China's RMB10trn local government debt swap programme and underlying credit demand Report Interpretation

Overview

Nomura examines where proceeds from China’s RMB10trn local-government debt-swap programme have gone and how much the programme has distorted credit data. It concludes that the swap has materially reduced reported loan growth, but cannot account for the broader weakening in corporate and household credit demand.

Core views

China’s debt-resolution programme combines RMB6trn of hidden-debt replacement bonds, issued at RMB2trn annually from 2024 to 2026, with RMB4trn drawn from the annual new special local-government bond allocation between 2024 and 2028. By end-June 2026, RMB7.47trn had been issued: 75% came from the RMB6trn replacement quota and 25% from new special LGBs. The replacement bonds can repay officially registered hidden debt, concentrated in LGFV bank loans, LGFV bonds and non-standard borrowing. The new special LGBs have a broader remit, including debt-risk resolution and payment of government arrears owed to corporates. Nomura notes that arrears must be settled from this latter allocation because they are not in the Ministry of Finance monitoring system. Nomura estimates that about RMB3.7trn of bank loans had been swapped out by June 2026, equivalent to roughly half of funds deployed. It derives this estimate by applying PBoC swap-adjusted RMB-loan growth to the outstanding loan stock, compounding the restored rate on the previously adjusted base, and treating October 2024 as the last undistorted month. The quarterly flow has remained substantial: RMB628bn of loans was removed in Q2 2026, close to the RMB715bn peak in Q2 2025. The reported-loan-growth distortion widened to 1.1 percentage points in Q3 2025, when headline growth was 6.6% versus a 7.7% restored rate, then narrowed to 0.6pp at end-2025 and 0.5pp in Q1 2026. Nomura assumes the Q2 2026 wedge remained 0.5pp because no official restored figure was released. Crucially, restored loan growth has still fallen by more than 2pp since late 2024, so the slowdown is not merely an accounting artefact. The report estimates that 13% of deployed funds has retired LGFV bonds. Early bond redemptions totaled RMB377bn from November 2024 to June 2026, or 6.2% of all repayments, but Nomura treats this as a lower bound because bonds can also be repaid at maturity without a public record of swap funding. LGFV issuers repaid RMB6.1trn while issuing RMB5.1trn over the period, leaving a RMB941bn refinancing gap funded outside the bond market. With LGFVs generating little free cash flow and facing tighter new issuance, Nomura views swap proceeds as the dominant source for this gap. Loans and bonds together account for 63% of deployed funds, leaving RMB2.8trn, or 37%, for timing differences, non-standard debt and government arrears. Nomura highlights arrears as the most consequential residual use. Replacing loans with bonds leaves the debt obligation in place but reduces its financing cost; settling arrears instead turns an interest-free, unmatured liability outside the official debt system into a formal bond obligation, providing contractors relief but increasing local-government costs. Policy support has intensified: the December 2025 Central Economic Work Conference called for faster arrears clearance in 2026, the RMB4.4trn 2026 special-LGB programme supports both projects and arrears resolution, and RMB300bn of previously unused LGB debt headroom activated in October 2025 was also directed to project debt and arrears. Yet Nomura says results remain uncertain: industrial receivables reached RMB28.6trn in H1 2026, up 7.2% year on year, while the average collection period lengthened to 71.7 days from 67.9 days at end-2025, implying arrears may still be accumulating faster than they are being cleared. The broader financing data reinforce Nomura’s conclusion that genuine private-sector credit weakness is the central issue. Aggregate financing, which includes loans, corporate bonds, government bonds and equities and is not distorted by the debt swap, slowed to a record-low 7.4% year-on-year in June 2026 from 8.9% in June 2025. Net government-bond financing declined to RMB6,440bn from RMB7,656bn, partly because 2025 issuance had been front-loaded, but aggregate financing excluding government bonds still fell RMB799bn in H1. Nomura therefore sees the decline as difficult to explain mainly through government-bond timing or accounting effects. Corporate lending appears more resilient in headline terms than in underlying demand. New corporate loans fell modestly to RMB11,130bn in H1 2026 from RMB11,570bn a year earlier, but medium- to long-term loans declined sharply to RMB5,550bn from RMB7,170bn. Bill financing shifted to positive RMB814bn from negative RMB46bn, which Nomura interprets as banks meeting lending quotas or directives rather than financing capital expenditure. Adding RMB2,068bn of corporate bond issuance produces a RMB477bn year-on-year gain in total corporate financing, but this improvement is entirely due to bill financing. Excluding bills, corporate loans plus bonds fell RMB384bn year on year, while corporate loans alone declined RMB1,301bn. The report concludes that corporates are borrowing for working capital and inexpensive bond refinancing rather than investment. Household data provide the clearest sign of deleveraging because they are unaffected by the swap or changes in corporate funding channels. Household loans contracted RMB367bn in H1 2026, versus RMB1,170bn growth a year earlier and a RMB4,580bn peak in H1 2021. Short-term household lending fell to negative RMB588bn from roughly zero, while medium- to long-term lending dropped to just RMB221bn as mortgage demand nearly disappeared amid a contracting property sector. Nomura characterizes this as unambiguous household balance-sheet repair that could restrain consumption while income expectations remain weak and property prices continue to fall. The report also identifies implementation problems. The programme is assessed through proxy targets—hidden-debt clearance, the number of financing platforms withdrawn, and replacement-bond issuance—which may encourage local authorities to optimize reported measures rather than actual debt-risk reduction. The National Audit Office found that, among 142 withdrawn platforms in 50 sampled counties across 10 provinces, nine had exited without meeting conditions. Two had cleared RMB149mn of hidden debt using illegal new bank loans and diverted special-bond proceeds, while seven exited with RMB2.15bn of illegally incurred new debt outstanding. The Ministry of Finance has also acknowledged continuing new hidden debt and false resolution, and subsequently required replacement proceeds to be held in ring-fenced accounts. Banks are described as involuntary counterparties: replacing higher-yielding LGFV loans removes assets from their books as the average interest cost of swapped debt falls by 2.5pp, adding pressure to already compressed bank margins. Banks have responded by shifting into bonds—loans plus bond holdings have grown around 8%, versus loan growth of 5% to 6%—and by managing reported loan growth through lend-and-recall or deposit-first practices. Finally, the replacement quota is nearing exhaustion. Nomura expects the RMB6trn quota to be fully used by year-end, leaving only the RMB800bn annual new-special-LGB allocation for 2027 and 2028, which must also fund arrears clearance. Unless further unused debt headroom is activated, replacement activity should slow sharply from 2027; this would reduce the statistical drag on loans while making clearer that current credit weakness is not primarily caused by the swap.

