Local Government Financing Vehicles Research Articles

‘One system, two shadows’: A local public Finance perspective on China's shadow banking system

Why does shadow banking persist in China despite repeated policy efforts to contain it? While studies of informal finance have traditionally emphasized the credit needs of private businesses as a demand-side explanation, this study contends that China's local public finance also constitutes an important driver for shadow banking. Based on document research and administrative data, we find that China's shadow banking system has bifurcated into two segments since the Global Financial Crisis (GFC). One is the ‘entrepreneurial shadow’ that has long provided informal credit to the private sector, especially small- and medium-sized enterprises. The other is a ‘fiscal shadow’, which serves property developers and local government financing vehicles (LGFVs), the two pillars of China's land-based local public finance regime. Property developers are major contributors to local fiscal revenues through the land economy, while LGFVs function as off-balance sheet backdoor financing intermediaries for local governments.Although localities have borrowed from unconventional sources throughout the reform era, the central government's GFC stimulus plan marked a turning point by fueling a debt-financed real estate and infrastructure construction boom. Property developers and LGFVs were launched onto a highly leveraged model of feverish expansion for over a decade. When the central government abruptly reversed its course by restricting the availability of formal credit, they became further entangled into the fiscal shadow for refinancing. Local public finance has thus become reliant on shadow banking, despite subsequent policy efforts to curb such activity. Our findings suggest the need for a more integrated analytic and regulatory framework that recognizes the mutual dependence between shadow banking and local debt – two major sources of systemic financial risks in China.

Land financialization and debt expansion: Evidence from city–county mergers in China

This paper discusses the “land-debt” financing pattern in China in the context of local governments under fiscal pressure and analyzes the development and economic effects of land financialization. Using a difference-in-differences approach based on the exogenous shock of city–county mergers, we find that city–county mergers significantly boost local governments' debt issuance, causing land financialization. City–county mergers relax land resource constraints on local governments, increasing land held by local government financing vehicles (land mortgages) and land transfer revenue (land guarantees). Accordingly, it is as such an impact mechanism rather than a fiscal pressure that mainly leads to debt expansion. We also document that this effect is more pronounced in China's central and western regions, where land is more correlated with local economies; in periods when the central government does not regulate local land financing; and in areas where officials have strong promotion incentives. Further analysis reveals that most of the debt funds raised by city–county mergers are used for infrastructure construction and loan repayment, and the increasing debt risk of local governments should also be a matter of concern.

Understanding local government debt financing of infrastructure projects in China: Evidence based on accounting data from local government financing vehicles

This study develops an analytical framework to investigate the complex relationship between local government debt issuing for infrastructure financing, state control, land finance, and development activities in the private sector in China. Using local government financing vehicles’ accounting data, we find that local governments are working creatively to meet infrastructure development targets handed down by the central government. Moreover, local government financing vehicles became more responsive to development activities from the private sector in their debt-issuing decisions after the regulations of local government debt issuing in 2013/14. By modelling the effect of three distinct forces, i.e., the central government, local governments, and the market, in one unified framework, our study provides reliable evidence of how infrastructure financing works in China. Our research extends the studies of land finance into the infrastructure development domain. The findings are also helpful for studies on China's land use policy under its leasehold land right system, particularly the impacts of different land planning uses on infrastructure development.

Finance and local economic growth: New evidence from China

AbstractWe study the relationship between finance and growth using a sample of 275 Chinese cities from 2009 to 2018. We exclude bank loans to local governments through the local government financing vehicles (LGFVs) and construct a better financial development index which measures the level of loans extended by banks to enterprises and households. We find that financial development in the form of a higher loan‐to‐GDP ratio leads to lower economic growth. This negative relationship between finance and growth may be attributed to various mechanisms, including discrimination in bank lending, housing market bubbles, and an imbalance in growth between real and financial sectors.

Local Government Debt and Firm Zombification: Evidence from China

Abstract We analyze the effects of local government debt on the proliferation of zombie firms. With aggregated prefecture-level debt data and firm-level data from 2006 to 2013, the empirical evidence demonstrates that the local government debt significantly exacerbates the “zombification” of local firms, mainly through the credit-favoritism to state-owned enterprises and capital misallocation. Our analysis also shows that the magnitude of zombification effects is influenced by debt liquidity and the primary functions of local government financing vehicles.

