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China’s local government debt: Causes, consequences, characteristics, governance and suggestions

Yang Yao and Ling Yu

China’s local government debt has long been a critical engine of economic growth; however, its rapid expansion since 2009 has generated significant systemic risks to fiscal stability and macroeconomic security. Despite sustained policy efforts to curb debt accumulation, subnational liabilities have continued to grow. In this chapter, we employ a multidimensional framework to investigate: 1) the institutional drivers of debt escalation, including imbalances in fiscal decentralisation, subnational development imperatives, the characteristics of a unitary political system, frequent official staff turnover and regulatory gaps in off-budget financing under the Budget Law; 2) the dual consequences of local government debt as both a catalyst for growth and an amplifier of fiscal vulnerability; 3) the dynamics of debt accumulation from 2015 to 2023, as quantified through panel data analysis; and 4) the central government’s debt governance mechanisms, particularly in the context of its debt-swap programs. Based on our findings, we propose a comprehensive three-step debt resolution strategy designed to mitigate both current and future debts, thereby enhancing fiscal sustainability and promoting balanced economic development.

Global debt has escalated sharply in recent years. According to a UN report, global public debt reached a record high of US$97 trillion in 2023, with public debt in developing countries increasing at twice the rate of that in developed nations (UNCTAD 2024). According to the International Monetary Fund (IMF 2024), global public debt was expected to exceed US$100 trillion (93 per cent of global GDP) by 2024. As the second-largest economy in the world, China’s central government debt is relatively light compared with other large countries, but the debt borne by its local governments has reached an alarming level. According to the Ministry of Finance (MoF), China’s official on-budget local government debt was RMB40.74 trillion in 2023 (State Council 2023). However, this figure fails to account for local governments’ substantial off-budget borrowings that are disguised as commercial debts borrowed by government-owned commercial entities. Given the profound implications of local government debt for economic development and financial stability, a comprehensive understanding of its causes, consequences and governance is of great value to both scholars and policymakers.

The off-budget debt is primarily borrowed through local government financing vehicles (LGFVs). In response to the 2008 GFC, the Chinese Government launched a RMB4-trillion (US$586-billion) infrastructure-centric investment stimulus plan to stabilise economic growth (Fan et al. 2022). To address the substantial funding gap between local government fiscal revenue and the expenditure required for the stimulus plan, in 2009, the central government permitted local governments to establish LGFVs to raise off-budget funds for investment projects (Huang et al. 2020; PBOC and CBRC 2009; MoF 2009). In legal terms, LGFVs are commercial entities, just like other kinds of state-owned enterprises (SOEs). However, unlike other kinds of SOEs that operate for profit, their major task is to raise funds from the debt market to finance local government projects. Subsequently, LGFV-induced off-budget financing became a critical funding source, leading to rapid off-budget debt accumulation. By 2023, off-budget debt through LGFVs had ballooned to RMB61.56 trillion, accounting for 87 per cent of local government fiscal revenues, or 70 per cent of the total government debt balance (RMB70.77 trillion) and 151 per cent of the official on-budget local government debt balance (RMB40.74 trillion).¹

The accumulation of local government debt in China is influenced by several institutional factors. The 1994 tax-sharing reform restructured fiscal relations by shifting revenue authority upwards to the central government while decentralising administrative responsibilities to local governments. This restructuring led to increased fiscal pressures on local governments to finance their expenditure needs, thereby incentivising off-budget borrowing. Additionally, China’s rapid urbanisation has intensified demands for local economic development, further straining fiscal resources and necessitating debt-financed investment. China’s unitary state structure implies that the central government ultimately bears responsibility for local debt, creating moral hazard as local governments anticipate potential bailouts and thus dare to engage in excessive borrowing. The frequent rotation of local officials, combined with the pressures of the ‘promotion tournament’, exacerbates the issue, as officials’ performance evaluations are heavily tied to short-term GDP growth. This system incentivises large-scale infrastructure and industrial investment through excessive borrowing. Moreover, weak budgetary constraints and an underdeveloped municipal bond market further exacerbate the reliance on off-budget financing, amplifying risks associated with local government debt accumulation.

While local government debt has played a positive role in supporting infrastructure investment (Aschauer 1989; Ludvigson 1996), enhancing market liquidity (Yakita 2008) and promoting economic growth (Adelino et al. 2017), its mismanagement has led to significant risks. Excessive debt accumulation has heightened repayment pressures, weakened fiscal discipline and resulted in inefficient resource allocation (Huang et al. 2020). Low-return investments have put financial distress on LGFVs, many of which are on the verge of bankruptcy, necessitating central government intervention. Furthermore, mounting debt burdens have exacerbated financial market volatility (Huang and Du 2018), triggered inflation (Cochrane 2011) and heightened systemic risks (Chen et al. 2020), particularly in the real estate and financial sectors, where local government debt is often intertwined with land markets and banking institutions. This poses a dilemma for policymakers in balancing perceived trade-offs.

To address these challenges, the central government has undertaken a series of governance reforms, including the introduction of a quota-based local government bond issuance system, strengthened monitoring and enhanced transparency requirements. In 2015, the central government launched a three-year debt-swap program that converted RMB14.34 trillion of LGFV debt into local government bonds to lessen local governments’ short-term payment pressure. However, this program did not stop local governments borrowing through their LGFVs. In 2019, pilot resolution programs in six highly indebted provinces facilitated RMB142.92 billion for debt swap again.² The Covid-19 pandemic further strained fiscal conditions, prompting a temporary relaxation of LGFV bond issuance in 2020. Recognising the mounting risks, the central government expanded debt-swap efforts to 26 provinces, reaffirming its commitment to long-term fiscal sustainability.

What has happened in China in recent years is paradoxical: while the central government has geared up its efforts to resolve the debt issue, local government debt has surged and exhibited sustained growth. To this end, we present a thorough examination of the causes, functions and problems of local debt, alongside a review of the central government’s strategies for managing the risks. We seek to provide insights into how to reduce financial vulnerabilities, improve debt management practices and ensure that local government debt contributes to sustainable economic development without posing systemic risks to the broader economy.

The chapter is structured as follows: section two presents the categorisation of local debts; section three examines the factors driving the accumulation of local government debt; section four explores the economic consequences of local government borrowing; section five outlines the characteristics and scale of local government debt; section six evaluates the central government’s approaches to managing local government debt; and section seven proposes systematic solutions for mitigating the risks associated with local government debt.

Categories of local government debt

Before setting out our analysis, it is useful to present the categories of local government debt in China, which have evolved over time. Currently, local government debt is classified into on-budget and off-budget debt based on whether the obligations are recorded in the government’s balance sheet and whether they constitute legally mandated liabilities.

Categories of on-budget local government debt

On-budget debt includes obligations explicitly recorded in government accounts and legally required to be repaid using fiscal revenues within statutory debt ceilings. This category primarily comprises general and special debts raised through the issuance of local government bonds (LGBs). General debt is typically financed through the issuance of general LGBs and is allocated to non–revenue-generating public welfare projects, such as education, health care and social security. These debts are primarily repaid using general budget revenues. In contrast, special debt is financed through the issuance of special LGBs, which are directed towards revenue-generating projects, such as infrastructure development in transportation, telecommunications and housing. Special debts are predominantly repaid using corresponding government funds or designated revenues. On-budget debt is characterised by greater transparency and more stringent monitoring and is commonly referred to as explicit debt.

Categories of off-budget local government debt

Off-budget local government debt refers to obligations that are not formally recorded in government accounts and fall outside the statutory debt ceiling or central government–authorised debt frameworks. Some of these liabilities are guaranteed by fiscal funds or may involve illegal guarantees (Xu et al. 2020). This category primarily includes the following forms.

Direct implicit local government debt

This includes three categories: 1) implicit debt arising from social security obligations, such as pension deficits and healthcare insurance shortfalls. In cases where social security funds fall short, the responsibility for bridging the payment gap ultimately rests with local governments. 2) Debt related to future capital and recurring expenditures arising from public investment projects, notably under government-paid public–private partnership (PPP) models and viability gap-funded PPPs. The reduction in financing costs for such PPP projects is heavily dependent on credit enhancements provided by government-issued approval documents. Furthermore, debt repayment for these PPP projects is contingent on government payments or subsidies. When the total scale of these projects becomes unmanageable or when payment delays, defaults or project operation failures occur, the local government assumes the responsibility for repayment. 3) Implicit debt resulting from arrears in various on-budget expenditures, such as unpaid project costs, outstanding procurement payments and refundable deposits that have been collected from enterprises but remain unpaid. These are obligations that the government or its departments are required to fulfil once the payment conditions are met.

