BAILOUT EXPECTATION AND DEBT RISKS OF CHINESE LOCAL GOVERNMENTS: AN EVIDENCE BASED STUDY ON QUASI-MUNICIPAL BONDS
DOI:
https://doi.org/10.12775/CJPS.2021.007Keywords
local government debt, bailout expectation, soft budget constraintAbstract
Expectation of bailout by central government distorts the debt pricing mechanism, and as a result local governments run the risk of incurring debts because of the soft budget constraint issues. Thus finding ways to harden budget constraints is crucial, but there is little empirical evidence as to their effects. Since the “No Bailout” signal sent by China’s central government through the new Budget Law provides an ideal quasi-experiment, this study examines its impact on quasi-municipal bonds. Using micro-level data, the authors find that the policies have effectively dispelled expectations of bailout and improved debt pricing mechanism, yet implicit guarantees from local governments still exist. Therefore, the authors show that the policy of the Chinese central government has a certain level of credibility, and that policies combining government credibility and market forces can help to resolve debt risks of local governments.
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