The 1 trillion yuan ($161 billion) debt-for-bond swap plan will not involve massive liquidity injection into the financial market, and the central bank remains confident about its success, a top official said.

Pan Gongsheng, deputy governor of the PBOC

Pan Gongsheng, deputy governor of the People's Bank of China, the central bank, on Friday confirmed the widely reported plan at a news conference, ending speculation on how the central bank would manage the unwieldy bond sale. The comment also put to rest fears that the PBOC may resort to massive liquidity injections through the Chinese form of quantitative easing.

Earlier reports said the Ministry of Finance, the PBOC and the China Banking Regulatory Commission have jointly issued a landmark document, which established detailed measures for promoting bond issues by local governments. At the center of the plan is a requirement that banks have to accept a minimum amount of bond placements, as defined by their pro rata share of the issuing local government's total debt to be swapped.

The Ministry of Finance in March announced a 1 trillion yuan debt-for-bonds swap plan that would cut local governments' interest payments and extend the maturity of their debt. But that plan hit a snag on April 23 when Jiangsu province had to delay a bond issue after failing to reach an agreement with lenders.

The joint document has, however, changed all the dynamics. According to the National Audit Office on debt stocks piled up by local governments as of June 2013, bank loans accounted for 56.6 percent of local governments' borrowing, which means equal size of the new bondswill be absorbed privately between debtors and creditors instead of being issued in the open bond market.

About 600 to 700 billion yuan of bonds will be absorbed via "private placement" with banks, while 300 to 400 billion yuan will be sold in the bond market, according to analysts at China International Capital Corp. They said that the move would help bond traders as it belies fears that the massive bond supply would soak up liquidity and drive up interest rates.

"The direct swap plan hinges on adjustment in banks' accounts from loans to bonds. Thus it would not lead to huge capital infusions," Pan said. "Banks have a high acceptance of local government bonds. The plan is good for banks to improve their asset portfolio and possibly improve the liquidity of their assets," Pan said. As part of the document, the PBOC accepted the bonds banks purchased as eligible collateral for re-lending purposes or for repos, thereby improving the liquidity of these assets.

However, Pan said that the inclusion of the bonds as collateral for repos and other liquidity operations does not necessarily mean that the PBOC will inject a corresponding amount of liquidity. It should not be regarded as quantitative easing.

Both he and Vice-Finance Minister Shi Yaobin said they are confident that the 1 trillion yuan bonds will be sold before Aug 31, as the document stipulated.

Also on Friday, the State Council urged banks to ensure funding to local governments' unfinished projects. Contracts signed before the end of 2014 should be honored, while banks should extend the maturity of the loans if local governments cannot repay them on time.