![Sample our Politics & International Relations journals, sign in here to start your FREE access for 14 days]({"type":"image" , "src" : "/sda/5947/TOC-Subject-Sample-2021-Politics-International-Relations.jpg"})
Abstract
While the local government debts and local government financing vehicle (LGFV) bonds underwent reconstruction, in 2018 the new asset management regulation introduced some tighter measures to restrain shadow banking business and to mitigate the moral hazard issue that led to an ongoing boom of the LGFV market. This paper examines the impacts of the 2018 new asset management regulation on the credit spread of newly issued LGFV bonds and explores how the new asset management regulation affects the implicit guarantee of local governments in the LGFV market that has piled up systemic risks. We find that the release of the new asset management regulation has raised the credit spread of LGFV bonds at issuance. More importantly, the credit spread becomes increasingly sensitive to the local governments’ financial capacity and credibility right after the introduction of the new asset management regulation. Therefore, investors are compensated by more risk premiums for holding LGFV bonds issued by the local governments with a weaker balance sheet. Consequently, the implicit guarantee problem in the LGFV bond market has worsened.
Disclosure statement
No potential conflict of interest was reported by the author(s).
Notes
1 In 1994, China started the tax-sharing reform, which lowered the local governments’ share of the total tax income relative to the central government. While local governments play an important role in the economic reform and opening-up in China, they are financially constrained by the central government. The LGFVs are thus created as a unique financing carrier to support local governments’ economic initiatives. However, they also trigger a large amount of fiscal spending across the country.
2 In principle, the funds raised through the issuance of LGFV bonds are mainly used in regional infrastructure projects, of which local governments are one of the crucial promoters and beneficiaries. Nevertheless, the default of LGFV bonds often triggers difficulties for local governments to continue financing involved parties in a cost-effective way. This motivates local governments to act as an implicit guarantor to ensure that LGFV bonds make timely repayments.
3 There had been no official record of LGFV bond default till April 2021. However, it should be noted that there were various forms of delay in the payment, renegotiation and/or reclassification of LGFV bonds in 2018 and 2019.
4 For example, Gong, Wang, and Jia (2011) argue that the risk induced by operational flaws and information opaqueness of LGFVs may be contagious to the banking system and cause economic instability. Niu, Hong, and Chen (2016) further reveal two channels through which the credit risk of LGFV bonds can transmit into the market of treasury bonds.
5 No. 19 Regulation, Notice of the State Council on Issues Concerning Strengthening the Administration of Companies on Local Government Financing Platform (Guowuyuan guanyu Jiaqiang Difang Zhengfu Rongzi Pingtai Gongsi Guanli youguan Wenti de Tongzhi), was released on 13 June 2010. This Regulation aims to regulate the issuance and retirement of LGFV debts while demarcating the boundaries of LGFV operations. No. 43 Regulation, Opinions of the State Council on Strengthening the Administration of Local Government Debts (Guowuyuan guanyu Jiaqiang Difang Zhengfuxing Zhaiwu Guanli de Yijian), was released on 2 October 2014. No. 88 Regulation, Notice of the General Office of the State Council on Issuing the Emergency Response Plan for the Debt Risks of Local Governments (Guowuyuan Bangongting guanyu Yinfa Difang Zhengfuxing Zhaiwu Fengxian Yingji Chuzhi Yu’an de Tongzhi), was released on 14 November 2016. Both No. 43 Regulation, in more general, and No. 88 Regulation, with greater details, regulate the financial behaviour of local governments and limit the growth of local government debts.
6 Another name for these bonds is simply Chengtou.
7 We can provide the presence or removal of these negative credit spreads upon request.
8 We thank one of the anonymous referees for his/her comment which enables us to interpretate various impacts of implicit guarantees in a different way.
9 A number of important studies adjust the approach of identifying partial effects by varying dates of important events to analyse the impacts of important policies and regulations. While a ‘treated’ but fake earlier event date is picked for doing the placebo test, some shorter samples of ‘post-event’ are consistently used to avoid oversampling the observation on which the true event date has an impact. For example, Wang and Wu (2019) explore the impact of Medium-term Lending Facility (MLF) expansion occurring in June 2018 in China. They pick up the first day of June 2015 for the placebo test and look at the sample of bonds issued between January and September 2015. In addition, Cao and Zhang (2020) look into the impact of Notice of the State-owned Assets Supervision and Administration Commission of the State Council on the Experimentation of Dividend Rights Incentives in Selected Central Government-owned Enterprises (Guowuyuan Guoyou Zichan Jiandu Guanli Weiyuanhui guanyu zai Bufen Zhongyang Qiye Kaizhan Fenhongquan Jili Shidian Gongzuo de Tongzhi), which was issued in 2010, using a baseline sample ranging from 2007 to 2012. They pick up a two-year earlier date in 2008 for the placebo test and then truncate the sample to incorporate the years from 2005 to 2010.