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| Social Credit, Rigid Redemption Belief, and Local Government Implicit Debt |
| ZHANG Muyang, PAN Yan, YU Yongze
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China Public Finance Institute, Shanghai University of Finance and Economics;
School of Public Economics and Administration, Shanghai University of Finance and Economics;
School of Public Finance and Taxation, Nanjing University of Finance and Economics |
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Abstract Credit is an important basis for debt financing. Since 2008, the scale of local government debt guaranteed by government credit has increased sharply, causing great uncertainty and systemic risk to the financial market. To avoid the “debt trap,” China implemented the new Budget Law and the Opinions on Strengthening the Management of Local Government Debt (hereafter Article 43) in 2014, aiming at restricting local government borrowing behavior through strengthened political accountability. Unfortunately, the scale of implicit debt guaranteed by government credit continued increasing. In March 2021, China reiterated that it is a key task to mitigate the risk of local government implicit debt and to enhance fiscal sustainability. Clearly, mitigating the risk of local government implicit debt is highly complex, and seeking a solution to mitigate this risk is still challenging at the current stage. However, research on local government implicit debt from the perspective of credit is far from sufficient.
It is beneficial to start with credit, an important basis of debt financing, to seek a solution to mitigate local government implicit debt risk. To do so, we use panel data from 293 cities in China between 2007 and 2019 to investigate how social credit environment affects local government implicit debt in terms of both amount and interest rate. Our main findings are as follows. (1) The deterioration of social credit environment increases both the amount and interest rate of local government implicit debt. (2) These effects on the amount and interest rate stem from both the supply and demand sides of the financial market. The total effects vary in different scenarios. (3) The implementation of the new Budget Law and Article 43 has promoted the marketization of municipal investment bonds by gradually breaking investors' belief in the rigid redemption of these bonds, and local government implicit debt is more subject to market constraints in terms of both amount and interest rate. This process was slow at first but accelerated after the scattered technical defaults since 2017.
This paper contributes to the literature in three aspects. (1) This paper extends the perspective of research on local government implicit debt to the scope of social credit. The literature mainly focuses on the behavior of local governments, whereas this paper studies the impact of social credit, government credit, and their interactions on local government implicit debt. Therefore, this study closes an important gap in the theory of government debt and helps enhance the understanding of the continued expansion of local government debt in practice. (2) The literature on local government implicit debt expansion is primarily grounded on a government perspective, whereas the interactions between the government and the financial market have long been neglected. This paper explores the heterogeneous effects of social credit on local government debt expansion from both the supply and demand sides and when the rigid redemption belief is present or broken. Through these analyses, this paper enriches the literature on the relationship between the government and the financial market. (3) This paper not only reveals the social and economic phenomenon that areas with low social credit have more local government implicit debt in China, but also helps answer whether the new Budget Law and Article 43 have been effective in breaking the rigid redemption belief. The above findings help us understand the risk of local government implicit debt and the effectiveness of various debt governance measures for informing policy makers.
Based on the above analyses, we believe that improving the social credit system, promoting the marketization transformation of local government financing vehicles, adopting implicit debt management methods adapted to local conditions, and reducing the implicit debt demand of local governments are important measures to mitigate the risk of local government implicit debt and important policy paths to regulate the financial market.
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Received: 02 September 2021
Published: 01 November 2022
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