Contingent implicit local government debt

There are two categories here: 1) illegal or irregular implicit debt, such as the issuance of unlawful or irregular commitment letters, guarantees or similar documents that are often provided for LGFV bonds, the execution of construction projects disguised as government service procurement, PPP projects structured as equity investments with government repurchase agreements or guaranteed fixed returns, effectively converting equity into disguised debt, guarantees provided by industrial guidance funds to other partners and local governments raising debt in the name of SOEs or public institutions; and 2) debt arising from local governments assuming rescue responsibilities, which manifests in expenditures aimed at addressing liabilities such as debts of public institutions, debts and losses of local SOEs, non-performing assets of local financial institutions, obligations of LGFVs, fiscal shortfalls in subordinate governments and defaults on non-guaranteed debts. Since these debts are typically excluded from official government statistics, they are characterised by a high degree of opacity and are commonly referred to as implicit debt.

General LGFV debt

This kind of debt is issued by the LGFVs that are commercial identities legally separated from the government. However, it is widely acknowledged that LGFV debts are a convenient tool for local governments to finance their infrastructural projects. The market also believes that those debts are government debts and will never be defaulted even if they do not bear government guarantees—and there has never been a single default. LGFV debt can be bank loans, municipal bonds, trusted loans and other forms of shadow bank finance. There are no reliable data on the size of LGFV debts, but, by most estimations, they make up the largest part of local government debts.

Figure 9.1 provides a visual presentation of the categorisation. The central government only recognises on-budget debts and direct and contingent implicit debts among the off-budget debts. In theory, this leaves most of the LGFV debts to the market, which contradicts the widespread belief held by the market that those debts are also government debts.

Figure 9.1: Categories of local government debt in China

Source: Authors’ original illustration.

Causes of rising local government debt

The 1994 tax-sharing reform

From the early 1980s to early 1990s, China had a contract system for central–local fiscal relationships, which greatly tilted towards local governments. The rapid expansion of rural collective industries in the 1980s significantly propelled China’s early economic growth, generating a substantial surplus that became a primary revenue source for local governments (Tian 2000; Huang 2012; Banerjee et al. 2020). However, this led to a fiscal imbalance, with local government revenues significantly surpassing those of the central government. By 1993, the central government’s share of total on-budget revenues was merely 22.02 per cent, while local governments accounted for 77.98 per cent (see Figure 9.2).

Figure 9.2: An effect of China’s 1994 tax-sharing reform

Notes: Central government (left) and local government (right).

Source: National Bureau of Statistics of China (data.stats.gov.cn/english/).

To address this imbalance, the central government implemented the tax-sharing reform in 1994, categorising tax revenue into central, local and shared taxes, thereby fundamentally altering the revenue-sharing arrangement between the central and local governments (Liu et al. 2017; Tsui 2005). Despite its intentions, the reform primarily resulted in an upward shift of fiscal resources to the central government (Chang et al. 2013). Stable and high-growth tax sources were designated as exclusive central government revenue or shared revenue. Consequently, local governments became increasingly reliant on smaller, less stable tax bases characterised by fragmented sources, inefficient collection mechanisms and high administrative costs. Notably, the value-added tax, the most significant shared tax, allocated 75 per cent to the central government and only 25 per cent to local governments (Liu et al. 2022). This redistribution effectively recentralised fiscal control, substantially reducing local government revenues.

Compounding the issue, the reform rectified the decentralised administrative system that allocated the bulk of financial responsibilities to local governments, including social security, basic education, health care and public safety (See Table A9.1). Wong (2025) observes that in China’s fiscal structure, prefectures and counties, constituting the third and fourth tiers of the government, respectively, are primarily responsible for nearly all social security expenditures, encompassing old-age pensions, unemployment insurance and other welfare programs. Counties and townships, representing the fourth and fifth tiers, respectively, account for approximately 70 per cent of total education spending and between 55 and 60 per cent of healthcare expenditures. As a result, local governments faced heightened fiscal pressures, with expanding expenditure obligations and contracting revenue bases. The decline in revenues coupled with rising expenditures produced a persistent and widening fiscal gap for local governments (see Figure 9.2). In the post-reform period, although the central government has secured more than 50 per cent of total on-budget fiscal revenues, local governments have been tasked with nearly 80 per cent of on-budget fiscal expenditures. Although central government transfers fill most of the gap, fiscal independence forces local governments to increasingly resort to borrowing, thereby contributing to the expansion of local government debt.

Local development imperatives

China’s urbanisation has experienced a sustained upwards trend. In 1994, urban residents as a share of the national population exceeded 30 per cent and, by the end of 2023, the share reached 66 per cent, reflecting an average annual increase of 0.93 per cent over the previous five years.³ This rapid urbanisation has amplified local development demands; however, suboptimal infrastructure standards, insufficient coordination of infrastructure and service facilities between regions (for example, poor functional integration between transportation, utilities and public service systems) and deficiencies in urban governance have constrained local economic growth. Consequently, there is an urgent need for local governments to engage in municipal construction to stimulate GDP growth as well as to provide necessary public goods for the newly added urban population. Most government-invested projects are the responsibility of local governments rather than the central government, intensifying the urgency for local authorities to secure substantial financing resources within a short time.

Figure 9.3: The relationship between municipal construction, GDP and local government debt in China, 2015–23

Notes: On-budget local government debt (left) and LGFV-induced off-budget local government debt (right). MC = municipal construction. LGD = local government debt.

Sources: National Statistical Yearbooks (www.stats.gov.cn/english/Statisticaldata/yearbook/); Local Government Bond Information Disclosure Platform (www.celma.org.cn); and Enterprise Early Warning System.

Local governments’ fiscal resources comprise four primary components: formal budgetary revenues, transfers from the central government, off-budget revenues and proceeds from land-related transactions (Wu and Feng 2014). Revenues from the first two components are strictly controlled under the budgetary arrangements and are predominantly allocated to daily government operations, education, health care and social security, leaving limited funds available for public projects. Notably, municipal construction—the principal component of infrastructure investments—is generally not included in these budgetary allocations (Xu and Zhang 2013). As a result, only the last two revenue sources can fund municipal construction, and any financing shortfall must be met through alternative channels—primarily debt borrowings. Empirical analysis demonstrates that both municipal construction and GDP had a positive linear relationship with local government debt from 2015 to 2023 (see Figure 9.3).

A unitary political system

Since the fall of Qing Dynasty, China has adopted a unitary political system (as shown in Figure 9.4). Under this system, the country is divided into administrative regions (provinces) that operate under a unified sovereign authority (Xu 2011). This structural arrangement has two key implications. First, the authority of local governments is entirely delegated by the central government as a direct consequence of the hierarchical political structure. As a result, local governments primarily function as administrative extensions of the central government rather than as autonomous political entities. Consequently, when local governments incur debt, the ultimate responsibility for repayment rests with the central government. This arrangement creates strong incentives for local governments to engage in excessive borrowing, as they can effectively shift the financial burden upwards, relying on the central government to absorb the risks associated with their fiscal imbalances. Second, the unitary political system precludes local governments from utilising formal bankruptcy mechanisms, such as Chapter 9 of the US Bankruptcy Code, to discharge their debt obligations. In this legal framework, any bankruptcy or default by a local government would undermine the creditworthiness of the central government and potentially trigger a systemic financial crisis (Gao et al. 2021).⁴ As a result, the central government is compelled to assume responsibility for local government debt, which further incentivises local governments to borrow excessively to finance their development projects.

Figure 9.4: The hierarchical structure of the unitary political system in China

Notes: At the top of the hierarchy are the members of the Politburo of the Communist Party of China (CPC), including the party General Secretary and the Premier, who hold national rank. Directly beneath them is the Central Committee of the CPC, which comprises approximately 200 full members at the ministerial level and about 170 alternative members. Provincial party secretaries and governors, typically ranked at the ministerial level, also serve as members of the Central Committee. Notably, some provincial leaders, such as the party secretaries of Guangdong and Xinjiang, hold positions within the Politburo. Below this level are city secretaries and mayors, who are generally classified at the department level within the hierarchy.

Source: Authors’ description.

Frequent rotation of officials

Chinese officials are engaged in a promotion tournament. Frequent rotation is a distinctive feature of this system (Li and Zhou 2005; Chen and Kung 2019).⁵ According to the Interim Provisions on Tenure of Leading Party and Government Cadres (General Office of the CPC Central Committee 2006), once an official has held a position for two consecutive terms, they will be moved to a new position if they have not reached retirement age. The performance of local officials is primarily evaluated based on short-term economic growth, which is crucial for advancing their political careers (Xu 2011). In pursuit of economic growth, local officials often engage in building physical infrastructure (Bai and Qian 2010; Ru 2018), establishing special economic zones to attract investment (Wang 2013; Lu et al. 2019) and appointing capable bureaucrats (Xu 2011; Yao and Zhang 2015). Among them, public investment requires significant financial resources and raising taxes may adversely affect officials’ reputations and prospects for promotion. As a result, borrowing becomes a preferred method for local officials to mobilise the necessary funds to achieve their economic objectives (Fan et al. 2022).

