Will China’s central bank use special-purpose vehicles to tackle local government debt?

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The governor of the People’s Bank of China (PBOC) – being the Chinese central bank, has flagged the use of special purpose vehicles (SPVs) to help deal with the worsening dilemma of local government debt. 

PBOC governor Pan Gongsheng (潘功胜) said that “when necessary, PBOC will provide emergency liquidity loan support to those regions where the debt burden is comparatively severe.”

Pan made the remarks on 8 November at the 2023 Financial Street Forum that was held in Beijing.  

Domestic observers have interpreted remarks as indicating that the Chinese central bank is on track to make greater use of SPVs as a tool for resolving local government debt challenges.

The statement from Pan arrives after state-owned media reported in August of this year that PBOC was mulling the launch of new SPVs with the participation of key commercial banks. 

According to the reports, Chinese authorities planned to use the SPVs as a means of providing local government financing platforms with liquidity via low-interest rate financing at longer maturities. 

SPVs come into play during Covid pandemic

PBOC established two SPVs in 2020 during the first year of the Covid pandemic, as part of ongoing financial inclusion policies as well as to help smaller regional businesses to weather the rigours of nationwide lockdown measures. 

The goal of these SPVs was to encourage local banks to provide extensions for loans made to micro-and-small enterprises (MSEs), as well as to increase the share of such loans in their portfolios. 

How SPVs could be used to deal with Chinese local government debt

A research report from Founder Securities speculates on how the Chinese central bank might use SPVs to help deal with local government debt. 

A first step would be to encourage banks to extend the maturities for loans, by providing subsidies or incentives to banks based on a set percentage of these loan amounts.

Local government finance platforms could also use high-quality assets as collateral for low-cost, long-term loans from banks. 

The central bank would then use SPVs for the contractual purchase of some of these loans, before their subsequent repurchase by banks upon the expiration of contracts. 

“If the central bank uses SPVs to inject liquidity into local banks, this would firstly be of benefit to further expanding liquidity in the banking system,” said Tan Yiming (谭逸鸣), chief analyst at Minsheng Securities, to state-owned media. 

“Secondly, banks could provide financial support to local government financial platforms via the SPVs. 

“The platforms would be able to obtain funding at lower interest rates for longer terms, which is of benefit to easing the debt risk of these platforms. This would also free up space on bank balance sheets.”

China on track to accelerate local debt disposal

Ming Ming (明明), chief economist with CITIC Securities, points out that “the financial system has previously made use of special refinancing and other methods to step up the disposal of debt.”

“The current remarks by the central bank governor indicate that the schedule for disposal of debt by the financial system may have accelerated,” Ming said. 

“In addition to the central bank providing emergency liquidity loan support, commercial banks could also use methods such as reducing financing costs and extending debt terms to ease the repayment pressure in certain regions of China.”