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There’s something strange going on in China’s fiscal accounts. Net bond issuance has run well ahead of the deficit. It seems that policymakers changed their minds in July about the need for a large deficit, but the quotas committed them to issuing bond worth ~8% of GDP. 1/x
We’ve seen this before, with the LGFV/muni swap program. But it was clear what was going on there. And there was some over-issuance in 2011-12, when China was overheating, which was made up for in 2013-14, when it was not. 2/x
So, we’re likely to see the excess funds issued this year being used to finance next year’s deficit. But what makes it more interesting is that now the excess issuance is coming from muni bonds, which didn’t exist in 2011. 3/x
And excess muni bond issuance seems to be deposited in the commercial banking system, not at the PBoC, and is classified as a corporate deposit. Which made sense during the swap program but doesn’t really this year. 4/x
So, to the extent that M1 growth is really being driven by excess muni bond issuance, we can expect to see a withdrawal of that liquidity next year. 5/x
And that comes on top of the PBoC’s tightening of liquidity conditions, which at least until the past couple of weeks had pushed up bond yields. That tends to result in a slowdown in credit growth with about a 9-month lag. 6/x
And so it’s very likely that China’s economy is going to be slowing next year as the rest of the world accelerates. The fact that China’s service sector has normalized already will further that divergence. /end
