On Monday, we highlighted what we called an “insane” debt chart and explained what it means for the PBoC. Here’s a recap:
China has launched a bewildering hodge-podge of hastily construed easing measures that can't seem to get out of their own way. Perhaps the most poignant example of this is how the country’s massive local government debt swap effort — which, as a reminder, aims to restructure a provincial government debt load that amounts to 35% of GDP — is effectively making it more difficult for the PBoC to keep a lid on rates, even as the central bank has embarked on a series of policy rate cuts.
Despite it all, China will likely continue to cut rates over the course of the next six months in a futile attempt to avert an economic and financial market collapse. In the end, the only recourse will be ZIRP and ultimately QE.
With that in mind, consider the following chart from SocGen which shows the projected supply for local government bond issuance in China. If the new muni bonds issued as part of the debt swap program are effectively treasury bonds — as Citi contends— then ask yourself the following question: how effective can benchmark rate cuts possibly be in terms of keeping a lid on rates with CNY20 trillion in new supply of what are effectively treasury bonds flooding the market? The answer is “not very effective,” which means that someone will need to soak up that supply directly. Enter Chinese QE.
As a reminder, we've long said China's LGB refi initiative would eventually form the backbone of Chinese QE. Here is what we said in March when the program was in its infancy: "It seems as though one way to address the local government debt problem would be for the PBoC to simply purchase a portion of the local debt pile and we wonder if indeed this will ultimately be the form that QE will take in China." Similarly, UBS has suggested that when all is said and done, the PBoC will end up buying the new munis outright. From a March client note:
Chinese domestic media citing "sources" saying that the authorities are considering a Chinese "QE" with the central bank funding the purchase of RMB 10 trillion in local government debt. In fact, the "sources" seem to be some brokerage research reports speculating ways of addressing the stock of local government debt, following the MOF announcement that local governments have been given a RMB 1 trillion quota to issue bonds to replace other forms of local government debt.
And so, here we are barely a month into the new LGB debt swap initiative (which, you're reminded, has already morphed into a Chinese LTRO program after the PBoC, recognizing that banks would be generally unwilling to take a 300bps hit in the swap, promised to allow participating banks to pledge the new munis for cash loans which can then be re-lent in the real economy at 6-7%) and the calls have begun for outright QE. Here's Bloomberg:
PBOC should directly or indirectly buy local gov bonds to ease concern that long-term interest rates will climb and help lower leverage, Haitong Securities analysts led by Jiang Chao write in a note today.
Local govts will use up 150-200b yuan of debt swap quota per week: Haitong
About 1.4t yuan of quota remaining, to be used up in 7-8 wks: Haitong
China may announce 3rd installment of debt swap quota in 4Q: Haitong
Local debt issuance sucks liquidity, reduces banks’ capital to buy bonds, contributes to stock slump: Haitong
Note that this rather hyperbolic appeal for implementing full-on QE in China checks all the boxes: there's a reference to bond market illiquidy, an assertion about constraints on bank balance sheets (which, with credit creation stalling in China, is a big deal), and most importantly, a contention that somehow, the LGB debt swap program is contributing to the implosion of China's all-important equity bubble.
A few more 'independent' assessments like these is likely all the PBoC will need to justify joining the global QE parade.