Does “Opening the Front Door” Help “Close the Back Door”? The Impact of Local Government Special Bond Issuance on Implicit Debt Accumulation
MENG Yuanyi, NIE Zhuo, MA Guangrong, ZHAO Yaohong
School of Public Finance and Taxation, Capital University of Economics and Business; School of International Trade and Economics, University of International Business and Economics; School of Finance, Renmin University of China; School of Government, University of International Business and Economics
Summary:
In recent years, the rapid growth of China's public debt, particularly the persistent expansion of implicit debt, has sparked concerns regarding systemic financial risks. To address this, the central government has sought to “open the front door” by issuing special bonds to meet local governments' legitimate financing needs and curb their reliance on irregular debt. However, the effectiveness of these special bonds in curbing implicit debt remains unclear. While existing research largely focuses on debt swaps for existing local government financial vehicles (LGFV) bonds, there is a lack of systematic study on how new special bonds, designed to fund capital expenditure, influence the accumulation of implicit debt. Exploring this issue is crucial for optimizing the debt management system and balancing economic stability with risk prevention. This paper investigates whether issuing new local government special bonds effectively “closes the back door” of implicit debt by “opening the front door.” It identifies three core mechanisms: the substitution effect, where special bonds replace high-cost implicit debt; the matching effect, where projects partially funded by special bonds necessitate additional LGFV financing, potentially driving up implicit debt; and the implicit guarantee effect, where bond issuance reinforces expectations of government bailouts and subsequently influences the cost and scale of implicit debt. The paper employs empirical analysis to evaluate the relative significance of these mechanisms in practice. This paper empirically examines the impact of new special bond issuance on implicit debt from 2017 to 2022, using city, LGFV, and bond-level data sourced from municipal final accounts and the WIND database. To address endogeneity, we construct a Bartik instrumental variable (IV) based on the sectoral distribution of local state-owned enterprise investment in 2016 and provincial-level changes in special bond allocations, which satisfies the requirements for relevance and exogeneity. Our study reveals four primary findings. First, at the aggregate level, an increase in new special bonds does indeed reduce implicit debt accumulation. For every 1 RMB increase in special bonds, implicit debt decreases by 0.72 RMB. This indicates that the “substitution effect” is the dominant mechanism, though it falls short of a one-to-one substitution. Second, mechanism analysis confirms the existence of a positive effect that partially offsets the “front door” policy's efficacy, characterized by a significant expansion in the interest-bearing debt of the specific LGFVs undertaking these projects. Third, by analyzing the impact on LGFV bond pricing, we distinguish between the “matching effect” and the “implicit guarantee effect,” finding that the positive impact on implicit debt arises primarily from the “matching effect.” Finally, spillover effects among LGFVs indicate that when certain vehicles within a city undertake special bond projects, the implicit debt of other vehicles decreases, confirming that the substitution effect prevails among peer LGFVs within the same city. Based on these findings, this paper offers three policy recommendations. First, continue to widen the “front door” for local government borrowing. According to macroeconomic performance, moderately increasing special bond quotas can meet legitimate funding needs and dampen the incentive for implicit borrowing at the source. Second, improve the matching financing system for special bonds. Given the limited revenue potential of some projects, local governments should increase the ratio of proprietary fiscal funds to reduce reliance on market-based leverage and enhance project screening to prevent the “packaging” of ineligible projects to obtain irregular financing. Third, firmly “close the back door” by accelerating the market-oriented transformation of LGFVs. It is essential to sever the excessive financing dependence between the government and LGFVs, fostering their development into self-sustaining entities while institutionalizing accountability for implicit debt to ensure that the “front door” policy replaces existing debt without fueling new risks. This paper contributes to the literature by evaluating the actual effectiveness of new special bonds in controlling implicit debt following the implementation of the new Budget Law. Furthermore, it expands the study of intergovernmental fiscal relations into the realm of project-specific matching financing, revealing the spillover effects inherent in this institutional design. Finally, by providing micro-level evidence on the internal mechanisms of fiscal management and debt expansion, this study offers new insights into the logic of China's local public debt growth and proposes refined policy approaches for the debt regulatory framework.
孟源祎, 聂卓, 马光荣, 赵耀红. 开“前门”是否有助堵“后门”？——地方政府专项债务发行对隐性债务举借的影响[J]. 金融研究, 2026, 552(6): 20-37.
MENG Yuanyi, NIE Zhuo, MA Guangrong, ZHAO Yaohong. Does “Opening the Front Door” Help “Close the Back Door”? The Impact of Local Government Special Bond Issuance on Implicit Debt Accumulation. Journal of Financial Research, 2026, 552(6): 20-37.
