Does China need its own Fannie Mae to combat rampant macro-debt?

Chinese deficit expected to hit 10 trillion yuan. Real interest rates diverge from central bank's benchmark rate

Our briefing on critical economic and financial developments in China as of Tuesday, 22 October, 2024:

• Renowned Chinese economist Lu Zhengwei has called for the establishment of Fannie Mae or Freddie Mac-style financial institutions in China to help deal with rampant growth in macro-debt levels.

• Prominent Chinese economist Li Xunlei sees the deficit rising to as high as 10 trillion yuan, as policymakers commit to hitting GDP growth targets in 2024.

• China’s loan prime rates (LPR) fall across both tenors in October, yet analysts point out that real lending rates have already diverged from these benchmark levels as the central bank unleashes loosening measures.

China needs its own Fannie Mae to combat virulent growth of macro-debt: Lu Zhengwei

A leading Chinese economist says the establishment of a Fannie Mae or Freddie Mac-style government sponsored enterprise is the best way for China to deal with the ongoing rise in its macro-debt levels.

Lu Zhengwei (鲁政委), chief economist at Industrial Bank, points out that China's overall macro-leverage has continued to rise despite the Covid pandemic abating several years ago.

"China's non-financial sector leverage ratio has already exceeded the US, is markedly ahead of Germany, and approaching that of France," Lu said at the Third China Economic Observer Round Table held in Shanghai on 19 October.

Lu cited figures from the Chinese Academy of Social Sciences (CASS) indicating that the country's macro-leverage ratio currently stands at 296%, after surging over 50 percentage points since the start of the Covid pandemic.

"By 2019, we already believed that (macro-leverage) couldn't raise any further, when it stood at around 240%," Lu said. "However, since then it's risen by over 50 percentage points."

While China has continued to enjoy steady growth and yields for its treasuries have actually declined despite rising debt levels, Lu considers a reduction in the country's macro-leverage to be an urgent task for Chinese policymakers.

To this end, he's called for China to follow the lead of the US, with the establishment of a "national housing bank" (国家住房银行) that would be a government-sponsored entity (GSE) in the style Freddie Mac or Fannie Mae.

According to Lu, the move would permit China to deal with the copious volume of debt in the economy - including hidden regional debt that could remain unaccounted for by official figures, via the issuance of GSE bonds that are given a more favourable risk rating on the balance sheets of commercial banks.

"When US commercial banks buy Fannie Mae or Freddie Mac bonds, the risk weighting is 20%, as compared to 100% for standard enterprise loans," Lu said.

"At present...China's hidden debts are likely over 40% of GDP according to 2023 data...but there is no need to transfer the 'hidden debt' of local government to the central government.

"Instead, we can convert them into GSE bonds."

Lu points to China's railroad bonds as setting a sound precedent for the widespread purchase of institutional debt by the country's commercial banks.

China's deficit could hit 10 trillion yuan this year

Li Xunlei (李迅雷), chief economist at Zhongtai Securities, provides a succinct round up of the latest set of accelerated fiscal policy signals sent by China's Ministry of Finance (MOF) since the end of September.

These include:

1. Outlining up to 10 trillion yuan in deficit spending to dispel the "misconception that "fiscal policy isn't sufficiently active."

Li points out that China has made arrangements for a normal budget deficit of over four trillion yuan for 2024, on top of which Beijing has also set a special bond quota of 3.9 trillion yuan, and made plans for the issuance of 1 trillion yuan in ultra-long-term treasuries.

Given that Beijing could also issue a further trillion yuan in special treasuries for disaster relief measures held over from last year, Li estimates that the fiscal deficit could be on track to exceed 10 trillion yuan.

"The central government's finances still have considerable room for raising debt and increasing the deficit," finance minister Lan Fo'an has announced.

2. Optimisation of the current budget, with a focus on property market recovery

"The core will be increasing the scope of usage for special bonds," Li writes, with new spending goals to potentially include:

• Supplementing the capital of state-owned banks and other SOE's.

• Purchasing apartment blocks for social housing.

• Buying back idle land for development.

"This will be of benefit to small and medium-sized banks and real estate developers, as well as arresting the decline of the property market and restoring its stability,” Li wrote.

3. "Quantitative increase policies."

Li sees this as including:

i) A one-time increase in the bond quota for local governments to swap out their "hidden debts", which means allowing local governments to engage in large-scale refinancing.

ii) The issuance of special treasuries to supplement the tier-1 capital of banks.

iii) Expanding special bond issuance to fund the acquisition of of land and residential housing.

iv) The allocation for greater funds to aged care, student assistance and aid for disadvantage groups.

Li Xunlei further points out that in order to avoid local government debt problems in future, MOF has placed heavy emphasis on:

i) Refusal to use central government treasuries to swap out or replace local government debt or hidden debt.

"The total debt borne by local government hasn't at all fallen, it's just that interest costs have declined,” he writes.

ii) No further increases in the hidden debt of local government.

China's benchmark interest rates decline, yet real lending rates fall further

The loan prime rates (LPR) announced on 21 October came in at 3.1% for the one-year tenor and 3.6% for the five-year tenor, both declining by 25 basis points compared to the prints for September.

The LPR is based upon a survey of the interest rates provided by a cohort of China's leading commercial banks to to their best customers, and is intended by the People's Bank of China (PBOC) - which is the Chinese central bank - to serve as the financial market's benchmark rate.

The LPRs invariably follow changes in PBOC's policy rates - which are the rates for the central bank's open market operations instruments.

Declines in the LPRs for October were widely anticipated following monetary loosening measures implemented by PBOC at the end of September.

On 25 September, PBOC reduced the policy rate for its medium-term lending facility (MLF) by 30 basis points to 2%, while on 27 September it reduced the policy rate for its 7-day reverse-repo by 20 basis points to 1.50%.

PBOC also reduced the required reserve ratio - the ratio of central bank money that commercial banks are required to hold against deposits, by 0.5 percentage points, in a move expected to unleash one trillion yuan in long-term funds.

While LPRs are supposed to reflect rates provided by banks to their best customers, Wen Bin (温彬), chief economist with China Minsheng Bank, points out that loosening measures including window guidance from PBOC have caused actual interest rates to diverge markedly from the benchmark rate.

In September, for example the weighted average interest rate for new enterprise loans was already 3.63% - 21 basis points lower than the print for the same period last year.

In the same month new personal home loan rates were 3.32%, around 2 basis points lower than for the previous month, and 78 basis points below the reading for the same period last year.