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Debt consolidation quote

A dilemma and a bold public debt consolidation scheme

Of course, one way to expand the Chinese treasury market would be simply for the MoF to run large current fiscal deficits to fund new spending programs and therefore borrow more. Additional expenditures on pensions, healthcare, and infrastructure are all worthwhile. A slightly elevated budget deficit to 3 percent of GDP is indeed tabled to cushion growth slow- down in 2015. However, borrowing excessively to fund wider government budget deficits, while expanding the CGB market, damages China’s fiscal position over the long term, even- tually hurts its credit standing, widens risk premiums, crowds out private-sector investment, and even depresses consumer spending.

Can something be done to expand the size of the CGB market meaningfully without running excessive fiscal deficits? Yes, it is possible, in our view, through consolidating var- ious and diverse public-sector liabilities at the central government level into the homogenous and marketable CGBs.

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One particular version of this proposed scheme involves the PBOC-MoF liability swaps, in which the MoF would overfund its current financing needs by issuing more CGBs to the public and then deposit the proceeds from this additional CGB issuance at the PBOC. This short-term drain on reserves can be offset by a corresponding reduction in the currently high required reserve ratio (RRR). In essence, this is a liability swap between the PBOC and MoF – a swap of the liquid and tradable MoF liabilities (CGBs) for the captive, non-tradable, and illiquid central bank liabilities (mandatory deposits or required reserves by commercial banks at the PBOC). Table 5 sketches this proposed public debt swap scheme, while McCauley and Ma (2015) present a more analytical discussion of various public sector lia- bility consolidation schemes.

Lower reserve requirements would also mitigate the burden on the Chinese banking sector, help contain shadow banking, and expand the bond market, together contributing to rebalance China’s financial structure. We illustrate this option here, because some version of this rebalancing would be so healthy for the Chinese economy that we think China’s lead- ers may find the logic compelling. If they do, it would greatly hasten the emergence of a truly global RMB.

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China’s RRR has been among the highest in the world, mainly because of the PBOC’s need to fund and sterilize its large-scale foreign exchange reserve buildup, which occurred mainly in the first decade of the 2000s (Ma et al 2013). China’s FX reserves rose more than 70-fold between 1994 and 2014 to a staggering pot of nearly USD4 trillion. The increase in the required deposits by commercial banks at the PBOC has funded some 85 percent of such a foreign exchange reserve accumulation during 2006–2014. The RRR was hiked from 6 percent in 2000 to a peak of 21 percent in 2011 before dipping back to an average 18 percent in April 2015. But the current RRR level is still very high by any inter- national standard.