Frequent political rotations also complicate audits for short-tenure local officials, presenting challenges in assessing the legitimacy of borrowing decisions for public investments in the short term. This situation exacerbates the moral hazard associated with borrowing, as local officials may exploit this ambiguity to meet their economic objectives. Consequently, fiscal resources obtained through borrowing are frequently allocated to short-term and low-return projects, often serving to save face for the incumbent officials.

Insufficient regulation for off-budget debt under the Budget Law

The persistent lack of transparency and accountability in fiscal budgeting has significantly exacerbated the challenges inherent in soft budget constraints. In response, the Budget Law was introduced in 1995, banning local governments from running deficits in their fiscal budgets. However, the law did not ban local governments’ off-budget borrowing. Consequently, local off-budget expenditures have grown considerably yet remained largely unreported. The RMB4-trillion stimulus in 2009 accelerated this process.

To reflect the reality that off-budget borrowing had become an important source of finance for local governments, the Budget Law was revised in 2014 to allow local governments to borrow within their budget. The law requires that the drafting and implementation of both central and local government budgets be reviewed and approved by the National People’s Congress (NPC). However, the law still does not provide a framework for the central government to regulate local governments’ off-budget borrowing, which has allowed local governments to circumvent formal debt constraints. In particular, local governments have increasingly relied on massive borrowing through various financing vehicles, such as LGFVs. A large part of these borrowings is secured by pledges of land or other assets, which already exposes local governments to significant debt-related risks (for example, Ang et al. 2018; Chen et al. 2018, 2020). Worse, to circumvent the borrowing constraints, local governments have progressively adopted more sophisticated and intricate financial instruments to run funds, including borrowing from trust funds, issuing LGFV bonds and borrowing from enterprises. Many of these are not reported, complicating the accurate estimation of their size (Chang et al. 2013).

The dual consequences of local government debt

The developmental role of local government debt

Enhancing infrastructure investment

Local government debt (LGD) functions as a pivotal fiscal mechanism in stimulating aggregate demand, with a pronounced emphasis on infrastructure investment. On-budget debt mechanisms, especially the special LGBs, have become the dominant financing channel for public infrastructure projects. Between 2015 and 2023, the infrastructure-targeted special LGBs accounted for 40.39 per cent (RMB9.42 trillion) of total special bond issuance. Within this allocation, infrastructure construction for municipal facilities and industrial parks comprised 20.78 per cent, transportation infrastructure 18.39 per cent and cold chain logistics and new infrastructure projects 0.71 per cent and 0.51 per cent, respectively. Additionally, a substantial share was allocated to infrastructure-adjacent areas, including shantytown renovation (12.03 per cent), agricultural, forestry and water projects (3.49 per cent), ecological and environmental protection (2.58 per cent), rural revitalisation (0.84 per cent), urban old residential community renovation (0.64 per cent) and energy projects (0.33 per cent) (see Figure 9.5-A).

Complementarily, off-budget financing via LGFVs addresses diverse infrastructure needs (Chen et al. 2020). From 2015 to 2023, the bond issuance of LGFVs was distributed across urban infrastructure construction (36.09 per cent), industrial investment (27.77 per cent), transportation construction and operation (12.57 per cent), land development and consolidation (8.72 per cent), public utilities (5.76 per cent) and other areas such as shantytown renovation and affordable housing development (3.79 per cent), comprehensive platforms (3.39 per cent),⁶ industrial park development and operation (1.71 per cent) and cultural tourism (0.21 per cent) (see Figure 9.5-B). Correspondingly, the distribution of LGFVs’ total debt reflected a comparable pattern, with infrastructure construction (40.05 per cent), industrial investment (26.77 per cent), transportation construction and operation (7.88 per cent), land development and consolidation (9.24 per cent), public utilities (6.44 per cent), shantytown renovation and affordable housing development (4.44 per cent), comprehensive platforms (3.26 per cent), industrial park development and operation (1.66 per cent) and cultural tourism (0.26 per cent) (see Figure 9.5-C). The investment carried out by the LGFVs has significantly enhanced the functionality of the urban system and addressed critical infrastructure gaps while providing a robust foundation for sustainable economic development and improved quality of life for ordinary people.

Figure 9.5: Distribution of special bond funds and LGFV bond issuance by business type

Notes: Allocation of funds raised through special bond issuance (A), share of LGFV bond issuance by business type (B) and proportion of LGFVs by business type (C).

Source: Wind database (www.wind.com.cn/).

Financial repurposing: From savings glut to productive capital

The rapid accumulation of savings in China has created a substantial pool of idle capital (Chen and Wen 2017; Piketty et al. 2019; Zhang et al. 2021). By the end of 2015, household deposit balances stood at RMB54.6 trillion, rising sharply to RMB137 trillion by 2023 (PBOC 2024). However, this capital surplus has led to a decline in its utilisation efficiency, as substantial savings remain underemployed in productive economic activities.

Local governments have utilised financing platforms and related mechanisms to mobilise low-yield idle funds, redirecting them towards high-yield capital expenditures (Zhang and Tsai 2024). Strategically, these funds have been allocated to sectors critical to economic development, including transportation, agriculture and water conservancy, energy and ecological and environmental protection (Zhu 2021). Investments in these areas not only strengthen infrastructure but also promote industrial chain coordination, fostering regional economic growth. Furthermore, many infrastructure projects generate sustainable revenue streams, such as toll fees from highways and revenues from utility projects. These revenue flows mitigate local fiscal shortfalls and contribute to long-term GDP growth, thereby reinforcing the foundation for high-quality economic development. Through this dual mechanism of resource mobilisation and revenue generation, idle funds are effectively utilised to advance regional and national economic objectives.

Enhancing the fiscal flexibility of local governments

China has made significant progress in developing a market-oriented economy (Chen et al. 2020). Market-based financing instruments, characterised by high operational flexibility and risk-sharing mechanisms, have systematically enhanced local governments’ fiscal flexibility through three channels: 1) diversification of funding sources beyond traditional fiscal transfers; 2) optimisation of intertemporal resource allocation via capital market integration; and 3) establishment of shock-absorbing mechanisms for fiscal resilience. Through these mechanisms, local governments have strengthened fiscal stability, ensured expenditure continuity and improved resource allocation efficiency. This institutional innovation has enabled provincial and municipal authorities to maintain fiscal stability while ensuring expenditure continuity and improving allocative efficiency.

Between 2015 and 2023, a confluence of external and internal pressures, including escalating United States–China trade frictions, the transition to new growth drivers, tax and fee reductions and the economic disruptions caused by Covid-19, intensified fiscal imbalances. During this period, the national public budget self-sufficiency rate declined from 86.60 per cent in 2015 to 76.76 per cent in 2023.⁷ In response, local governments issued RMB26.91 trillion in new bonds, with the proportion of on-budget bond issuance relative to fiscal resources rising from 3.88 per cent in 2015 to 21.15 per cent in 2023.⁸ Additionally, LGFVs issued RMB33.44 trillion in bonds, with the proportion of LGFV bonds relative to fiscal resources increasing from 9.75 per cent in 2015 to 30.36 per cent in 2023.⁹ These bond issuances not only mitigated fiscal shortfalls but also strengthened local governments’ financial autonomy, enhancing their capacity to address regional economic challenges and implement development priorities more effectively.

The crowding-in effects: Stimulating private investment

While the conventional literature finds that government debt crowds out private investment, there are several ways for government debt to have a crowding-in effect for private investment.

The first is the trade credit channel. A portion of local government debt arises from repayment obligations to private suppliers through procurement activities (Hu et al. 2022). Delays in payments or the accumulation of accounts receivable often impose liquidity constraints on private enterprises, adversely affecting their financial stability. To mitigate these challenges, private enterprises have increasingly used high-credit government receivables as collateral to secure external financing, thereby replenishing working capital. In this context, local government debt may serve as a catalyst for private enterprise financing by enhancing access to financial resources that might otherwise be restricted. Contrary to concerns about crowding out private financing, government debt may stimulate additional funding opportunities, enabling private firms to address liquidity challenges and support their operational growth. Thus, local government debt not only stabilises private enterprise financing but also contributes to broader economic resilience and growth.

The second is the reputation channel. Private firms engaged in government procurement or investment projects must go through a screening process. As a result, they are often better than the average private firm in the market. In this case, local governments play the role of quality screening for the entire market. Private firms passing the screening process thus build a reputation that can facilitate their borrowing in the market.

