China Wants Banks To Bail Out Government

Peter Fricke | Contributor

In an effort to revive its moribund economy, China is embarking on a massive stimulus program to boost commercial lending and alleviate debt burdens on local governments.

An “extra urgent” joint directive issued by China’s Finance Ministry, central bank, and top banking regulator earlier this week will allow commercial banks to use bonds purchased from local governments as collateral on cut-rate loans from the central bank, The Wall Street Journal reported Wednesday.

The measure has two main goals: to help local governments restructure debts by issuing new bonds, and to provide banks with liquidity to allow for increased lending. (RELATED: China Lets State Firm Default on Debt for First Time)

Earlier this year, Fortune reported that borrowing by local governments had surpassed $3 trillion—about a third of China’s GDP—prompting the Ministry of Finance to authorize the issuance of $160 billion in low-interest bonds to pay off higher-cost debts. Previously, local governments were not allowed to issue bonds, forcing them to finance construction and infrastructure projects with high-interest loans.

Banks, however, were reluctant to purchase the new bonds, mainly because they could earn far greater returns from traditional lending, even after a series of recent interest-rate cuts. (RELATEDE: We Can Outgrow China)

The new directive seeks to make the bonds more attractive by eliminating that tradeoff. Under the new rules, banks will be able to purchase the bonds without reducing their lendable funds, because the central bank will effectively reimburse them for the cost.

The urgency with which the scheme was implemented suggests growing concerns among government officials about China’s long-term growth prospects.

The latest data indicate that China’s economy is on pace for its worst performance in 25 years, according to Reuters, and some authorities are even worried that the country will fail to meet its 7 percent target growth rate for 2015. (RELATED: China Overtakes US as World’s Largest Economy)

Louis Kuijs, China economist at Royal Bank of Scotland in Hong Kong, told Reuters that China has already tried conventional monetary stimuli such as cutting interest rates and reducing capital reserve requirements for banks, and predicted presciently that, “This type of data will motivate policymakers to further ease on the monetary and fiscal sides.”

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