Assessing Local Government Debt Risks in China: A Case Study of Local Government Financial Vehicles

Strong credit expansion in China after the recent global financial crisis has brought local government financial vehicles (LGFV) into the spotlight. Rapid growth of LGFV has triggered concern about local government indebtedness, banks 'asset quality and, more broadly, China's medium-term financial stability and sovereign risk. This paper constructs a unique firm-level dataset to evaluate the country's local government debt. We find an uneven distribution of LGFV, which are concentrated in the coastal areas, and a deterioration of their debt repaying ability from 2010 to 2012. We use principal component analysis (PCA) along with multivariate discriminate analysis (MDA) to identify the credit risk of LGFV based on conventional financial variables as well as local governments 'fiscal status. We also estimate the safe boundaries of debt bearing at the provincial government level. The estimations reveal more severe local government debt risks in the middle-western provinces and higher risks associated with LGFV at the municipal and county levels. Although it is very unlikely that there will be a national debt crisis in China, the high risk of LGFV should be noted and effectively controlled by improving the fiscal transparency of local governments and reforming the fiscal system.