Social Sciences in China (Chinese Edition)

No. 8, 2022

Coordinating the Fiscal and Financial Framework of the Management of Local Government Debt: Evidence from Financial Markets

(Abstract)

Wu Wenfeng and Hu Yue

Theories based on fiscal guarantees cannot explain either the fact that the decline in local fiscal resources has not significantly increased local government financing costs, nor the fact that local government debt has been rising at a time of strict central government regulation. The theoretical and empirical analyses provided in this study show that it is the financial resources under local government control that provide the implicit guarantee for local government debt. Such financial resources lower local governments’ financing costs but have the potential to lead to the contagion of financial risk through local government to the financial sector. To look at the question solely in terms of either fiscal or financial sector guarantees will not be sufficient to resolve the problem of local government debt. The central government needs to coordinate fiscal and financial policy under a joint management framework in a way that rationally disperses and resolves the risks attached to local government debt and avoids the assumption of excessive risk by either sector. At the same time, close attention should be paid to local financial institutions’ asset quality and their money market reputation to avoid the risk of contagion from local financial institutions to local public finance.