China's Bond Market: A New Engine for Growth

China's bond market, the world's second largest, is set to play an even more significant role in driving economic growth as local governments gain more leeway in bond issuance. This shift, driven by the central government's desire to spur economic development, could lead to a more balanced distribution of debt across different levels of government. But what does this mean for the distribution of debt, the sustainability of local government bond issuance, and the overall liquidity and stability of China's bond market?



Firstly, the increased bond issuance by local governments is likely to diversify their funding sources, reducing their reliance on bank loans. This could lead to a more balanced distribution of debt across different levels of government, mitigating risks associated with excessive bank lending. However, it is crucial for local governments to manage their debt levels responsibly to avoid potential defaults and maintain fiscal sustainability.

To ensure the sustainability and solvency of local governments' bond issuance, China has implemented measures such as setting clear debt ceilings, enhancing transparency, and strengthening supervision. The government has established a debt-to-GDP ratio limit of 100% for local governments, with a 60% sublimit for debt service costs. Additionally, the National Development and Reform Commission (NDRC) oversees bond issuance, and the Ministry of Finance (MOF) manages debt risks. These measures have helped maintain local government bond issuance at manageable levels, with a default rate of less than 1% as of 2021.

The increased bond issuance by local governments could also impact the overall liquidity and stability of China's bond market. As of 2021, the total depository balance of China's interbank bond market reached nearly 115 trillion yuan, with a trading volume of over 1,400 trillion yuan. The market, dominated by interbank and exchange markets, is the main trading venue for CGBs, policy bank bonds, and NCDs, popular among overseas investors. The increased bond issuance by local governments could enhance market liquidity, providing more investment opportunities and diversifying asset classes. However, it also raises concerns about potential risks, such as increased debt levels and potential defaults. To mitigate these risks, China has been strengthening its bond market infrastructure and regulations, including the revision of the China Bond Market Handbook (2022) to provide detailed information on market entry processes, investment and trading mechanisms, and FX conversion and hedging.

In conclusion, China's bond market is poised for further growth as local governments gain more leeway in bond issuance. This shift could lead to a more balanced distribution of debt, enhanced market liquidity, and diversified asset classes. However, it is crucial for local governments to manage their debt levels responsibly, and for China to strengthen its bond market infrastructure and regulations to mitigate potential risks. By doing so, China can harness the power of its bond market to drive sustainable growth and reduce regional disparities.