curve and dredge the transmission from short-term interest rates to medium- and long-term interest rates.
The fifth significance of increasing the issuance of treasury bonds is that it will help promote the high-quality opening of China's financial market and the internationalization of the renminbi.
At present, China's financial market and the international financial market have been interconnected through a number of channels, such as Shanghai-Hong Kong Stock Connect, Shenzhen-Hong Kong Stock Connect, Bond Connect, Cross-boundary Wealth Management Connect, QFII and RQFII, QDII, QDLP, etc. However, one of the key obstacles to the opening up of China's financial market is the insufficient supply of high-quality bonds (such as government bonds, CDB bonds, and financial bonds issued by some banks) in China's bond market. Therefore, increasing the scale of treasury bond issuance can provide foreign investors with larger-scale and more liquid financial products.
In addition, since 2018, the People's Bank of China (PBOC) has begun to increase the opening of the domestic financial market to foreign institutional investors as one of the important levers to promote the internationalization of the RMB. Whether in the onshore or offshore RMB financial market, the insufficient supply of high-quality RMB-denominated financial assets has always been a major shortcoming restricting the internationalization of RMB. Therefore, increasing the issuance of RMB-denominated treasury bonds in both the onshore and offshore markets will not only help the government finance, but also help to prosper the financial market, and promote the internationalization of the RMB.
After the outbreak of the Russia-Ukraine conflict, the US government and its allies froze Russia's foreign exchange reserves, which effectively means a targeted default of US Treasury bonds on Russian sovereign investors. This weaponization of the dollar has damaged the reputation of U.S. Treasuries as the safest financial asset in the world. In response, emerging-market countries with large foreign exchange reserves will step up their global allocation of new safe assets. As a high-grade bond issued by a large emerging market economy with medium and high-speed growth, huge scale and excellent historical credit, Chinese government bonds have the potential to become important safety assets in the world. The Chinese government should seize this opportunity to develop RMB government bonds into a safe asset recognized by global investors as soon as possible. This is undoubtedly an important opportunity for the internationalization of the RMB.
