。Fixed Income ● Credit20 February 20192There has been much talk about whether China’s fiscal deficit in 2019 can sustainably beenlarged to 3% of GDP or more. The trouble is, the concept of ‘government borrowing’ in Chinais not being defined clearly. There are so many entities that borrow on behalf of the governmentthat the official fiscal deficit number really depends on what types of borrowing are included.We have decided to analyse China’s consolidated fiscal deficit situation by including all thegovernment borrowing channels that we can track. This has important implications for privateborrowers, such as corporations and banks, whose access to credit resources depends on whatis left over after government borrowing demand is satisfied. Some of the de facto governmentborrowing is done directly under the name of corporate borrowers or banks, making it difficult forcredit analysts to decide whether to treat such debt as government or non-government debt.In this report, we discuss the explicit and implicit government borrowing channels one by one.1. Government bondsGovernment bonds are supposed to be the only tool for funding the government deficit. Theofficial deficit budget is set by the Ministry of Finance at the beginning of each year. Fig 1 showsthe historical amount of the deficit and the ratio of deficit to GDP. The result is by no meansexcessive: the official fiscal deficit as percentage of GDP has consistently been at or below 3%,and the ratio declined during 2017 and 2018.Official vs real public sectordeficit The official fiscal deficit significantly underestimates the real situationif all forms of borrowings with no credit risk are included Government credibility is the last line of defence for financial stabilityand cannot be tested when the economy faces a serious slowdown Offshore LGFV bond default risk reduced; buy CHDXCH’21 andCQNANA’21 3Fixed Income ● Credit20 February 2019 1. Official fiscal deficit and as percentage of GDPSource: Ministry of Finance, HSBCThe central government’s official deficit is financed by China government bonds (CGBs) issuedby the Ministry of Finance. This part is straight forward: each year, net CGB issuance hasclosely tracked the central government’s fiscal deficit budget, as Fig 2 shows. 2. Official central government deficit and net issuance of CGBSource: Ministry of Finance, Wind, HSBCHowever, the local governments’ fiscal deficits are trickier to track. They are supposed to befinanced by the municipal bonds (‘munis’) issued by local governments. But, as Fig 3 shows, netissuance of munis has been well above the official local government fiscal deficit since 2015.The huge gap exists for two reasons, or two initiatives: muni project bonds and muni swaps, andboth have the effect of underreporting local governments’ deficits.1.00% 1.50% 2.00% 2.50% 3.00% 3.50%-5001,0001,5002,0002,500 2013201420152016201720182019E RM Bb n Offical central gov fiscal deficit budgetOfficial local gov fiscal deficit budget Total official deficit budget / GDP ratio, RHS 0.0% 0.2% 0.4% 0.6% 0.8% 1.0% 1.2% 1.4% 1.6% 1.8% 2.0%-2004006008001,0001,2001,4001,6001,800 201320142015201620172018 RM Bb n Offical central gov fiscal deficit budgetNet issuance, CGBNet issuance, CGB / GDP, RHS Fixed Income ● Credit20 February 20194 3. Official local government deficit and net issuance of munisSource: Ministry of Finance, Wind, HSBCFirst, muni project bonds. These are issued in massive amounts, but not included in localgovernment fiscal deficits. There is an argument that muni project bonds’ interest and principalpayments should come strictly from the underlying projects that the bonds’ proceeds are putinto. These projects will pay for themselves; if they don’t, investors – not the government – mustbear the loss. Thus, muni project bonds could be excluded from local governments’ fiscaldeficits. But the market does not agree. If muni project bonds are indeed project bonds insteadof government borrowing, the market would have demanded much higher premiums over theissuance price of muni general bonds, which are officially admitted to be government borrowing.In reality, there is a negligible difference in the issuance cost between these two types ofgovernment bonds, as Figs 4 and 5 show. 4. Primary market issuance price, 3Ymunis, monthly series 5. Primary market issuance price, 5Ymunis, monthly seriesSource: Wind, HSBCSource: Wind, HSBCThen there is the muni swap programme. From 2015 to 2018, local governments cumulativelyissued RMB12.17trn of munis and used the proceeds to repay their other borrowings that0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0%-1,0002,0003,0004,0005,0006,0007,000 201320142015201620172018 RM Bb n Official local gov fiscal deficit budgetNet issuance, Muni Official local gov fiscal deficit budget / GDP, RHSNet issuance, Muni / GDP, RHS2.002.503.003.504.004.50 2015201620172018 Muni General BondMuni Project Bond2.002.503.003.504.004.505.00 2015201620172018 Muni General BondMuni Project Bond 。。。。。。