The Influence of Implicit Guarantee on the Yield Spread of China’s Quasi-municipal Bond

Local government debts are an important part of the bond market. This paper mainly investigates the risk that the implicit guarantee brings to the market of quasi-municipal bonds. The implicit guarantee comes from local government financing vehicles (LGFVs), which are the finance entities for the local government, issue quasi-municipal bonds. Because people are potentially thought these bonds are guaranteed by the local government, the funding cost of quasi-municipal bonds is lower than other bonds. However, some local government's ability to pay back the investors' money is weak which causes some high-rated quasi-municipal bonds to default and triggers many defaults, which, along with the local government's mounting debt, may make investors more concerned about its capacity to repay the loan in the event of default. Therefore, China's central government then issues some policies to reduce the effectiveness of implicit government guarantees, trying to make the quasi-municipal bonds turn to become more marketize and contain less guarantee. In this paper, the author initially tries to demonstrate that the implicit guarantee reduces the yield spread of quasi-municipal bonds. Then, the author argues that the issue of relevant policies lessens the implicit guarantee and increases the marketability of quasi-municipal corporate bonds. Lastly, the author tries to show that different administrative levels of LGFVs will affect the yield spread of the bond.

Air pollution and local government financing costs: Evidence from the Chinese municipal corporate bond spread

Using a sample of Chinese municipal corporate bonds from 2011 to 2019, this paper investigates the effect of city-level air pollution on local government financing costs. We find that cities with severe air pollution tend to have higher municipal corporate bond spreads, indicating that air pollution leads to higher local government financing costs. Moreover, air pollution is associated with lower economic growth, decreased population, and worse fiscal conditions, supporting the “implicit guarantee channel” that air pollution curtails implicit guarantees for municipal corporate bonds and thus increases bond spreads. Furthermore, the detrimental effect of air pollution is more salient for municipal corporate bonds without explicit guarantees, implicitly guaranteed by governments at lower administrative levels, and issued by local government financing vehicles located in regions with less marketization. Our study enhances understanding on the effect of air pollution on agents’ behaviors and provides guidance for reducing local government financing costs.

The Lease-debt Relationship of Chinese Local Government Financing Vehicles

In recent years, the number of local government financing vehicles in China has been increasing, the scale of development has been expanding rapidly, and the financing methods used have also been increasing. At present, bank loans are still the main financing channels, but the financing lease mode has become one of the important ways for local government financing vehicles to obtain financial access. This paper mainly studies the lease-debt relationship of Chinese local government financing vehicles, and selects the unbalanced panel data of 1435 Chinese local government financing vehicles from 2012 to 2020 for empirical analysis. The empirical results show that the relationship between the lease ratio and the loan ratio is significantly negative, indicating that the lease-debt relationship of the local government financing platform in China is a substitution relationship. Increasing the use of lease financing will reduce the use of loan financing by the local government financing platform, while the control variable bond ratio, total assets, leverage ratio and cash ratio also have a significant impact on the lease ratio, Finally, based on the empirical results, this paper analyzes and puts forward corresponding suggestions.

Local officials’ promotion incentives and issuance of urban investment bonds

This paper investigates the effects of local officials’ promotion incentives on the issuance of urban investment bonds (UIBs) in China. Based on data from 2014 to 2019, we find that local officials’ promotion incentives have a positive effect on the amount of UIBs but a negative effect on the cost, and these effects are much stronger in cities with a lower level of marketization and greater pressure on economic growth. We also find that before issuing bonds, local officials with strong promotion incentives intervene in the issuance of UIBs by transferring state-owned equity, providing fiscal subsidies, and injecting land assets to local government financing vehicles. The study enriches the understanding of the UIB market and Chinese local government debt.

