CHINESE policymakers are considering plans to as much as double the size of a clean-up program for local government finances, according to people familiar with the discussions.

    In what would be the second stage of the program, a further 500 billion yuan (US$81 billion) to 1 trillion yuan in local government loans would be authorized to be swapped into bonds issued by provinces and cities, the sources said. The first stage of the bond swap, currently under way, is 1 trillion yuan.

    An expansion would signal officials are confident in the template they have crafted for reducing risks from a record surge in borrowing that local authorities took on to fund a glut of investment projects.

    The complex process, which includes inducements for banks to buy new, longer-maturity, lower yielding bonds, is alleviating a funding crunch among provinces that had threatened to deepen the economy’s slowdown.

    “It is solving the cash flow issue at the local governments and ensuring that infrastructure projects this year aren’t delayed,” said Nicholas Zhu, a Beijing-based senior analyst at Moody’s Investors Service, referring to the initial 1 trillion yuan program. He said any additional quota probably would be for debt swaps in 2016.

    Shandong Province sold 10-year notes Friday at close to yields on sovereign debt, becoming the fifth issuer of municipal debt to do so in the last two weeks.

    “The initial success of the first batches of bonds, especially the lower-than-expected yields, may have encouraged the Ministry of Finance to expand the swap,” said Ding Shuang, chief China economist at Standard Chartered Plc. in Hong Kong. “Additional swaps, if confirmed, can show China’s handling of the local government debt problem will be faster than previous expectations.”

    The up-sized plan needs State Council approval, according to the sources. The Ministry of Finance yesterday didn’t immediately respond to a faxed request for comment. Finance Minister Lou Jiwei had previously said that the swap program could be expanded.

    Lou is grappling with ways to rein in local governments’ largess without accelerating an economic slowdown.

    A 1994 law banned regional authorities from issuing bonds directly, spurring the birth of thousands of local government financing vehicles (LGFVs) to fund infrastructure projects. The LGFVs typically used State-owned resources and assets such as land as collateral to set up companies that allowed provinces to borrow from banks.

    Local government obligations may have reached 25 trillion yuan, bigger than the size of the German economy, according to estimates from Mizuho Securities Asia Ltd. That compares with the figure of 17.9 trillion yuan as of June 30, 2013 given by the National Audit Office.

    Lou initiated a crackdown last year on the off-balance-sheet financing, plans that collided with the economy’s slowdown and a new imperative set by President Xi Jinping to shore up the economy amid a weakening job market.

    “The timetable of fiscal transition was too aggressive, and the economic slowdown has been faster than expected, so the government relaxed its rules,” said Zhu at Moody’s.

    By reducing debt-servicing costs for local authorities, policymakers are helping them sustain spending that’s crucial to shoring up growth. A gauge of manufacturing yesterday suggested that the fiscal loosening, along with monetary easing by the central bank, has helped arrest a deterioration. (SD-Agencies)