Analysis Of Determinats On Credits Spread Of Chinese Local Government Bonds

To innovate on and to ameliorate the debt financing mechanism of local governments, the Treasury Department issued a document in March 2015, stipulating that ordinary debts are issued and payed back autonomously by local government conforming to market principle. Consequently, the volume of local government debts has grown dramatically, so has the market concern over the credit risk implied in the local government debts. Credit Spread, a crucial indicator of the credit risk implied in the local government debts, is measured by the difference between local government debt and treasury debt subjected to the same term structure. Credit Spread is affected by many factors, and this paper, focusing on the market of China’s local government debts and building upon the credit risk structure model and foreign empirical research findings, intends to select explanatory variables from the two standpoints of government credit risk and market risk, and to examine empirically the contributing factors affecting the level of credit risk of local governments nationwide via step-wise regression model.My empirical results indicate:Both the interest rate level and local government rate have relatively good explanatory power (negative impact) over the level of credit spread between corresponding local government debt and treasury debt. The higher the level of interest rate and tax rate, the narrower the credit spread carried.Obviously, the worse the debt profiles of local governments (accumulation of direct liabilities and weakening of solvency), the wider the credit spread. The accumulation of local government debts would incur higher default risk premium for the local governments; Likewise, over-indebtedness would also overwhelm the local government as their fiscal revenue can’t afford their share of debt. The immediate outcome is the widening of credit spread. Coastal regions have their congenital geographic advantages, which leads to narrow credit spread for their local governments. The market liquidity measure, inflation indicator and the stock market volatility index are all positively correlated with the credit spread carried by local government debt. As revealed by my empirical examination, the impact of currency inflation over the credit spread dominates that of favorable prediction for quantitative easing, which, by and large, drives up the credit spread. Both currency inflation and higher raise the level of market risk, and in turn expand the credit spread. Individually, the scale of debt undertaken by each local government is positively correlated with its credit spread, whereas the impact of average maturity of all the debts issued by one particular local government over the credit spread is so far unidentifiable. Credit rating so far has not demonstrated the risk identifying function that it should have. However, fiscal deficits suffered by local governments and the shape of treasury debt yield curve (upward, downward or flat) bear insignificant influence on the credit spread carried by local government debts. Interactions between each other are still obscure.This paper, based on the above empirical results and the status quo of local government debts in our nation, advises to further specify the main responsibility of local government, to perfect the market-oriented issuing mechanism of local government debt, and to activate the risk identification function of credit rating, to enhance the capitalizing efficiency by local government, and to increase transparency of fiscal policy of local government and to advance the regulation and supervision of local government debts. The ultimate goal is to foster a healthy and stable market for our nation’s local government debt.