A senior official from China's Ministry of Finance (MOF) hinted that the country was likely to increase the amount of treasury bonds issued in the second half of 2009.

More Bonds On The Way?
At a recently concluded conference, the official warned that the present economic situation was still unclear and recommended that local governments make haste so that the issue of bonds to raise capital for local coffers takes place in the first half of the year.

Otherwise, he added, if the economic situation was such that the MOF was required to issue more treasury bonds later in the year, that would likely impact on bond sales and issuance costs.

An official from the National Development and Reform Commission confirmed that a decision-making body had carried out detailed calculations on the impact of issuing more treasury bonds on the country's fiscal deficit. However, he went on to note that the MOF was unlikely to issue more treasury bonds to stimulate the economy in the short term.

By late May, 111.8 billion yuan of treasury bonds had already been issued on behalf of local governments, accounting for close to 56% of the total 200 billion yuan worth of bonds planned to be released this year on their behalf. However, the MOF was still not satisfied with the pace at which bonds were being issued.

This pressure to speed up the rate of bond issuance on behalf of local governments is a strong hint that the government is considering increasing the number of bonds that will be issued in the second half of 2009.

Fiscal Pressure On The Central Government
According to a local official "A key factor in determining whether the central government finally decides to issue more treasury bonds, will be the affordability of sustaining local governments through transfer payments."

Since 1994, China has adopted a system which involves the transfer of central government funds to offset the imbalance in payments among the provincial governments. This has left local governments heavily reliant on the central government for funds to support the cost of their social welfare programs.

According to the 2009 central budget, the central government plans to transfer 2.4 trillion yuan to local governments this year. Taking tax revenue return into consideration, the amount of funds flowing from the center to the local governments climbs to nearly 2.9 trillion yuan, a rise of 31.3% on last last year.

Public data showed that in 2008, some 38% of local governments' expenditures were sourced from the central treasury. In central and western regions, this number climbs to an average of 54.4%.

"The use of central government funds has already been budgeted into our local treasury plans, so the central government will have to fulfill its promise," said a local official.

However, the MOF is now facing major problems as a sharp drop in the state fiscal revenues - partly caused by tax cuts and sliding income due to a decline in business profits - is exacerbated by a surge in government outlays.

The national fiscal revenues in the first four months registered a year-on-year decrease of 9.9% or nearly 226 billion yuan to come in at just over 2 trillion yuan. Of that number, the central fiscal revenues were down 20% from a year earlier, to just over 1 trillion yuan.

At the same time, the national fiscal expenditure in the first four months rose 31.7% from a year earlier, with central fiscal expenditure up 29.3%.

Yang Zhigang, researcher at the Chinese Academy of Social Sciences, said despite signs of recovery in the Chinese economy, it's still possible that the economy could run into trouble. If circumstances were to worsen, there would be an impetus on the central government to further stimulate the economy. If that were to happen, the likelihood of a rise in the number of treasury bonds being issued would increase dramatically.

This is not the first time that China has increased the number of treasury bonds being issued in the middle of the year. In the wake of the Asian Financial Crisis, China revised up the amount of bonds issued in the middle of 1998, 1999 and 2000.

How Big A Deficit Can China Handle?
In crafting the 4 trillion yuan stimulus package announced at the end of 2008, Chinese policy makers carefully considered the size of the fiscal deficit that the government could manage.

In the end, they budgeted for a deficit of 950 billion at the end of 2009, equivalent to 2.88% of GDP, believing that a deficit of this size would not adversely affect the health of the economy.

Economists are divided in their analysis of a safe level of fiscal deficit, with some recommending that China limit its deficit to below 3% of GDP, while others believe that the deficit could blow out to 4 or 5% of GDP without too much negative effect.

A lot of academics believe that if in the middle of this year the MOF decides to increase the number of bonds on offer, no matter by how much, this decision will have a huge effect on the market, local government, and regular consumers.

It will be a sign that the economy is still not showing signs of picking up and also display the government determination to get the economy going again.