Research on PPP Enterprise Credit Dynamic Prediction Model

The debt default risk of local government financing vehicles (LGFVs) has become a potential trigger for systemic financial risks. How to effectively prevent hidden debt risk has always been a hot issue in public-private partnership (PPP) financing management research. In recent years, machine learning has become more and more popular in the study of enterprise credit evaluation. However, most scholars only focus on the output of the model, and do not explain in detail the extent to which variables affect the model and the decision-making process of the model. In this paper, we aim to apply a better credit rating method to the key factors and analysis of LGFV’s default risk, and analyze the decision-making process of the model in a visual form. Firstly, this paper analyzes the financial data of LGFVs. Secondly, the XGBoost-logistic combination algorithm is introduced to integrate the typical characteristics of PPP projects and construct the credit evaluation model of LGFVs. Finally, we verify the feasibility of the model by K-fold cross validation and performance evaluation. The results show that: (1) net worth, total assets, operating income, and return on equity are the most critical factors affecting the credit risk of LGFVs, asset-liability ratio and tax revenue are also potentially important factors; (2) the XGBoost-logistic model can identify the key factors affecting the credit risk of LGFVs, and has better classification performance and predictive ability. (3) The influence of each characteristic variable on model decision can be quantified by the SHAP value, and the classification decision visualization of the model improves the interpretability of the model.

Recomputation of Public Capital Based on PIM and the Effect on China Regional Economic Growth

This paper first reestimates the public capital stock of each China province from 1994 to 2019 by improving the computing method of the components of the perpetual inventory method (PIM). Then, it brings the public investment and public capital into the extended Cobb-Douglas production function and explores the mechanism of public investment affecting economic growth from the regional perspective. Furthermore, through the analysis of the Local Government Financing Vehicles (LGFVs) as the major investor of local public investment during the last two decades, This paper confirms the importance of complementary factors such as institutional innovation and effective management of the public infrastructure in making public investment an “effective catalyst for growth” (Kessides, 1993).

Does government debt impede firm innovation? Evidence from the rise of LGFVs in China

Does government debt impede firm innovation? We address this question by examining the effects of the debt accumulated by local government financing vehicles (LGFVs) across Chinese prefectures between 2006 and 2012 on industrial firms’ R&D spending and patents. We find that government debt reduces firms’ R&D expenditures and lowers firms’ number of new patents. One plausible explanation is that government debt raises firms’ capital costs, which limits innovation activities. Consistently, we find that the innovations of firms that are more likely to be financially constrained – small firms and firms with low cash flow – are more affected by the expansion of government debt. Our results imply that although government deficit spending may stimulate the economy in the short run, it could have negative repercussions for economic productivity in the longer run.

Exploring China’s Impacts on Development Thinking and Policies

In this article, we explore the impacts, actual and potential, of China’s development experiences upon development thinking and policies elsewhere. New Structural Economics, a theoretical innovation by Professor Justin Yifu Lin drawing on a longer tradition of pragmatic ‘learning by doing’ development strategies, provides a framework in which three agendas stand out: structural transformation as a policy priority; the return of industrial policy; and the use of Special Economic Zones. We integrate related drivers of growth in China: rapid urbanisation pulling in massive rural migration in an economic transformation process; the financing of provincial and city governments by improvised local government financing vehicles based on rising urban land values; and competition and accountability processes in China’s subnational governance system. While China’s experiences cannot be directly replicated elsewhere, we argue that lessons on why and how to achieve structural transformation are relevant for other developing countries, especially in fast urbanising and integrating Africa.

Crowding in or crowding out? How local government debt influences corporate innovation for China.

The pressure upon local governments to redeem their debt could affect government fiscal ability. It could consequently affect their fiscal policies on corporations, which might distort corporate innovation. Based on the data of Chinese Shanghai and Shenzhen A-share listed companies and the local government implicit short-term debt financed by local government financing vehicles (LGFVs) in 31 provinces, this paper shows that local government debt (LGD) negatively affects corporate R&D investment in China, thereby suggesting a strong crowding-out effect. The crowding-out effect is more pronounced when the firm is a non-state-owned enterprise (NSOE), the firm's size is small, the firm's age is young, or the firm is in the lower market competition. This paper provide evidence by interacting the terms that local government actions, such as consumption of fiscal resources, strengthening tax collection efforts, or consumption of credit resources, might partially account for the crowding-out effect. This study illustrates the innovation costs of local government debt.