The third is the channel of financial acceleration. Much local government borrowing has been spent on building infrastructure, which has accumulated a large number of assets, facilitating further local government borrowing. This is a kind of financial acceleration like the one created by investment in the real estate sector. Moreover, private firms can also benefit. Better infrastructure increases the value of assets held by private firms. As a result, private firms can borrow more from banks and other financial institutions because they have large amounts of collateral to offer.

The challenges of local government debt

Escalating debt servicing risks

The exponential growth of local government debt issuance and its cumulative stock has imposed severe repayment obligations, thereby amplifying local government debt risks. The off-budget debts are especially concerning. Traditionally, repayment of those debts has relied on revenues from government-managed funds, primarily coming from land sales, in addition to the revenue generated by the projects financed by those debts. However, in recent years, economic slowdowns, adjustments to real estate policies and other structural factors have constrained the growth of revenues from the sale of state-owned land use rights. From 2015 to 2023, the average annual growth rate of revenues from government-managed funds stood at merely 5.07 per cent,¹⁰ significantly lagging the average annual growth rate of local debt balances. This widening gap has grown into a huge risk.

To make up the gap, local governments have increasingly relied on borrowing new debts to roll over the old debts, exacerbating the risks. As we will show later, more than 90 per cent of the LGFV bonds have been refinancing borrowings in recent years. However, this is not enough to cover all the maturing LGFV bonds. Local governments, under the approval of the central government, must issue on-budget refinancing special LGBs to swap maturing LGFV bonds. Since 2018, local governments have increasingly resorted to refinancing special LGBs to alleviate their repayment pressures. The issuance of such bonds surged from RMB135.8 billion in 2018 to RMB2.03 trillion in 2023, with their share of total special LGBs rising from 6.98 per cent to 33.96 per cent.¹¹ While the swaps provided short-term relief, their rapid growth has created long-term challenges. Under the constraints of the official debt ceilings, the expansion of refinancing special LGBs has reduced the available quota for new bond issuances, thereby limiting the financing capacity for new projects. In addition, by moving local governments’ repayment pressures from their off-budget balance sheets to their on-budget balance sheets, debt swaps have increased local governments’ fiscal stress over time.

Return and term mismatches

Local government financing is predominantly directed towards public infrastructure projects. The heavy reliance on market finance leads to dual mismatches. First, there is a mismatch between the public nature of the projects and the cost of finance. Infrastructural projects bring low returns and many generate no return. But the interest rates incurred by LGFVs, whether through bond issuance (for example, 4.07 per cent in 2023) or other mechanisms,¹² often exceed the financial returns generated by infrastructure projects. As of 31 December 2023, the average coupon rate of LGFV bond issuance was 4.07 per cent. The resulting cost–return imbalances have led to persistent financial losses for LGFVs, undermining their long-term operational sustainability. Second, a mismatch also exists between the timespan for infrastructural projects to recoup their costs and the term of most off-budget debts. As Kroeber (2016) describes, ‘localities often used three to five-year bank loans to finance infrastructure projects whose economic benefits (and revenue streams, if any) would only materialize over two or three decades’. The maturity of LGFV bonds is like that of bank loans. This disparity implies that debt obligations often mature before the infrastructure projects can generate sufficient returns, thereby exacerbating fiscal pressures and increasing financial risks.

Underutilisation of debt

Despite substantial funds raised through debt issuance, many local governments fail to effectively channel these resources into productive investments, leading to resource misallocation and the underutilisation of local economic development potential.

First, the prevalent issue of ‘over-packaging’ of investment projects significantly undermines the efficiency of fund allocation. To secure approval and additional financial support, some local governments artificially enhance project feasibility by inflating projected revenues or underestimating costs. In 2022, 24 regions issued a total of RMB198.21 billion in special LGBs through such practices. Of this amount, RMB5.03 billion was illegally allocated to prohibited areas, including landscaping and commercial projects. Moreover, 47 regions misappropriated RMB15.80 billion, while five regions falsified expenditure progress for 33 projects, leaving RMB6.03 billion in unused funds by the end of the year. These actions not only led to the inefficient use of financial resources but also increased repayment risks, particularly for projects with low or negligible returns.

Second, the persistence of idle funds exacerbates inefficiencies. Poor project preparation, inadequate planning and delays in implementation often leave allocated funds unutilised for extended periods. For example, the National Audit Office reported that the value of special bond funds left idle for more than one year was RMB13.2 billion in 2020, rising to RMB21.7 billion in 2021. Such prolonged underutilisation reflects structural weaknesses in project execution and resource management.

Third, the misuse of funds remains widespread, undermining the intended objectives of local government debt financing. While these funds are designated for public projects within specific sectors, some regions have diverted them to unauthorised purposes, such as projects on the negative list or recurrent expenditures such as employee salaries. From 2020 to 2022, illegal fund usage amounted to RMB41.32 billion, RMB13.66 billion and RMB20.80 billion, respectively. Such mismanagement not only distorts resource allocation but also exacerbates fiscal risks, ultimately compromising the sustainability of local government finances (NAO 2023).

How big is Chinese local government debt?

On-budget local government debt

Over the years, the balance of on-budget debt has grown substantially while it generally remaining within the statutory limits. Figure 9.6 illustrates the trend in on-budget local government debt from 2015 to 2023. During this period, the total debt balance increased from RMB14.21 trillion in 2015 to RMB40.74 trillion in 2023, staying below the statutory debt ceiling of RMB42.17 trillion. However, by 31 October 2024, the total on-budget debt had risen to RMB45.31 trillion. In terms of debt composition, special debt has seen accelerated growth since 2019, surpassing general debt in terms of total balance. As of 31 October 2024, the balance of special debt reached RMB28.71 trillion, compared with RMB16.60 trillion for general debt. Notably, the balance of special debt remains within the prescribed ceiling, with the ceiling projected to increase from RMB29.52 trillion to RMB35.52 trillion by the end of 2024.¹³

Figure 9.6: Local government debt balance in China, 2015–24

Source: Local Government Bond Information Disclosure Platform (www.celma.org.cn).

Figure 9.7: Local government bond balances in Chinese provinces in 2023

Source: Local Government Bond Information Disclosure Platform (www.celma.org.cn).

Significant regional disparities exist. Figure 9.7 presents the regional trends in on-budget local government debt ratios in 2023. The provinces with the highest debt ratios were Qinghai, Guizhou and Tianjin, with outstanding balances of RMB3.33 trillion, RMB15.12 trillion and RMB11.12 trillion, respectively, accounting for 87.87 per cent, 72.32 per cent and 66.42 per cent of their regional GDP. Within these provinces, general debt stood at RMB2.54 trillion in Qinghai, accounting for 66.78 per cent of GDP; RMB8.23 trillion in Guizhou, accounting for 39.36 per cent of GDP; and RMB2.93 trillion in Tianjin, accounting for 17.51 per cent of GDP. Meanwhile, special debt reached RMB800 billion in Qinghai, representing 21.08 per cent of GDP; RMB6.89 trillion in Guizhou, or 32.96 per cent of GDP; and RMB8.18 trillion in Tianjin, or 48.91 per cent of GDP. In contrast, the provinces with the lowest local government debt ratios were Guangdong, with outstanding balances of RMB27.19 trillion, accounting for 20.04 per cent of GDP; Shanghai, RMB8.83 trillion, or 18.70 per cent of GDP; and Jiangsu, RMB22.73 trillion, or 17.73 per cent of GDP. General debt in these regions amounted to RMB7.50 trillion in Guangdong, representing 5.53 per cent of GDP; RMB3.68 trillion in Shanghai, or 7.78 per cent of GDP; and RMB7.66 trillion in Jiangsu, or 5.98 per cent of GDP. Meanwhile, special debt totalled RMB19.69 trillion in Guangdong, or 14.51 per cent of GDP; RMB5.16 trillion in Shanghai, or 10.92 per cent of GDP; and RMB15.06 trillion in Jiangsu, or 11.75 per cent of GDP.

Figure 9.8: Local government bond issuance in China, 2015–24

Source: Local Government Bond Information Disclosure Platform (www.celma.org.cn).

LGB issuance in China has shown a generally increasing trend, albeit with fluctuations. Figure 9.8 illustrates LGB issuance since 2015, revealing an upward trajectory. In 2015, the total LGB issuance amounted to RMB3.84 trillion, including RMB2.86 trillion in general LGBs and RMB970 billion in special LGBs. By 2023, total LGB issuance had risen to RMB9.34 trillion, comprising RMB3.35 trillion in general LGBs and RMB5.99 trillion in special LGBs. From January to October 2024, total LGB issuance amounted to RMB7.38 trillion, including RMB1.90 trillion in general LGBs and RMB5.49 trillion in special LGBs.

