Scale-up of special-purpose bonds likely

Areas of investment to include emerging industries, urban redevelopment

China is giving local governments more say with their special-purpose bonds to invest in a broader range of areas, while also streamlining the approval process. This policy shift is expected to help translate into greater domestic demand and provide a much-needed boost to the economic momentum in the year ahead, analysts said.

China is likely to scale up the quota for local government special-purpose bonds, in addition to the widely anticipated increase in the deficit ratio for this year, creating a powerful fiscal stimulus that can help offset external headwinds and maintain a stable growth trajectory for the world's second-largest economy, they added.

Local authorities have been granted more flexibility in channeling their special-purpose bonds toward project categories as long as they are not included on the negative list released by the State Council, the country's Cabinet, the government said in a document published in late December.

China's public finance ecosystem comprises central government and local government debt. While central government debt can be equated to treasury bonds, local government debt is financed through the issuance of general bonds and special-purpose bonds.

Special-purpose bonds are dedicated to financing projects that are expected to generate returns, such as infrastructure development or public service improvements. In contrast, general bonds do not carry this requirement.

According to data from the Ministry of Finance, China's local government debt reached 44.7 trillion yuan ($6.1 trillion) as of the end of September, with special-purpose bonds accounting for 63 percent of this total.

According to the latest document, project categories such as buildings for official use, vanity projects, theme parks and imitation ancient towns are on the negative list for the allocation of special-purpose bonds.

The negative list effectively defines the pool of eligible projects, which in turn reduces the difficulty in identifying suitable investment opportunities, said Yang Fan, chief macro policy analyst at CITIC Securities.

As China's infrastructure and public facilities continue to mature, this progress has resulted in a shrinking pool of investment projects that can balance project revenue and financing costs, Yang said.

An analysis of nearly 6,000 special bond issuances between 2017 and 2022, conducted by the School of Economics and Management at Tongji University, showed that over 41 percent of funds raised were directed toward infrastructure construction projects.

The new mechanism will help local authorities effectively steer away from inefficient or inappropriate uses of these resources. This, in turn, can contribute to the prevention of debt risks by ensuring that these funds are not directed toward unsustainable projects, Yang added.

In addition to the negative list, the document identifies the eligible areas for special-purpose bond financing, which have been expanded to include infrastructure supporting emerging industries, such as information technology and new materials, as well as dilapidated urban village redevelopment programs and public service facilities like elderly care and childcare infrastructure.

Meanwhile, the document stipulates that special-purpose bonds can now make up a greater proportion of a project's overall investment when used as equity capital, up to 30 percent.

The proportion of special-purpose bonds used as capital investment nationwide stood at 7.6 percent in 2024. Even in the Guangxi Zhuang autonomous region, which recorded the highest usage of such bonds as equity capital, the ratio was only 15.6 percent, said Wu Qiying, an analyst at GF Securities.

The government is empowering local authorities to more effectively utilize their fiscal resources to catalyze larger investment volumes from the private sector, Wu said, adding that for projects that local governments have thoroughly vetted and deemed strategically important, this reform can enable them to move forward more swiftly.

The State Council has also asked local governments to expedite the issuance and utilization of special-purpose bonds and advance the construction of relevant projects, to produce economic gains as quickly as possible.

Chen Xing, chief macro analyst at Caitong Securities, said that amid escalating geopolitical tensions and a rising tide of protectionism globally, the Chinese government has made boosting domestic demand a top priority for its 2025 economic agenda.

A key component of this domestic-focused approach is the utilization of local government special-purpose bonds, which have emerged as a crucial financing instrument to fuel effective investment, Chen added.

According to a recent report by GF Securities, the peak period for local government special-purpose bond issuances in 2024 occurred during the August-September timeframe, leading to a significant backlog of unutilized funds. As of early October, over 2.3 trillion yuan worth of special-purpose bonds remained undeployed.

The Ministry of Finance allocated 4 trillion yuan in local government special-purpose bonds for 2024, including 100 billion yuan carried over from 2023.

To see bond issuance at a faster pace, 10 provincial-level regions, including Beijing, Shanghai and Guangdong province — along with Xiong'an New Area in Hebei province — will be allowed to review and approve their projects funded by special-purpose bonds, according to the document.

Prior to the new policy, localities needed to seek approval from the National Development and Reform Commission and the Finance Ministry before selling the bonds.

Wen Laicheng, a professor at the Central University of Finance and Economics, said this has given local authorities a more comprehensive understanding of their regions' socioeconomic development needs, as well as a deeper project pipeline.

This shift in decision-making power is expected to enable local governments to select and prioritize bond-financed initiatives that are more closely aligned with their specific development requirements, ultimately enhancing the efficiency and impact of these crucial fiscal instruments, Wen said.

As local governments gain more autonomy in the special bond project approval process, they must also strengthen their project management and supervision mechanisms to ensure the efficient and compliant deployment of these funds, Wen added.

Wen Bin, chief economist at China Minsheng Bank, said local authorities are expected to front-load the issuance of special-purpose bonds this year, aiming to rapidly unlock the stimulative impact of these crucial fiscal instruments and lay the foundations for a more sustained economic recovery.

Noting that the issuance of new special-purpose bonds is demarcated within the government-managed funds budget rather than the fiscal deficit, Wen said that China is likely to raise the limit for new local government special-purpose bonds to 4.5 trillion yuan in 2025.

Therefore, coupled with the increase in the deficit ratio highlighted during the annual Central Economic Work Conference in mid-December, which could be as high as 4 percent, the latest move signals the country's determination to shore up fiscal firepower to stabilize economic growth, Wen added.