Fact or fiction: Implicit government guarantees in China’s corporate bond market

This paper explores how implicit government guarantees affect the yield spreads of Chinese corporate bonds. We argue that quasi-municipal corporate bonds (“Chengtou” bonds), issued by local government financing vehicles (LGFVs), carry an implicit government guarantee and therefore enjoy a reduced yield spread. Using a sample of publicly traded corporate bonds between 2010 and 2017, we show that bond investors are significantly less sensitive to bond-specific risks for corporate bonds with an implicit government guarantee: the yield spreads of Chengtou bonds are significantly lower than those of corporate bonds issued by privately-owned enterprises (POEs). Furthermore, we find that policy changes introduced by China’s central government, which were intended to regulate local governments’ debt financing activities, significantly reduced the gap in yield spreads between Chengtou bonds and bonds issued by POEs. Overall, our results suggest that implicit government guarantees play a crucial role in China’s nascent corporate bond market, but that the country’s recent policy changes have reduced the effectiveness of such guarantees, making China’s corporate bond market more market-oriented.

Local Government Implicit Debt and Corporate R&D Activities：Evidence from Chinese Non-financial Listed Companies

Since the central government implemented the “four-trillion” fiscal stimulus plan in 2008, the implicit debt problem of local governments has increasingly become an important factor affecting macroeconomic stability and economic development. Despite the increasingly stringent restrictions of the central government, local governments still borrow in various ways via Local Government Financing Vehicles (LGFVs), resulting in the continuous expansion of implicit debt. The disorderly expansion of local implicit debt may not only induce “gray rhino” systemic financial risks in the short term, but also worsen the efficiency of resource allocation, “crowd out” the financing and investment of manufacturing companies, and weaken the long-term economic growth of China. Compared with the existing literature, this paper focuses on another important but neglected economic impact of implicit debt expansion: the inhibitory effect on corporate R&D activities and output. In the face of the continuous expansion of the scale of implicit debt and the decline in the growth rate of corporate R&D activities, many observers of the Chinese economy have such questions: Will excessively high levels of local debt inhibit micro-enterprises’ innovation? What is the underlying mechanism of this effect? These are the questions that this paper seeks to answer.Based on the data of non-financial listed companies from 2008 to 2017 and the hand-collected data on the implicit debt of local governments, this paper studies the impact of implicit debt levels of local governments on micro-enterprises’ R&D investment and patent applications. The empirical results show that the level of implicit debt in cities has a significant “inhibitory effect” on the patent applications of local companies, and leads to the reduction of internal R&D expenses. This shows that implicit debt is “squeezing” in both R&D input and output dimensions. Next, we perform the mechanism analysis and find that the reduction of government R&D subsidies and long-term external borrowing are the potential mechanisms. Finally, this paper also conducts a heterogeneity analysis and a robustness test on the main empirical results, and finds that the “crowding-out effect” of implicit debt is mainly reflected in the samples of high-budget constrained companies, state-owned companies and listed companies in non-first-tier cities.This paper demonstrates that the expansion of local government implicit debt may weaken the long-term economic growth momentum of China. To deal with this problem, this paper suggests that: Firstly, a well-functioned municipal bond market with Chinese characteristics should be established as soon as possible, and its risk to the level of return, thus avoiding the “squeeze-out” effect. Secondly, local governments should gradually strip off the debt financing function of LGFVs, and try to transform them into an institution focusing on long-term strategic investment (referring to the Temasek company in Singapore) to help the long-term development of the local economy. Finally, local governments need to establish institutional R&D funds to support the long-term fundamental R&D activities of companies.

The Financial Value of the Within-Government Political Network: Evidence From Chinese Municipal Corporate Bonds

This paper examines the effect of the political network of Chinese municipal leaders on the pricing of municipal corporate bonds. Using municipal leaders' working experience to measure the political network, we find that this network improves the credit ratings of the issuer, local government financing vehicles (LGFVs), reducing their issuance yield spreads. The relationship between political networks and issuance yield spreads is strengthened in areas where financial markets and legal systems are less developed.