Regional disparities in LGB issuance are evident across China. Figure 9.9 illustrates the regional variations in the on-budget LGB issuance ratio for 2023. The provinces with the highest LGB issuance ratios were Tianjin, Jilin and Qinghai, with total LGB issuance of RMB361.2 billion in Tianjin, accounting for 21.58 per cent of regional GDP; RMB2.38 trillion in Jilin, or 17.58 per cent of regional GDP; and RMB57.0 billion in Qinghai, or 15.00 per cent of regional GDP. In these provinces, general bond issuance reached RMB116.5 billion in Tianjin, or 6.96 per cent of GDP; RMB116.2 billion in Jilin, or 8.59 per cent of GDP; and RMB46.0 billion in Qinghai, or 12.11 per cent of GDP. Meanwhile, special bond issuance amounted to RMB244.7 billion in Tianjin, or 14.62 per cent of GDP; RMB8.99 billion in Jilin (2.90 per cent); and RMB11.0 billion in Qinghai (2.89 per cent). In contrast the provinces with the lowest LGB issuance ratios were Beijing, RMB171.3 billion, or 3.91 per cent of GDP; Jiangsu, RMB458.0 billion (3.57 per cent); and Shanghai, RMB112.0 billion (2.37 per cent). General bond issuance accounted for RMB37.4 billion in Beijing, representing 0.85 per cent of GDP; RMB134.7 billion in Jiangsu (1.05 per cent); and RMB52.1 billion in Shanghai (1.10 per cent). Meanwhile, special bond issuance totalled RMB133.9 billion in Beijing, or 3.06 per cent of GDP; RMB323.3 billion in Jiangsu (2.52 per cent); and RMB59.8 billion in Shanghai (1.27 per cent).

Figure 9.9: Regional distribution of local government bond issuance in China in 2023

Source: Local Government Bond Information Disclosure Platform (www.celma.org.cn).

In addition to general and special debt, local government fiscal deficits also constitute a component of on-budget local government debt, as these deficits are formally recorded in government accounts and reflect structural funding gaps where fiscal revenues are insufficient to meet expenditure demands, thus are legally required to be repaid through government debt instruments or other financing mechanisms. The primary drivers of local fiscal deficits can be summarised as follows: first, the reduction in tax revenue. As a fundamental pillar of fiscal income, tax revenue has undergone a significant contraction due to the sustained implementation of tax cuts and fee reduction policies in recent years. The ratio of tax revenue to GDP in China declined from 18.45 per cent in 2015 to 14.36 per cent in 2023.¹⁴ This downward trend has substantially amplified local fiscal deficits, undermining the ability of local governments to meet their financial obligations. Second is the decline in revenue from land-use rights transfers. Traditionally, revenue from this source has served as an essential supplementary income stream for local governments, alleviating fiscal pressures and supporting expenditure needs. However, this revenue has experienced a sharp decline in recent years. In 2023, revenue from state-owned land-use rights amounted to RMB5.8 trillion, representing a 31.8 per cent decrease from its peak in 2021.¹⁵ This contraction has further exacerbated fiscal shortfalls, reflecting both a cooling real estate market and the diminishing efficacy of land-based financing strategies. Third, the significant increase in government expenditure due to the Covid-19 pandemic. According to estimates by Chong’en Bai, the pandemic resulted in a cumulative local government fiscal deficit exceeding RMB4 trillion over three years. Specifically, local deficits were RMB2.08 trillion in 2020, RMB988.8 billion in 2021 and RMB1.19 trillion in 2022. The financial pressures stemming from pandemic-related expenditures have directly contributed to the substantial growth of local fiscal deficits, ultimately increasing on-budget local government debt.¹⁶

In recent years, although the scale of on-budget local government debt has increased, it remains within a manageable range of risk. This is primarily due to the high transparency of on-budget debt, as the Chinese Government has established clear regulations governing the scale of on-budget debt financing, which stipulate that local governments may only borrow within prescribed limits, as well as the arrangements for debt repayment.

Off-budget local government debt

As indicated in section two, off-budget debt includes implicit local government debt and general LGFV debt. They pose a significant financial risk within China’s local government debt framework. They are not included in official government debt statistics and there is a lack transparency (Bai et al. 2016; Chen et al. 2020), creating substantial challenges for government departments to effectively supervise and manage them. Their concealed nature makes it difficult to accurately assess their scale.

Several studies have sought to estimate the scale of off-budget implicit local government debt using various methodologies, yielding significantly varied results. A common approach involves using the debt of LGFVs as a proxy for implicit debt. For instance, B. Zhang et al. (2018) and X.J. Zhang et al. (2018) estimated the off-budget implicit local government debt to be approximately RMB39.25 trillion by the end of 2017. Similarly, Liang and Liu (2019) reported that, by the end of 2018, off-budget implicit local government debt had surpassed RMB30 trillion. Another methodology for estimating this debt involves analysing various debt sources (for example, LGFV debt, debt from local SOEs, government-paid PPP projects and collateralised supplementary loans) and debt allocation. Mao et al. (2018) applied this approach and estimated that, as of 2016, the scale of off-budget implicit local government debt ranged between RMB21 trillion and RMB30.5 trillion, based on these debt sources. Li and Zhang (2024) refined this estimate further, projecting that implicit local government debt reached RMB59.83 trillion by 2020, considering debt allocation patterns. In addition to these domestic estimates, the IMF (2022) provided its own evaluation, estimating that the scale of implicit local government debt stood at RMB48.6 trillion by the end of 2020. Furthermore, data from the Bank for International Settlements reveal that the nominal value of government sector credit in China reached RMB68.05 trillion by the end of 2020. Taking into account the Ministry of Finance’s report that China’s government debt balance stood at RMB46.55 trillion by the same period, the scale of implicit local government debt for 2020 can be further estimated at RMB21.50 trillion (BIS n.d.). Additionally, after comprehensive project identification and multi-level reviews, the Ministry of Finance reported that the national balance of implicit local government debt stood at RMB14.3 trillion by the end of 2023.¹⁷

The implicit local government debt is not the total of local governments’ potential off-budget debt; all the debt incurred by LGFVs, regardless of whether it is guaranteed by local governments, could have to be paid back by local governments. This debt mainly comprises loans obtained from commercial banks, corporate bonds issued by LGFVs in the capital markets and funds obtained by non-standard financing tools (for example, trust loans financing, direct financing from non-bank financial institutions or investors, wealth management direct financing, factoring and financing leases). Here, we focus on the interest-bearing liabilities of LGFVs because relatively complete data exist for them. Note that these liabilities overlap with the implicit government debt.

Overview of the interest-bearing debt of LGFVs

The interest-bearing debt of LGFVs has experienced significant and sustained growth. As depicted in Figure 9.10, the total interest-bearing debt of LGFVs rose from RMB20.09 trillion in 2015 to RMB61.56 trillion in 2023.¹⁸ In terms of financing structure, bank loans have consistently remained the primary source of capital for LGFVs. From 2015 to 2023, bank loans accounted for more than 50 per cent of the total financing. Specifically, in 2023, bank loans to LGFVs amounted to RMB41.32 trillion, representing 63.92 per cent of the total interest-bearing debt. Bond financing has emerged as the second-largest source of capital, contributing more than 27 per cent of the total interest-bearing debt since 2015. In 2023, bond financing reached RMB15.55 trillion, accounting for 27 per cent of the total debt. Non-standard financing had consistently accounted for more than 5 per cent of the total interest-bearing debt between 2015 and 2023. In 2023, non-standard financing totalled RMB4.69 trillion, constituting 5.72 per cent of the overall debt.

Figure 9.10: Interest-bearing debt balance of LGFVs, 2015–23

Source: Enterprise Early Warning System (www.qyyjt.cn).

Figure 9.11: Interest-bearing debt balances of regional LGFVs in China in 2023

Source: Wind database (www.wind.com.cn/).