Analysis framework

Nomura decomposes issued swap-bond proceeds across bank loans, LGFV bonds, non-standard debt and arrears. It uses PBoC swap-adjusted loan-growth data to reconstruct loan volumes, Wind data on LGFV repayments and issuance to estimate the bond refinancing gap, and aggregate-financing, corporate-loan and household-loan data to distinguish statistical distortions from underlying credit demand.

Methodology notes

• Industry AnalysisSupply-demand framework

  Credit-demand analysis using adjusted loan, aggregate-financing, corporate and household borrowing data

  The report separates the mechanical removal of local-government loans from the underlying demand for financing. It uses financing volumes and composition to argue that weak investment and household borrowing, rather than the debt swap alone, are driving the slowdown.

• Industry AnalysisUpstream-Midstream-Downstream Transmission

  Debt-swap proceeds decomposition across LGFVs, banks, non-standard lenders and corporate arrears

  Nomura traces how local-government refinancing affects banks, LGFV bondholders, trust and leasing obligations, and contractors owed arrears, showing that different uses of proceeds have different fiscal and credit effects.

Key data

• Debt-swap bonds issuedRMB7.47trn by end-June 2026RMB6trn replacement bonds accounted for 75%; new special LGBs accounted for 25%.
• Replacement-bond quota utilizationRoughly 94%The RMB6trn three-year quota was nearly exhausted by mid-2026.
• Estimated bank loans swappedRMB3.7trnEstimated cumulative removal from bank balance sheets by June 2026, about half of funds deployed.
• Swap drag on headline loan growth1.1pp in Q3 2025; 0.5pp in Q1 2026 and assumed for Q2 2026The reported-versus-restored loan-growth gap narrowed, but adjusted growth still weakened materially.
• LGFV bond refinancing gapRMB941bnLGFV issuers repaid RMB6.1trn and issued RMB5.1trn from November 2024 to June 2026; Nomura estimates this represented 13% of deployed swap funds.
• Aggregate financing growth7.4% in June 2026A record low, down from 8.9% in June 2025.
• Household loans-RMB367bn in H1 2026Reversed RMB1,170bn growth in H1 2025; short-term lending was -RMB588bn and medium- to long-term lending was RMB221bn.
• Industrial receivablesRMB28.6trn in H1 2026Up 7.2% year on year; the average collection period rose to 71.7 days from 67.9 days at end-2025.

Impact & implications

Nomura argues that the debt swap has distorted headline loan data but does not explain the sustained deterioration in China’s underlying credit conditions. The approaching exhaustion of replacement bonds may reduce the mechanical drag on reported loans, while exposing weak corporate investment demand, household deleveraging and unresolved arrears more clearly.

Risks

• Local authorities may meet measurable debt-resolution proxies without achieving genuine risk reduction, including through false resolution, illegal new borrowing or diversion of replacement proceeds.
• Government arrears may continue accumulating faster than they are cleared, as indicated by rising industrial receivables and longer collection periods.
• The near-exhaustion of the RMB6trn replacement quota could slow debt replacement from 2027 unless additional debt headroom is activated.
• Replacing higher-yielding LGFV loans with lower-cost bonds may further compress banks’ profit margins.

What to watch

• Whether authorities activate additional unused debt headroom after the replacement-bond quota is exhausted.
• The pace of new special-LGB issuance and the allocation between arrears clearance and other debt resolution.
• Official release of swap-adjusted loan-growth data for the latest quarter.
• Industrial receivables and collection-period data as indicators of whether arrears are actually being cleared.
• Corporate medium- to long-term loans, bill financing and household mortgage demand as measures of underlying credit appetite.