The Crowding-In Effects of Local Government Debt in China

RePEc Short ID: pxu45
ORCID iD: 0000-0002-6591-4183

Li, Xiaoming; Liu, Zheng; Peng, Yuchao; Xu, Zhiwei

doi:10.24148/wp2024-35

Working Paper

The Crowding-In Effects of Local Government Debt in China

Abstract: We study how changes in the composition of Chinese local government debt influenced bank risk taking, credit allocation, and local productivity. Using confidential loan-level data and a difference-in-difference identification approach, we show that a debt-to-bond swap program for local governments implemented in 2015 significantly increased bank risk taking through a risk-weighting channel under Basel III capital regulations. The debt swap program converted bank holdings of municipal corporate debt to local government bonds, reducing banks’ risk-weighted assets. Banks responded by lowering credit spreads on loans to privately owned firms (POEs) relative to state-owned enterprises (SOEs), with significantly larger reductions in POE credit spreads in provinces with more outstanding government debt. Furthermore, the credit reallocation toward more productive private firms—a crowding in effect of the debt swap—significantly raised local productivity.

Keywords: Local Government Debt; credit allocation; Bank Risk Taking; misallocation;

JEL Classification: E52; G21; G28;

https://doi.org/10.24148/wp2024-35