Why China will unleash trillions in ultra-long-term treasuries

Regional debt risk, renminbi internationalisation, infrastructure stimulus and fiscal reform are all part of the agenda.

China plans to issue 1 trillion yuan in ultra-long-term treasury bonds this year with tenors ranging from 20 years to half a century, for a range of purposes including the funding of ambitious stimulus plans. 

Domestic analysts say policymakers also hope the copious volume of long-term debt issuance can address some of the most vexing dilemmas for the Chinese economy - chief amongst them regional debt risk and the urgent need for fiscal reform. 

Other policy aims include driving further internationalisation of the renminbi and the opening up of China's financial markets, alongside giving a boost to systemwide liquidity and enhancing the central bank's implementation of open market operations. 

One trillion yuan in ultra-long-term bonds in 2024

On 13 May, the Ministry of Finance (MOF) released its "Notice on Arrangements for the Issuance of Publicly Announced Regular Treasuries and Ultra-Long-Term Special Treasuries in 2024" (关于公布2024年一般国债、超长期特别国债发行有关安排的通知).

According to the Notice, China's first issue of ultra-long-term treasuries in 2024 will take place on 17 May. The 40 billion yuan in treasuries will have a maturity of 30 years and pay yields on a semiannual basis. 

The schedule for ultra-long-term treasury issuance in 2024 runs from July to November, and includes 7 issues of 20-year bonds, 12 issues of 30-year bonds and 3 issues of 50-year bonds.

A distinguishing feature of the ultra-long-term treasuries is their categorisation from a fiscal perspective. This debt will not be included as part of China's deficit, but instead siloed on the balance sheet of a special fund. 

The issuance of ultra-long-term treasuries was one of the landmark announcements made by China's Two Sessions congressional event in March of this year. 

The Government Work Report for the 2024 Two Sessions outlined plans to issue ultra-long-term bonds over each of the next three years. 

According to the Report, China plans to use the bonds to fund  “key national strategic arrangements and the development of security capabilities in key areas.”

Zheng Shanjie (郑栅洁), chair of the National Development and Reform Commission (NDRC), said the launch of ultra-long-term treasures is a "response to deep changes in the global environment."

"The issuance of ultra-long-term special treasuries over the next several years is a key strategic policy of Party Central Committee and the State Council, with a view to the creation of a strong nation and the revival of the people," Zheng said. 

"It can drive current investment and consumption, and create the foundations for long-term high-quality growth."

NDRC previously indicated that funds raised using the new treasuries will mainly focus on "key missions including self-strengthening in technology and science, driving integrated urban-rural development, and shoring up food and energy security."

Trillions in treasuries to fuel stimulus

One of China's leading economists says the new treasury bonds will play a critical role in helping to fund what he considers urgently needed infrastructure stimulus.

Ren Zeping (任泽平), chief economist at Zhongyuan Bank and deputy head of the China Private Economy Research Association (中国民营经济研究会), argues that stimulus is still necessary for the short and long-term well-being of the Chinese economy. 

In an opinion piece widely circulated on Chinese social media, Ren mounted a vigorous defence of the effectiveness of fiscal stimulus both in the recent past and for China's current economic conditions.

"There is some black-and-white thinking in society which is incorrect, such as the smearing of economic stimulus," Ren writes. 

"Right now if you mention stimulus and infrastructure development, some people will say that we're retreading an old path - this is a real misunderstanding. 

"Over the past four decades, if we didn't have infrastructure development that was completed in advance, could China have become such as competitive manufacturing power?"

Ren argues that large-scale infrastructure stimulus will still prove fruitful in boosting China's short-term economic performance and fostering employment, as well as laying the foundations for future growth driven by emerging, high-tech sectors. 

"The most simple and effective means of solving current problems with regard to local government finances and enterprise and household incomes is new economic stimulus and new infrastructure," Ren writes. 

"Going big on infrastructure during economic troughs helps to drive employment, while infrastructure development costs will be comparatively low. 

"At present China has an abundance of excess labour, and prices for commodities such as iron are languishing. It's a great opportunity to go big on infrastructure."

Zhang Ming (张明), deputy head of the Financial Research Institute of the Chinese Academy of Social Sciences, also believes that the conditions remain ripe for further debt-fuelled infrastructure spending. 

"There is extremely ample space for treasury issuance," Zhang writes. 

