China Tightens Stimulus Bond Program Amid Concerns Over Cost, Effectiveness

(Beijing) — The national government has revamped a program aimed at boosting infrastructure investment and providing low-cost funding to targeted firms in the wake of concerns that too many companies were getting cheap money for projects that didn't meet policy makers' goals.

Analysts have also speculated that the Special Construction Bond program has cost the Ministry of Finance too much in subsidies. It also contributed to a slowdown in formal bank lending to the corporate sector and failed to kick-start support from other financial institutions.

In June, the National Development and Reform Commission (NDRC) was said to have suspended approvals for investments by the program. The program involves state-owned policy banks taking equity stakes in funds, projects and companies using money raised by the issue of so-called special construction bonds.

Sources familiar with the matter told Caixin that following a review of its effectiveness, the program is now restarting but with changes, including fewer government subsidies. The NDRC did not respond to a faxed request for more information about the program.

The special construction bonds program was launched in August 2015 to provide low-cost, long-term funding of 10 to 20 years for investment projects. The funding program started with 300 billion yuan ($44.7 billion) raised through bond sales by two policy banks — the China Development Bank and the Agricultural Development Bank of China — to the Postal Savings Bank of China, the first purchaser. Sources told Caixin at the time that a total of 1 trillion yuan of bonds would be issued over a three-year period, and could be increased to 1.5 trillion yuan if the economy weakened too much.

The purpose of the funding program was to support key government policies. These included encouraging new technology and other innovative industries as part a strategy to upgrade the country's manufacturing, reducing borrowing costs to the "real economy," and providing more money to targeted sectors such as infrastructure investment.

Some analysts described the program as stimulus by stealth as the government sought to boost the weakening economy.

Proceeds from the bond sales were put into separate funds that took equity investments in companies or local government funds involved in local infrastructure projects, which applied for the cash. Recipients had to pay up to 1.2 percent annually for the funds they received from the program, according to some of the companies' stock exchange filings.

The cheap long-term money attracted strong demand from local government financing platforms and companies, and investments made through the program far exceeded the original target. According to bank sources, an estimated 1.8 trillion yuan was channeled in six batches into publicly listed companies as well as financial platforms run by local governments to shore up their capital for infrastructure building projects.

There has been no systematic disclosure of the amount of bonds issued, the coupon rates on the bonds, who has bought them, or the investments made through the program, although stock exchange filings have provided some details.

By the end of 2015, more than a dozen companies on the domestic stock exchanges had received funds, including auto-parts manufacturer Wanxiang Qianchao Co., Xiamen Tungsten Co. Ltd. and Yatai Group, a company based in the northeast Changchun city whose core businesses include property development and cement manufacturing.

But this almost-free lunch is ending. Under the modified program, the cost of funds to the recipients, previously at a maximum of 1.2 percent annually, may increase depending on the nature of the company and the purpose of the funds, people close to the matter said.

The Ministry of Finance is also cutting back on the subsidies it's paying the policy banks. Initially the cost of funds to the recipients was kept low because government subsidies covered 90 percent of the payments. But now that percentage is being slashed and the ministry will subsidize at four rates – zero percent, 50 percent, 70 percent and 90 percent.

Sources close to the program have told Caixin there were concerns that the low cost of funds compared with the 4.35 percent benchmark one-year lending rate has had a crowding-out effect on bank loans as policy banks have been able to undercut the lending rates of normal commercial banks.

Contact reporter Dong Tongjian (tongjiandong@caixin.com)