Dr. Yongheng Deng “Understanding the Risk of China’s Local Government Debts and Its Linkage with Property Markets”

Summary
The intertwining of local Chinese housing markets with government fiscal policies coincides with the significant economic growth in China over the past 25-years. This connection is the direct result of China’s central government reforms to its fiscal system that have encouraged local governments to rely on land sales and development to fund required infrastructure projects. Since China does not allow local governments to directly participate in the municipal bond market, these governments rely on a unique funding mechanism known as Local Government Financing Vehicle (LGFV). We study the linkage between the solvency of local government debt and local housing market risk. Our results indicate that areas with higher expected house price growth issue debt with lower risk premiums. Furthermore, bonds issued by LGFVs from areas that experience greater changes in housing prices have a corresponding decline in observed yield spreads. Thus, the results suggest that investors do price local housing risk into Chinese municipal bond risk premiums.