"Chinese central government debt accounts for less than 30% of GDP – in the US it's more than 100%, and in Japan over 200%."

"Costs for treasury issuance are quite low - at present the yield on China's 10-year treasuries is only around 2.3%, much less than the 4.5% for US treasuries."

Ren stressed the need to focus spending of funds raised via ultra-long-term treasuries on emerging industries that can best drive China's economic growth in future, such as new energy, artificial intelligence and the digital economy. 

"In launching a new round of economic stimulus and spending on new infrastructure, the key thing is that it be 'new,'" Ren writes.

"The focus will be on the creation of a modernised industrial system, and the development of new quality productive forces."

Fiscal reform needed to combat debt risk

The issuance of ultra-long-term treasuries is also a key part of Beijing’s efforts to address the challenges of an imbalanced fiscal system that has become an acute source of systemic risk. 

The existing fiscal system that has been in place since 1994 places onerous spending burdens on local governments, while depriving them of adequate revenues. 

This arrangement has prompted regional authorities to finance their expenditures by using local government investment platforms to covertly ratchet up leverage, leading to perilous levels of debt. 

Local governments also generate revenue via the sale of land rights – which incentivises policies to keep property prices high and puts the conditions in place for regional housing bubbles. 

Luo Zhiheng  (罗志恒), chief macroeconomist at Yuekai Securities, says the issuance of ultra-long-term treasuries will enable Beijing to make a greater volume of transfer payments to cash-strapped local governments, alleviating the need for them to become excessively leveraged. 

According to Luo, the central government will make a total of around 10.2 trillion yuan in transfer payments to China’s local authorities throughout 2024. 

“The launch of ultra-long-term bonds is one means for Beijing to raise funds at a lower cost in large volumes, for the purpose of making transfer payments to cash-strapped local authorities," he said. 

"The move enables local governments to avoid risk-fraught leverage, and gives them greater room for fiscal manoeuvring.”

Optimisation of China’s government debt structure

Central government treasuries could play a key role in reducing risk by optimising China's debt structure and reducing the cost of funds. 

Zhang Ming argues that structural imbalances are the central dilemma when it comes to government debt. 

"The problem with Chinese government debt isn't the quantity but the structure," Zhang writes. "An irrational structure has led to the misallocation of yields and tenors for local government liabilities."

Zhang points in particular to the preponderance of higher-cost, shorter-term debt on the liabilities side of the Chinese government's consolidated balance sheet, due to the overrepresentation of smaller municipal authorities. 

"Treasuries account for four-fifths of US government debt, and municipal debt accounts for just one-fifth," he writes. 

"When it comes to Chinese local government debt, the share of province-level debt which has lower costs and longer terms is very low. 

"By contrast, the share of debt borne by third and fourth-tier municipalities with higher costs and shorter terms is very high.

"If we want to effectively prevent and reduce government debt risk, in addition to fiscal reform that addresses the worsening imbalances between central and local governments, we must also increase the issuance of high-quality bonds such as treasuries and provincial government bonds, and reduce new debt raising by third and fourth-tier cities."

Luo Zhiheng says the issuance of ultra-long-term special treasuries is one way of directly addressing this dilemma. 

"Special bond issuance optimises the debt structure, and reduces debt risk," he said. 

"Ultra-long-term treasuries are high-quality assets, and the central government can issue debt at a lower cost and for longer tenors than local governments."

 

Long-term bonds to boost systemwide liquidity

In addition to reducing the cost of funding for the Chinese government, the issuance of ultra-long-term treasuries is expected to have a range of beneficial effects for the financial system by expanding the volume of high-quality debt assets. 

Zhang Ming believes that recent movements in China's finance cycle have led to a mismatch between macroeconomic trends and levels of liquidity.

According to Zhang, a raft of key economic indices in China are posting improvement, including consumption growth, manufacturing investment growth, export growth, growth in industrial added value and the performance of the Purchasing Managers Index (PMI).  

By contrast, key credit measures are languishing, with total social financing decreasing by nearly 200 billion yuan in April from the previous month, according to figures from Bloomberg. 

"At present, China's economic cycle and its financial cycle are obviously out of synch," Zhang contends. 

Zhang argues that a key reason for weak credit extension is a lack of valuable collateral in the wake of housing price declines. 

"Because of structural adjustments to the real estate market, housing prices have fallen and transaction levels are now tepid. This has undermined lending by banks, who depend on real estate as a key form of collateral. 

