Whac-a-mole: China's debt policies and local debt risks

Abstract

To address the problem of implicit local government debt, China's government has rolled out a series of debt management policies. However, these measures have not fully achieved their intended goals. To investigate the issue, we construct a general equilibrium model and employ a generalized difference-in-differences (DiD) method for in-depth research. The study finds that China's debt policies have imbalanced impacts on major financing vehicles of local financing platforms: bonds and loans. The policies can effectively suppress the issuance of urban investment bonds but lack sufficient constraining power over local banks. Local governments usually have close ties with local banks, and under the financial pressure caused by debt policies, local financing platforms turn to riskier bank loans, thereby increasing the overall risk of local debt. China's debt policies are facing a “whac-a-mole” situation, which makes it difficult to achieve the expected effects.