Beijing's efforts to restructure local government debt look set to boost the size of China's nascent municipal bond market by up to twenty times, analysts say.
China is in the midst of unraveling the web of local government debt in the shadow banking system and, in the process, kick start its long held plan to promote a market driven municipal bond market.
Once the central government finalizes a proposed debt swap with commercial banks, China's municipal bond market could grow by nearly twenty times, to up to 2 trillion yuan ($322 billion) this year, according to Societe Generale rates strategist Frances Cheung.
Last year, Beijing started taking tentative steps to move municipal debt out of the shadows. A handful of cities, including Beijing, were authorized to issue 100 billion yuan of bonds in 2014, after a central government audit recognized local government debts issued through financing vehicles to banks of 18 trillion yuan ($2.9 trillion), more than a quarter of China's 2014 GDP of 63 trillion yuan.
To make sure the commercial banks have enough liquidity to handle the latest and bigger restructuring of around one trillion yuan, Beijing has cut the reserve requirement ratio (RRR) twice over the past few months, most recently on April 19, by a full percentage point to 18.5 percent.
"We see the recent reserve ratio rate (RRR) cut by the People's Bank of China [as] very much related to this issue," Aberdeen Asset Management's Head of Asian Fixed Income Adam McCabe told CNBC by email. The commercial banks will be the main buyers of the local government debt, and a reduction of the RRR would ease the liquidity burden, he said.