The interest-bearing debt of LGFVs also shows considerable regional variation. As depicted in Figure 9.11, in 2023, the provinces of Zhejiang, Guangdong and Tianjin recorded the highest interest-bearing debt ratios, with total debt of RMB7.57 trillion, RMB5.31 trillion and RMB1.29 trillion, respectively. These figures represented 91.75 per cent, 88.28 per cent and 76.96 per cent of their respective regional GDPs. Financing through bank loans accounted for RMB5.02 trillion in Zhejiang, or 60.88 per cent of regional GDP; RMB3.93 trillion in Guangdong (65.45 per cent); and RMB820 billion in Tianjin (49.31 per cent). Bond financing amounted to RMB2.14 trillion in Zhejiang (25.97 per cent of regional GDP); RMB1.06 trillion in Guangdong (17.57 per cent); and RMB390 billion in Tianjin (23.12 per cent). Non-standard financing totalled RMB405.19 billion in Zhejiang (4.91 per cent of regional GDP); RMB315.65 billion in Guangdong (5.25 per cent); and RMB75.84 billion in Tianjin (4.53 per cent). In contrast, the provinces exhibiting the lowest interest-bearing debt ratios were Hainan, with total debt of RMB75.70 billion, or 10.02 per cent of regional GDP; Qinghai, with RMB29.89 billion (7.87 per cent); and Liaoning, with RMB141.66 billion (4.69 per cent). Bank loans amounted to RMB59.49 billion in Hainan, RMB20.71 billion in Qinghai and RMB99.53 billion in Liaoning, representing 7.88 per cent, 5.45 per cent and 3.29 per cent of regional GDP, respectively. Bond financing in these provinces totalled RMB15.46 billion in Hainan (2.05 per cent); RMB6.41 billion in Qinghai (1.69 per cent); and RMB23.28 billion in Liaoning (0.77 per cent). Non-standard financing in these regions amounted to RMB740 million in Hainan (0.10 per cent); RMB2.76 billion in Qinghai (0.73 per cent); and RMB18.84 billion in Liaoning (0.62 per cent).

Overview of LGFV bond issuance

LGFV bonds are corporate bonds issued by LGFVs that have implicit government guarantees (Liu et al. 2017). Bond issuances of LGFVs in China have exhibited a consistent upward trend, albeit with minor fluctuations over time. As depicted in Figure 9.12, the issuance trajectory of LGFV bonds from 2015 to 2023 demonstrates sustained growth, except for declines in 2017 and 2022. The total bond issuance increased from RMB1.48 trillion in 2015 to a peak of RMB6.68 trillion in 2023.

Figure 9.12: LGFV bond issuance, 2015–23

Source: Enterprise Early Warning System.

Figure 9.13: Regional LGFV bond issuance in 2023

Source: Enterprise Early Warning System.

From a regional perspective, provinces with stronger economies and more robust fiscal capacities tend to exhibit higher LGFV bond issuance volumes, whereas less-developed provinces generally show lower issuance volumes. As shown in Figure 9.13, in 2023, Tianjin, Jiangsu and Zhejiang ranked as the top three provinces in terms of LGFV bond issuance relative to regional GDP, with issuance amounts of RMB360 billion, RMB1.47 trillion and RMB820 billion, respectively. These amounts accounted for 5.43 per cent, 21.94 per cent and 12.24 per cent of the national total LGFV bond issuance (RMB6.68 trillion) and represented 21.70 per cent, 11.43 per cent and 9.91 per cent of their respective regional GDPs. In contrast, Liaoning recorded issuances of RMB69.60 billion, accounting for only 0.10 per cent of the national total LGFV bond issuance; Hainan recorded RMB12.00 billion (0.02 per cent); and Inner Mongolia recorded RMB35.00 billion (0.05 per cent). These amounts represented 21.10 per cent, 11.43 per cent and 9.91 per cent of their respective regional GDPs.¹⁹

Figure 9.14: Fund allocation of LGFV bond issuance, 2015–23

Source: Enterprise Early Warning System.

The allocation of funds raised through LGFV bond issuance has undergone substantial changes in recent years, with a notable shift towards increasing the proportion directed to debt repayment. LGFVs reveal the fund allocation of bond proceeds in their prospectuses, and these funds can be classified into four primary categories: 1) debt repayment, which includes the settlement of maturing LGFV bonds, as well as the principal and interest on bank loans, non-standard borrowings and other financial obligations of LGFVs; 2) project construction such as rebuilding shanty areas or constructing infrastructure; 3) supplementing operating capital; and 4) others such as financing for other entities through entrusted loans. Figure 9.14 provides a detailed analysis of the allocation of funds from LGFV bond issuances between 2015 and 2023. The data clearly indicate a shift towards debt refinancing, with the proportion of funds allocated to this purpose rising from 23.91 per cent in 2015 to 94.00 per cent in 2023. In contrast, the share of funds allocated to project construction has steadily declined, from 40.87 per cent in 2015 to only 2.31 per cent in 2023. Similarly, the proportion of funds used to supplement operating capital has decreased from 9.13 per cent in 2015 to 1.93 per cent in 2023. Moreover, the allocation of funds to other purposes has decreased significantly, from 26.09 per cent in 2015 to 1.76 per cent in 2023. These trends highlight a growing reliance on bond issuance to service existing liabilities, accompanied by a substantial reduction in funding for new projects and operational needs.

Regionally, certain provinces allocate a larger proportion of the funds raised through LGFV bond issuance to the repayment of existing debt. As shown in Figure 9.15, all provinces allocate at least 70.03 per cent of the raised funds for debt repayment. Among them, provinces such as Ningxia, Jilin, Qinghai, Hainan, Tianjin, Guizhou, Liaoning, Yunnan and Tibet allocate close to 100 per cent of the raised funds to debt repayment. Additionally, Guangxi allocates 99.27 per cent to debt repayment; Hebei, 97.91 per cent; Jiangsu, 97.71 per cent; Hunan, 97.25 per cent; and Henan, 95.74 per cent. This pattern highlights the significant debt burdens in these regions and emphasises their increasing reliance on bond issuance as a key mechanism for managing and servicing growing debt obligations.

Figure 9.15: Regional fund allocation of LGFV bond issuances in 2023

Source: Enterprise Early Warning System.

Figure 9.16: Distribution of LGFV bond maturity in 2023

Notes: Funds distribution by LGFVs bond issuance maturity (left) and distribution of LGFVs by issuance maturity (right).

Source: Enterprise Early Warning System.

In terms of maturity, most bonds are concentrated in the range of three to five years. As shown in Figure 9.16, in 2023, bonds with a maturity of three to five years accounted for the largest proportion of funds raised, representing 33.44 per cent of the total issuance amount. The corresponding issuance quantity was 31.53 per cent of the total number of issuances. Bonds with a maturity of one to three years ranked second, raising 29.03 per cent of the total amount, with their issuance quantity making up 31.71 per cent of the total issuances. Bonds with a maturity of less than one year followed, representing 26.77 per cent of the total issuance value and 27.99 per cent of the total number of issuances. Bonds with maturities between five and seven years accounted for 7.99 per cent of the total issuance value, with their corresponding issuance quantity representing 6.73 per cent of the total. Bonds with maturities exceeding seven years represented the smallest share, accounting for only 2.86 per cent of the total issuance value and 2.03 per cent of the total issuance quantity.

Figure 9.17: Distribution of coupon rates for LGFV bond issuance in 2023

Source: Enterprise Early Warning System.

The coupon rate for LGFV bond issuance has consistently remained above 2.3 per cent. As shown in Figure 9.17, the average coupon rate for LGFV bond issuance in 2023 was 4.07 per cent. A breakdown by maturity indicates that the weighted average coupon rate is 2.32 per cent for bonds with maturities of less than one year, 3.91 per cent for those with maturities of one to three years, 3.84 per cent for three to five years, 5.43 per cent for five to seven years, 4.45 per cent for seven to 10 years and 3.74 per cent for those exceeding 10 years.

The central government’s debt-swap programs

The indebtedness of local governments has profound implications for the country’s financial security and economic stability. To assess the scale of local government debt, the central government conducted two comprehensive audits between 2011 and 2013. The first audit, conducted in 2011, revealed that the total on-budget explicit local government debt amounted to RMB10.72 trillion. This figure included RMB6.71 trillion with direct repayment obligations, RMB2.34 trillion related to guarantee obligations and RMB1.67 trillion potentially subject to bailout measures. In parallel, the off-budget implicit local government debt induced by LGFVs was quantified at RMB4.97 trillion. Of this, RMB3.14 trillion was classified as debt with repayment obligations, while RMB1.83 trillion was considered contingent liabilities, collectively representing 46.38 per cent of the on-budget explicit local government debt (NAO 2011).

The second audit, conducted from November 2012 to February 2013, revealed a substantial increase in both on-budget and off-budget local government debt. On-budget explicit debt had surged to RMB17.89 trillion, with RMB10.89 trillion classified as debt with repayment obligations, RMB2.67 trillion as debt with guarantee obligations and RMB4.34 trillion as debt that could potentially require government intervention. Similarly, the off-budget implicit debt induced by LGFVs had risen to RMB6.97 trillion, with RMB4.08 trillion categorised as debt with repayment obligations and RMB2.89 trillion as contingent liabilities. This off-budget debt accounted for 38.96 per cent of the on-budget explicit debt (NAO 2013).