"The decline in the value of collateral or the loss of collateral function is a key factor behind the downward trend in China's financial cycle."

Long-term treasury issuance can alleviate this problem, by providing an abundant source of high-quality collateral for the Chinese financial system. 

Upgrades to monetary policy implementation

In addition to facilitating credit growth, an increase in treasury supply could also enhance the Chinese central bank’s implementation of monetary policy, making it more consistent with international practice. 

Zhang points out that reforms implemented in 2015 to loosen China’s exchange rate regime forced the People's Bank of China (PBOC) – the Chinese central bank, to scramble for new channels for the issuance of base money. 

China saw massive inflows of forex during the period from 1999 to 2011, when PBOC undervalued the yuan to boost the country’s export sector. 

In order to keep the exchange rate down, PBOC needed to purchase forex using the yuan in the form of its own base money, to increase the relative supply of the Chinese currency. 

This in turn created the problem of an overabundance of liquidity in Chinese bank accounts. To deal with this problem, PBOC had no choice mop the excess by issuing central bank bills to lenders and raising the required reserve ratio.

According to Zhang, during this period forex purchases also emerged as the primary channel for PBOC to make injections of base money, whenever monetary policy imperatives called for expansions in the money supply. 

The 811 Exchange Rate Regime Reform of 2015 sought to apply more market-based mechanisms to the pricing of the yuan. 

Zhang says this deprived PBOC of its primary channel for increasing the base money supply, by removing the need for it to intervene so actively in forex markets and influence exchange rates. 

This in turn forced the Chinese central bank to make fundamental changes to the tools it used for the implementation of monetary policy. 

“The central bank’s open market operations and various forms of re-loans, including supplementary lending facilities and medium-term lending facilities, have become the new mechanism for base money issuance,” Zhang writes. 

Expanding treasury supply will give PBOC a greater volume of assets to employ for its open market operations, which will become more consistent with the monetary policy practices of advanced economies. 

“In the majority of developed economies, central banks use the trading of treasuries on secondary markets as the primary mechanism for base money issuance," Zhang writes. 

“For this reason, expanding treasury issuance will normalise the trading of treasuries by PBOC on the secondary market, helping China’s issuance mechanisms for base money to dovetail with the international mainstream.”

Increases in the volume of long-term treasuries could also improve the effectiveness of monetary policy, by shedding greater light on market pricing and improving transmission effects via the yield curve. 

“At present a big problem for Chinese monetary policy is lack of transmission from short-term interest rates to long-term interest rates, and a key barrier to this is China’s lack of a sound, highly elastic treasury yield curve,” Zhang writes. 

“The treasury yield curve can provide the market with sound pricing for the term structure, which is of help to transmitting changes in the short-term rate to long-term rates.

“For this reason, increases in the range of tenors for treasuries will help improve the treasury yield curve and monetary policy transmission.”

Accelerating yuan internationalisation

For China's economic policymakers, a final advantage of the sharp increase in long-term treasury supply will be the boost it gives to renminbi internationalisation and efforts to open up China's financial markets. 

This is because large-scale treasury issuance will create a greater volume of high-quality assets denominated in the yuan for offshore investors to hold.

"One of the key barriers to progress on the opening up of financial markets is that the supply of high-quality bonds on the Chinese bond market is inadequate," Zhang Ming writes. 

"Expanding the scale of treasury issuance will provide offshore investors with a greater volume of highly liquid financial assets."

Zhang Ming further points out that US sanctions against Russia provide China with a rare opportunity to drive the internationalisation of the renminbi, given that Washington's actions may have undermined the status of the greenback as a reserve asset. 

"Following the outbreak of war between Russia and Ukraine, the US Federal Government froze Russia's foreign reserves, which amounts to a targeted default on Russia as a sovereign investor," he writes. 

"The weaponisation of the US dollar has harmed the reputation of US treasuries as the most secure global reserve asset."

According to Zhang, China should make haste to capitalise upon this opportunity, adopting measures to elevate its own treasuries to the status of safe harbour asset for global investors. 

"Chinese treasuries are a high-quality bond issued by a large, emerging economy with medium-to-high growth rates and an excellent credit record," he writes. 

"China should seize the opportunity to make renminbi treasuries become a generally accepted safe asset for global investors...this is undoubtedly a key opportunity for internationalisation of the yuan."