Sustainable Local Public Finance in China: Are Muni Bonds the Structural Solution?

Abstract

We assess the economic and institutional factors that have driven the growth of debt in China. We ask whether there is a clear strategy for managing the risk that such debt levels pose and assess the likelihood that policy actions will prove successful. In particular, we explain how much of the growth of debt is attributable to particular features of Chinese local public finance and why a program involving swapping municipal bonds for older city construction bonds and other debt has emerged as a crucial component of the Chinese strategy. We assess this strategy in detail and argue that this constitute a deep structural reform that is having clear and important consequences for the structure of China’s domestic debt markets. We present evidence that these changes in structure are being reflected in bond market pricing.