As monetary policy becomes more neutral, fiscal policy is expected to carry more weight in counter-cyclical management going forward. As we pointed out in our recent report on the evolution of China’s fiscal policy framework, policy banks have become an integral part of China’s broadly-defined fiscal policy conduct, and the China Development Bank (CDB) is the largest among the three policy banks (CDB’s total asset was equivalent to 1.7x that of the other two policy banks combined by end-2015). In this report, we analyze the recent evolution of the financing and investment patterns of the China Development Bank (CDB) – our method is to piece together the changes in CDB balance sheet using the Source & Use of Funds table (SUFT) of the “big-4” and “large banks” (i.e. big-4 + CDB + Postal Savings Bank + Bank of Communications), along with the publicly available annual and/or quarterly financial statements of large banks.

The balance sheet of China Development Bank (CDB) may have grown ~Rmb2.5~3trn over July 2015~June 2016, when the latest round of fiscal stimulus took place. The estimated YoY growth of CDB’s total assets came at between 24~28% YoY, and the net expansion of its balance sheet over the 12-month-window was equivalent to 1.3~1.5% of China’s total bank assets. Furthermore, CDB took an important role in driving China’s monetary expansion by contributing 8~10% to the total bank asset growth between July 2015 and June 2016.

Our estimates of CDB’s balance sheet items are based on deduction, triangulation, and back-testing using a few currently available data sources.

On the liability side (source of funds), CDB’s balance sheet expansion over the past 12 months has become heavily reliant on loans/deposits from the central bank and special construction bond (SCB) issuance, compared with a regular-CDB-bond-driven  growth model previously. We estimate CDB’s liability expansion was mostly driven by the increase of loans/deposits from the central bank, which amounted to ~Rmb1.4trn over the past 12 months.
It is worth noting that the balance of this category was close to zero prior to the launch of PSL last year. The rapid increase of CDB liability on the PBoC’s balance sheet may indicate the first step towards the central bank’s more direct involvement in facilitating broadly-defined fiscal policy conduct in China. In addition, the total increase of special construction bonds on the CDB balance sheet may have exceeded Rmb600bn since its launch in 3Q15, which may have outnumbered the Rmb437bn net increase of regular CDB bonds over the same period.

In regards to CDB assets, i.e. the “use” of funds, CDB has invested more in equities, bonds, and “other investments” since July 2015, notably different from the pattern of mainly expanding its assets via loan issuance before. CDB has ramped up its “equities and other” investment to >Rmb1trn from practically none since the launch of the SCB last year. This particular development is in line with what we have observed among listed companies last year, where fiscal stimulus took the form of replenishing equities rather than issuing loans. As we have discussed in a related note, we believe the “point to point” equity investment is superior to loan disbursement in terms of improving the capital structure of the beneficiary companies and achieving a wider and “more equitable” distribution of these funds that are typically smaller in “amount-per-project” than direct CDB loans (their beneficiaries include both SOEs and private enterprise). Furthermore, the bond investment portfolio of CDB may have grown by at least Rmb500bn since July 2015 and more than doubled in size. On the other hand, the growth of CDB loan book has slowed and became a less significant driver of CDB asset expansion.

The recent evolution of the CDB balance sheet may indicate a few budding trends in China’s quasi-fiscal policy conduct. Firstly, the PBoC may continue to step up its involvement in facilitating fiscal expansion. Given time, the forms of central bank investment may include more bond and equity holding of the policy banks. Furthermore, we cannot rule out the PBoC’s direct purchase of sovereign and quasi-sovereign bonds someday down the road, especially considering the central bank’s need to expand its domestic assets amid stalling FX asset growth. Secondly, consistent with the government’s policy goal to increase the share of direct-financing, fiscal expansion may continue to take form of corporate equity and bond investments.

Looking forwards, the growth of CDB balance sheet may slow in the near term, as the SCB quota is still pending for 3Q and its base becomes higher in 2H16. However, the expansion of the CDB balance sheet financed by the PBoC and/or CDB bonds will remain a handy, nimble, and effective counter-cyclical fiscal policy tool. Since the quota of the fourth tranche of SCB is still being rationalized, the growth of CDB balance sheet may have slowed since July 2016, as evident by slower growth of estimated total CDB bonds outstanding and the combined balance sheet of CDB, PSBC and BoCom. However, as the rapid growth and significant changes in the CDB balance sheet has indicated, expanding the CDB assets and shifting the composition of CDB investments remains a handy and nimble fiscal policy tool that can be “effective in multiple aspects”.