These audit results highlight the persistent and accelerating rise in local government debt, particularly the growing volume of off-budget implicit debt generated through LGFVs. In response to these mounting challenges, the central government conducted several rounds of debt swaps.

Debt screening and the first debt-swap program from 2015 to 2018

In October 2014, the central government introduced the Measures for the Clearance and Screening of Local Government Outstanding Debt into Budget Management, which mandated a comprehensive assessment and classification of local government debt (MoF 2014). This initiative required local governments to integrate their outstanding debt into formal budgetary management frameworks. By the end of 2014, the total outstanding debt of local governments nationwide amounted to RMB15.40 trillion. Of this, RMB1.06 trillion had been authorised for LGB issuance, while RMB14.34 trillion was raised through nongovernment financing channels, such as bank loans, trust financing and LGFV bond issuance (General Office of the State Council 2018).

To address the escalating debt burden, the revised Budget Law, effective 1 January 2015, authorised local governments to issue LGBs within the central government’s prescribed debt limits. This revision allowed local governments to swap off-budget implicit debt with more transparent on-budget debt instruments, primarily LGBs. As shown in Figure 9.18, for each year between 2015 and 2018, the amount of LGBs for the swap purposes was RMB3.24 trillion, RMB4.88 trillion, RMB2.77 trillion and RMB1.32 trillion, respectively, accumulating to a total of RMB12.2 trillion. This debt-swap program converted virtually all off-budget implicit local government debt into LGBs with higher credit ratings, thereby reducing the interest burden on local governments. Moreover, this restructuring extended the maturity profile of the outstanding debt, further lessening local governments’ repayment burden. By the end of 2018, the outstanding balance of off-budget implicit local government debt had been reduced to RMB315.1 billion, successfully achieving the key objectives of the debt-swap initiative (Xinhua 2016).

Figure 9.18: Local government bond issuance for debt swaps, 2015–19

Source: Wind database (www.wind.com.cn/).

The pilot program for small-scale implicit debt resolution

Despite the effort of the first round of debt swaps, local government debt continued to rise significantly during this period. By the close of 2016, the outstanding debt of local governments had reached RMB15.32 trillion, marking an increase of more than RMB4 trillion compared with 2011 (NAO 2017). Two primary factors contributed to this upward trend. First, although a comprehensive debt screening was conducted in late 2014, certain local government debts were excluded from official statistics. These uncounted debts remained the responsibility of local governments, thus creating potential future repayment or bailout obligations. Second, while the revised Budget Law established clear regulations governing government borrowing, local governments continued to engage in unregulated borrowing through newly established public institutions and LGFVs. This led to further accumulation of off-budget implicit debt, exacerbating the fiscal risk.

In response to the escalating levels of local government debt, a pilot program was launched in November 2019 to resolve implicit debt again by way of debt swaps. The program specifically targeted fiscally vulnerable counties in six provinces: Guizhou, Yunnan, Hunan, Gansu, Inner Mongolia and Liaoning. Operating within the central debt issuance limits, the program resulted in the issuance of RMB157.92 billion in LGBs across seven provinces (see Figure 9.19). Of this total, Jiangsu Province—although not initially included in the program—accounted for RMB15 billion, representing 24.27 per cent of the total issuance, while the remaining six provinces collectively issued RMB142.92 billion. The provincial breakdown is as follows: Guizhou, RMB38.32 billion (23.15 per cent); Yunnan, RMB22.62 billion (14.38 per cent); Hunan, RMB36.56 billion (14.32 per cent); Gansu, RMB5.97 billion (10.60 per cent); Inner Mongolia, RMB22.71 billion (9.50 per cent); and Liaoning, RMB16.74 billion (3.78 per cent) (see Figure 9.19).

Figure 9.19: Local government bond issuance for the 2019 debt-swap program

Source: Wind database (www.wind.com.cn/).

The primary objective of this pilot program was to alleviate the implicit debt burden faced by financially vulnerable counties and cities, thereby mitigating fiscal risks and promoting regional economic stability. By converting implicit debt into more transparent and manageable LGBs, the program aimed to enhance fiscal transparency, improve debt sustainability and facilitate more efficient resource allocation within these regions.

Expansion of debt swaps and the ‘no implicit debt’ initiative

The Covid-19 pandemic significantly disrupted Chinese enterprises, leading to widespread production halts and, in some cases, permanent closures. This disruption resulted in a substantial decline in corporate income tax, value-added tax and other business-related revenues, thereby causing a sharp reduction in the overall tax revenue collected by the Chinese Government. Concurrently, the government increased public spending to ensure the wellbeing of citizens, including investments in nationwide nucleic acid testing, vaccination campaigns and the establishment and management of quarantine facilities. As a result, local governments faced mounting fiscal pressures, compelling them to resort to borrowing to address these financial difficulties, which contributed to a rise in local government debt (Oi et al. 2025; Wong 2025).

In response to these challenges, between December 2020 and September 2021, the government expanded its debt resolution pilot program, extending it from incorporated counties to 26 regions, and issuing special refinancing bonds (a type of LGB) to swap implicit debt.²⁰ During this period, RMB612.8 billion in special refinancing bonds were issued (see Figure 9.20). From October 2021 to June 2022, the government further advanced its efforts by implementing ‘no implicit debt’ pilot programs across entire regions, beginning with Beijing, Shanghai and Guangdong. In this phase, special refinancing bonds amounting to RMB325.23 billion were issued in Beijing, RMB65.48 billion in Shanghai and RMB113.48 billion in Guangdong, totalling RMB504.18 billion across the three areas (see Figure 9.20). By the end of the initiative, several regions, including the initial three, formally announced the successful completion of their ‘no implicit debt’ pilot programs.

This round saw a notable expansion in both the scope and the scale of debt resolution efforts. The introduction of regional ‘no implicit debt’ pilots in major cities marked a critical milestone, signalling the beginning of a new stage of debt management. This phase represents a decisive shift towards achieving a state of ‘zero implicit debt’—a significant achievement in the Chinese Government’s ongoing efforts to address implicit debt risks and promote fiscal transparency.

Figure 9.20: Local government bond issuance for debt swaps, December 2020 – June 2022

Source: Wind database (www.wind.com.cn/).

Strengthening of implicit debt resolution

Since 2022, local governments in China have faced severe financial challenges due to the combined effects of the Covid-19 pandemic and the downturn in the real estate sector. This has resulted in significant declines in tax revenues and land transfer income, severely reducing financial resources and solvency. Concurrently, local governments and LGFVs have accumulated substantial unpaid, interest-free debt, including supplier accounts, construction deposits, salaries and public sector allocations, exacerbating implicit debt risks and making its resolution a priority for both central and local authorities.

In response, the central government introduced a ‘comprehensive debt reduction plan’ in July 2023, marking the beginning of a new round of debt resolution efforts, focusing on three key areas. First, from October 2023 to September 2024, local governments issued special refinancing bonds and new special LGBs (as supplementary debt instruments) to address outstanding debt.²¹ High-debt (that is, priority) provinces predominantly issued special refinancing bonds to resolve outstanding debt, while low-debt (non-priority) provinces primarily issued new special LGBs. The issuance of special refinancing bonds totalled RMB1.1 trillion in high-debt provinces and RMB400.5 billion in low-debt provinces, while the issuance of new special LGBs amounted to RMB294.4 billion in high-debt provinces and RMB819.9 billion in low-debt provinces (see Figure 9.21). Second, the central government increased the debt ceiling by more than RMB2.2 trillion for 2023 and committed to an additional RMB1.2 trillion for 2024. These measures aim to facilitate the issuance of LGBs to swap implicit debts and address outstanding arrears owed to enterprises (Shen 2024). Third, in November 2024, the government introduced the ‘6+4+2’ collaborative debt resolution plan, targeting the replacement of RMB14.3 trillion in implicit debt and achieving ‘zero implicit debt’. This includes: 1) a RMB6-trillion increase in the local debt ceiling from 2024 to 2026, with RMB2 trillion issued annually to swap existing implicit debt; 2) a RMB4-trillion allocation over five years to replace implicit debt with RMB800 billion in new special LGBs annually; and 3) RMB2 trillion in continued repayment of debt related to shantytown renovation, due after 2029, in accordance with the original contractual terms. It is projected that, by 2028, the total implicit debt of local governments will decline substantially, from RMB14.3 trillion to RMB2.3 trillion.

Figure 9.21: Local government bond issuance for debt swaps in priority provinces versus non-priority provinces, October 2023 to September 2024

Source: Wind database (www.wind.com.cn/).

