Chinese lawmakers have approved a State Council bill on raising the ceiling on local government debt by 6 trillion yuan ($840 billion) to be used to replace existing hidden debts. Under the new arrangement, the debt ceiling for special local government debt will be increased to 35.52 trillion yuan from 29.52 trillion yuan by the end of 2024.

Also starting from 2024, China will set aside 800 billion yuan from each year's newly issued local government special-purpose bonds for five consecutive years, thereby providing debt relief to replace 4 trillion yuan of hidden debts, according to the Ministry of Finance.

The new measures will add a combined 10 trillion yuan to China's debt relief resources. Meanwhile, the 2 trillion yuan of hidden debts resulting from housing improvement projects in run-down areas due by 2029 and beyond will be paid in accordance with the original contracts. As a result, the amount of hidden debts that China's local governments need to deal with by 2028 is expected to drop from 14.3 trillion yuan to 2.3 trillion yuan.

This move can help effectively manage the risks arising from local government debt. Raising the ceiling of local government debt can help them shift from emergency risk disposal to active risk resolution, and from the "dual track" management of hidden debts and statutory debts to standardized and transparent management of all debts.

Through debt replacement, since the statutory debt interest rate is much lower than the implicit debt interest rate, the local governments can save about 600 billion yuan in interest expenses in the five years after the replacement. This will help free up policy space to support investment and consumption.

The central government still has a large space for debt and deficit increase. For instance, the central government can also further increase the deficit space, issue more ultra-long-term special treasury bonds, increase the scale of transfer payments, and strengthen investment guarantees in key areas.

The policymakers will need to take into account many international and domestic factors. The country's incremental policy should therefore be regarded as a dynamic adjustment process to provide powerful policy support to help the nation achieve relevant economic development goals.

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