Minmetals Securities: Fundamental Change in Debt-to-Equity Thinking

Minmetals Securities released a research report stating that the overall debt-for-bond plan is in line with market expectations. The strategy of borrowing to repay old debts is in line with market logic, and the funds used for debt-for-bond are still mainly at the local level, without transferring local debt responsibilities to the central government. This is beneficial for clarifying responsibility. Overall, the debt-for-bond plan meets expectations, but there is still room for improvement in terms of scale and speed of implementation. In addition, to ensure that the economy does not enter a contraction phase during the debt-for-bond process, a larger scale of funding is needed for debt restructuring rather than just incremental debt, and the actual stimulus policy requires the central government to leverage more. Therefore, it is believed that fiscal policy will further expand in 2025. Minmetals Securities' main points are as follows: The overall debt-for-bond plan is in line with market expectations. The strategy of borrowing to repay old debts is in line with market logic, and the funds used for debt-for-bond are still mainly at the local level, without transferring local debt responsibilities to the central government. Minmetals Securities believes that the total scale of the 10 trillion debt-for-bond plan is divided into two categories: existing and incremental policies. Initially, the 800 billion local government special bonds set aside for five consecutive years are taken from existing special bonds, which belong to existing policy. This is expected to reduce the funds available for infrastructure investment in the coming years, resulting in a convergence of investment amounts and project numbers related to infrastructure over the next five years. Secondly, in the incremental policy, the additional 6 trillion government debt ceiling is arranged in three stages, meaning that 2 trillion of new debt-for-bond funds will be added each year. Although it may not quickly solve the bottleneck problem of debt in the macro economy in the short term, the debt-for-bond plan to be introduced as scheduled is expected to gradually improve the expectations of local enterprises, especially private enterprises, and help restore confidence. Matching the use of local funds for debt restructuring is an increase in the amount of central transfers to local governments. Although the 800 billion withdrawn from local government special bonds is mainly for infrastructure, the decrease in investment will further weaken local demand and may create a weak investment-consumption cycle. In addition, since 2022, local finances have been affected by the decline in land transfer income, leading to deficits in some areas. Using existing funds for debt restructuring is a more conservative approach. In light of this, the Ministry of Finance has proposed measures to increase transfer payments to ensure smooth progress of the debt-for-bond plan while meeting local spending needs. Overall, the debt-for-bond plan meets expectations, but there is still room for improvement in scale and speed of progress. If local governments do not add new debt and use investment expenditures for debt restructuring, it means that investment entities may further shift towards the central government. In addition, the increased transfer payments may further raise the fiscal deficit rate. In the long run, the key to resolving the debt issue still lies in economic growth. To return economic growth to normal, it is necessary to move away from the gravitational pull of debt and real estate downturns and to solve current bottlenecks through continuous liquidity injection, debt restructuring, and promoting the repair of balance sheets to create a mild inflation growth environment. Minmetals Securities believes that to ensure that the economy does not enter a contraction phase during the debt-for-bond process, a larger scale of funding is needed for debt restructuring rather than just incremental debt, and the actual stimulus policy requires the central government to leverage more. Therefore, the fiscal policy will further expand in 2025. In 2023, the national budget deficit was set at 3%, with the budget being adjusted in October 2023 to add 1 trillion yuan to the deficit, resulting in a final fiscal deficit rate of 3.8%. The final deficit rate in 2025 is expected to exceed 4%. Secondly, further expanding the size of ultra-long-term national bonds to over 2 trillion yuan. Unlike other fiscal tools, ultra-long-term special national bonds are more flexible and can be expanded to support different areas based on demand. In addition to further implementing the "two new" and "two heavy" policies and the issuance of special national bonds to support large state-owned commercial banks in replenishing core Tier 1 capital proposed at the October Ministry of Finance meeting, support may also be provided for people's livelihood areas. Specific directions and amounts will need to wait for the Two Sessions in 2025. Risk warning: 1. If the scale and speed of debt restructuring are too slow, it may lead to a slow recovery of market expectations and slow down the uplift of asset prices. 2. Influenced by the geopolitical uncertainties in 2025, stronger incremental policies may be needed.