Conclusion and policy implications

Conclusion

Local government debt has played an indispensable role in driving China’s economic growth. However, the rapid accumulation of debt, particularly through off-budget financing mechanisms such as LGFVs, has led to significant systemic risks. The issue of local government debt in China has been the focus of scholarly attention. To this end, we have systematically examined the drivers and impacts of local debt expansion, provided a detailed overview of its current developmental characteristics and scale and reviewed the central government’s management of local debt. Our analysis reveals that the current debt resolution paradigm inadequately addresses the intertemporal fiscal stress. To address the challenges posed by local government debt, we propose a comprehensive three-step debt resolution strategy.

Policy recommendations

Step 1: Enhancing fiscal relief for local governments

The fiscal conditions of local governments have significantly deteriorated due to the Covid-19 pandemic, posing a major threat to regional economic stability. Between 2019 and 2022, local governments in China recorded a cumulative fiscal deficit of RMB4 trillion. However, the scale of existing debt resolution plans is inadequate to effectively alleviate the growing fiscal pressure, leading to sharp reductions in public expenditures and declining quality of public service provision. This, in turn, may distort local government behaviour, such as increasing burdens on enterprises or adopting non-market mechanisms to fill fiscal gaps, exacerbating market uncertainty. To address the issue, the central government should issue special bonds to bail out local governments, easing their short-term fiscal difficulties, ensuring the fulfilment of public service responsibilities and stabilising market confidence. The central government has taken steps to bail out local governments. Premier Li Qiang announced a plan of RMB4.4 trillion in special bonds for local governments at the 2025 National People’s Congress. Local governments can use the funds to pay their wage and business arrears.

Step 2: Resolving the stock of local government debt

To deal with the mounting stock of local government debt, the central government should move all LGFV debts to new or existing asset management companies (AMCs). For distressed but promising projects or platform company debts, AMCs could facilitate debt restructuring by negotiating adjustments to debt terms, such as extending repayment periods, lowering interest rates or converting debt to equity. For debts backed by liquid assets, public auctions, listings or private sales could be employed to monetise assets and repay the debts. For assets generating stable cash flows (for example, toll roads, bridges, wastewater treatment plants), AMCs could securitise future revenue streams into marketable financial products, raising funds in advance. AMCs could revitalise large fixed assets such as factories or equipment through leases or joint operations, securing rental income or profit-sharing agreements with capable enterprises.

On the other hand, local governments should clarify debt liabilities and share losses with other stakeholders. Local debt formation is not solely a result of government actions; financial institutions often contributed by overestimating local governments’ repayment capacity or inadequately assessing risks. For debts that cannot be fully resolved, the debt chains should be thoroughly audited and liabilities clearly identified. A ‘mutual offset’ mechanism could be implemented to clear debts through reciprocal write-offs. Stakeholders should bear their respective responsibilities and share part of the debt losses with local governments. This approach not only strengthens risk awareness in future credit decisions but also optimises debt management and enhances financial market discipline.

Step 3: Preventing the generation of new debt

The Chinese Government should accelerate the reform announced by the Third Plenum of the Twentieth Party Congress to create an asset balance sheet for every level of government. This would help governments comprehensively understand economic conditions, develop informed policies and strengthen local debt management. This system should cover enterprises, banks and governments, incorporating all types of local government assets and liabilities to ensure transparency and dynamic updates. Specifically, commercial and public welfare debts should be unified within the budget and final accounts system to improve financial transparency. Standardised statistical and disclosure guidelines should ensure data comparability and consistency, with regular public disclosures creating a transparent debt management environment. Additionally, incentives and penalties should be implemented, linking the quality of debt disclosure to government performance evaluations and holding local governments accountable for incomplete or misleading information disclosures.

The asset balance sheet will strengthen the central government’s monitoring of local government debt. A comprehensive, normalised monitoring framework for local government debt should be established, integrating implicit and statutory debts under unified supervision. Collaborative monitoring mechanisms should be improved, involving financial, banking, state-owned asset, auditing, legislative and disciplinary inspection bodies. Auditing agencies should enhance scrutiny of debt fund usage, while legislative bodies must reinforce monitoring throughout the debt lifecycle to ensure compliance and transparency. Violations leading to debt issues should face stringent penalties and responsible parties be held accountable. Highlighting and exposing cases can reinforce deterrence and serve as a warning.

References

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Appendix 9.1

Table A9.1: Top-10 government spending categories, central versus local government

Central government spending (top 10)	RMB billion	%	Local government spending (top 10)	RMB billion	%
Total	1,876	100.0	Total	10,719	100.0
National defence	648	34.5	Education	2,014	18.8
Science and technology	221	11.8	Social security and employment	1,200	11.2
Interest payment for debt	206	11.0	General public service	1,170	10.9
Public security	118	6.3	Agriculture, forestry and water conservation	1,147	10.7
Education	110	5.9	Urban and rural community affairs	906	8.5
General public service	100	5.3	Transportation	733	6.8
Transportation	86	4.6	Medical and health care	717	6.7
Grain, oil & materials reserve & management services	65	3.4	Public security	593	5.5
Social security and employment	59	3.1	Housing security	407	3.8
Agriculture, forestry and water conservation	50	2.7

Sources: Ministry of Finance (www.mof.gov.cn/en/data/); Barclays Research (research-centre.barclays.co.uk/).

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1. 1 The calculation is based on data from the Wind database (www.wind.com.cn/).

2. 2 ibid.

3. 3 Data are sourced from the National Bureau of Statistics of China (data.stats.gov.cn/english/).

4. 4 Under this legal framework, Detroit’s bankruptcy proceedings facilitated the discharge of its outstanding debt, thereby laying the groundwork for its subsequent economic recovery.

5. 5 While the standard tenure for government officials is generally set at five years, early appointments to new positions, regardless of whether they constitute a promotion, may occur based on specific exigencies or directives from higher levels of government. Promotions typically proceed incrementally, with officials advancing one rank at a time, such as from the prefectural to the subprovincial level. Each political rank is subject to an age threshold—referred to as the ‘age dilemma’—above which officials become ineligible for promotion. This age limit varies across ranks, typically ranging from 40 to 67 years, as specified by Kou and Tsai (2014).

6. 6 Comprehensive platforms are a type of LGFV the operations of which span multiple domains of urban development and serve dual purposes: financing and investing in public-interest projects and engaging in market-oriented operations.

7. 7 The fiscal self-sufficiency rate is the ratio of general budget revenue to general budget expenditure. The calculation is based on data from the official website of the Chinese Government (english.www.gov.cn/).

8. 8 The data are sourced from the local government bond information disclosure platform. See CELMA (n.d.).

9. 9 The calculation is based on data from the Wind database (www.wind.com.cn/).

10. 10 The data are sourced from CELMA (n.d.).

11. 11 The data are sourced from the Wind database (www.wind.com.cn/).

12. 12 For details, see the subsection titled ‘Overview of the LGFVs’ bond issuance’.

13. 13 The Standing Committee of the NPC (2024) approved an increase of RMB6 trillion in the local government debt ceiling to replace existing implicit debt.

14. 14 The data are sourced from the official website of the Chinese Government (english.www.gov.cn/).

15. 15 ibid.

16. 16 The data were presented by Chong’en Bai, a member of the Academic Committee of the China Economist 50 Forum, during the 403rd session of the Chang’an Forum on 21 September 2023.

17. 17 These implicit debt data include obligations explicitly guaranteed and acknowledged by the government, while numerous implicit debts lacking government guarantees remain unrecognised. The data are sourced from NPC Finance and Economic Committee (2024).

18. 18 The interest-bearing debt of LGFVs here is based on the debt data disclosed by enterprises through the Enterprise Early Warning Platform. However, a significant portion of LGFVs’ interest-bearing debt remains unreported, primarily due to the opacity of many debt obligations. This includes debts incurred through PPP projects, entrusted loans, financing leases and other similar financial arrangements.

19. 19 In 2023, the GDP of Tianjin was RMB17.21 trillion; Jiangsu, RMB128.22 trillion; Zhejiang, RMB82.55 trillion; Liaoning, RMB30.21 trillion; Hainan, RMB7.55 trillion; and Inner Mongolia, RMB24.63 trillion.

20. 20 The distinctive feature of special refinancing bonds lies in the fact that the raised funds are not only allocated for the repayment of maturing debt, but also extended to address local governments’ existing debt stock, including non-standard forms of off-budget implicit local government debt, such as debt associated with LGFVs and arrears owed to enterprises.

21. 21 The new special government bonds represent a distinct category of local government bonds, characterised by the absence of detailed disclosures regarding the specific allocation of the funds raised for investment projects. Furthermore, these bonds do not provide key documents typically required for transparency, such as the project implementation plan, financial audit report and legal opinion. This lack of disclosure raises concerns about the level of transparency and accountability in the use of the funds.