Fiscal Self-Sufficiency, Debt Limits, and Fiscal Sustainability in China’s Emerging Municipal Bond Market

China’s municipal bond market suffers from a tension between centralized policymaking by the national government and the decentralized implementation of those policies by subnational governments. That tension and the recent policy transformations in the China’s municipal bond market provide important insights into the erosion of the fiscal self-sufficiency of China’s local governments and the long-term sustainability of a viable municipal bond market.

Using panel data from 155 Chinese provincial-level governments between 2015 and 2020, this study develops fiscal indicators to measure the sustainability of China’s bond market given its institutional context. With these indicators, the research empirically explores the effect of fiscal institutions such as centrally-imposed debt limits on local governments’ sustainability to meet debt service obligations. It also investigates the capacity of local governments for selfsufficiency to meet their debt obligations and maintain debt sustainability. We find that debt limits have promoted local debt sustainability while local fiscal self-sufficiency has had little effect on debt sustainability in the long-term.

The findings provide public finance and policy scholars with an understanding of the effectiveness of fiscal institutions such as debt limits imposed by China’s central government. It also assists local government officials in understanding the potential effects of debt limits on their capacity to manage debt risk and maintain fiscal sustainability. Moreover, China’s development of a municipal bond market illustrates both the advantages and limitations of a centralized administrative approach to governing. Finally, this research provides important insights and policy recommendations for moving toward a more financially sustainable bond market in China.