Government debt, land financing and distributive justice in China

Massive funds that are necessary to finance China’s capital-intensive urbanisation are channelled through Local Government Financing Vehicles (LGFVs), which are established by local governments to circumvent the prohibition on borrowing. This study examines LGFV development and how this land financing development strategy influences villagers. We argue that China’s discriminatory land property system and the feature of land being a captive asset allow local governments to transfer their debt pressure to land-losing villagers. Specifically, we find that more indebted local governments take a more extractive approach by paying land-losing villagers less compensation, suggesting the intrinsic connections of the local state, land-centred local public finance and society in China’s urban transformation. Our findings suggest that local governments can be developmental and predatory at the same time. Our arguments are developed using data that combine a self-compiled data set on LGFV debt with the China Household Finance Surveys. It systematically examines the connections between land financing via LGFVs and land-losing villagers. It contributes to a better understanding of the debt-fuelled urbanisation in China and, more broadly, of how the state intervenes in the economy and impacts distributive justice in developing and transition economies.

Marketization vs. market chase: Insights from implicit government guarantees

Local Government Financing Vehicles (LGFVs) and state-owned enterprises (SOEs) provide implicit guarantee during the issuing of bonds, thereby reducing their funding cost. The credit spreads are lower when issued by a LGFV with a higher administrative level. This means that implicit guarantee is also strengthened with government centralization. We also explain the anomaly of municipal corporate bonds (MCBs)’ spreads decrease after a marketization regulation of removing implicit guarantees. This paper provides strong evidence that the market will chase implicit guarantee when default wave comes even under tight government regulations.

Real Estate Cycle，Local Government Fiscal Pressure and LGFVs’ Land Purchasing

Since the reform of the “tax-sharing system” in 1994, the problem of “unbalanced fiscal revenue and expenditure” of local governments has increasingly become a hot topic of concern to many observers. This is mainly reflected in the lack of budgetary fiscal revenue caused by the mismatch between financial power and responsibility. On the other hand, under the long-term promotion mechanism based on local GDP growth, local officials have continued enthusiasm for “investment attraction” and fixed asset investment. In the context of the central government’s “four-trillion” fiscal stimulus plan in 2008, a large number of local government financing vehicles（LGFVs hence after）have sprung up, and funds have been obtained through bank loans and “Municipal Investment bonds” to support infrastructure construction and stimulate local economic growth. The disorderly expansion of the financing vehicle business also inevitably accumulates a large amount of debt, which makes local governments face the pressure of debt repayment either explicitly or implicitly.Faced with “budgetary pressures within the budget” and “debt pressures” outside the budget, local governments have increasingly relied on land sales for more than a decade. Land transfer income can not only supplement the local fiscal gap, but also become the most credible source of debt service income for local governments. In addition, land assets are the most important financing collateral for financing vehicles. Land income and land assets have become the most important means for Chinese local governments to make up for fiscal pressure and maintain local debt.However, the income from local government land sales is not always stable, but is often affected by shocks from the housing demand side. In order to “cool down” the long-term “overheated” real estate market, the central government announced more than 30 national real estate regulation and control policies between 2003 and 2016. The most typical example is the two waves of “Purchase Restriction” during 2010 and 2013. These regulatory policies have caused short-term negative impacts on the real estate market and the land market, and have significantly reduced the land sales revenue of local governments. Faced with this situation, local governments with greater financial pressure will strive to find other ways to increase land sales income.Under the above background, this article hopes to answer the following important economic question: What measures will local governments that rely on “land finance” take to smooth out fluctuations in fiscal revenue in the face of adverse real estate market shocks? Under the guidance of this goal, this article identifies and analyzes a potentially important mechanism: Chinese local governments use LGFVs to obtain land transfer fees and “feed back” budgetary fiscal revenue. Using micro data from land transfer and LGFVs, we find that the proportion of land purchased by LGFVs in Chinese cities for goods and services has a significant “reverse cycle”, that is, the proportion of transaction volume（area）during the real estate market adjustment period has increased significantly. Further analysis shows that for cities with greater “financial pressure” and higher incentives for local officials to promote, this “countercyclicality” is more intense. Secondly, the funds for land acquisition by LGFVs mainly come from the increase of debt, instead of the subsidies of local governments in the later period, which may further increase local hidden debt. Finally, the above “countercyclicality” mainly comes from the central and western regions and the small cities. The findings of this article are of great significance for the in-depth understanding of the operation mechanism of the “land finance” of local governments and the interactive relationship between “fiscal pressure” within the budget of local governments and “hidden debt” outside the budget.