Bond Financing Of Local Government: Mode Selection And Risk Control

Although local government borrowing is forbidden by law in China, the debt is still growing rapidly as local government seeks funding through alternative methods, such as local government bonds issuing through the Ministry of Finance or Investment and Financing vehicles. The rapid growth of local government indebtedness has caused people to worry that it may trigger severe fiscal risk. In this context, this paper is trying to shed the light on three questions: Should local government be allowed to borrow? Among different financing models, which one is the best theoretically? What should be the choice of China at present and how to control the risk?First, local government borrowing is necessary due to the mismatch of local government's expenditure and revenue. The use of Local government bond as major external financing tools would increase the transparency of the indebtedness of local government and therefore leads to a better risk control. In addition, the sustainability analysis model in this paper finds that the debt outstanding of local government is still acceptable, leaving the room for further growing of debt financing. Second, the local government bond issuing could be summarized as three models:"issuing with self-determination","issuing through financing vehicle", and"issuing through central government". Based on international experience and theoretical analysis, this paper concludes that the choice of issuance model is the tradeoff between the financing efficiency and risk control. Therefore, the financial position of local government, which decides how badly the financing efficiency and risk control are needed, is a major factor that should be considered in the choice of issuance model. However, the possible reform should be started with the innovation of existing methods through induced institutional change, and maximize their effectiveness. Third, we draws the conclusion from the mathematical analysis model that the"issuing with self-determination"model is more efficient compared with"issuing through central government". Finally, this paper suggests that China should allow local government to issue general obligation bonds through central government and issue revenue bonds through Investment and Financing Vehicle at present, and adopt the model of"issuing with self-determination"when conditions permitting in the future.