The Governance of Local Government Debt from the Perspective of Fiscal and Financial Coordination: Evidence from Financial Markets

Theories based on fiscal guarantees cannot explain either the fact that the continuously decline in local fiscal resources has not significantly increased local government financing costs, or the fact that local government debt has been rising at a time of strict central government regulation. The theoretical and empirical analyses provided in this study show that it is the financial resources under local government control that provide the implicit guarantee for local government debt. Such financial resources lower local governments' financing costs but have the potential to lead to the contagion of financial risk through local government to the financial sector. Therefore, to look at the question solely in terms of either fiscal or financial sector guarantees will not be sufficient to resolve the problem of local government debt. The central government needs to coordinate fiscal and financial policies under a joint management framework in a way that rationally disperses and resolves the risks attached to local government debt and avoids the assumption of excessive risk by either sector. At the same time, close attention should be paid to local financial institutions' asset quality and their money market reputation to avoid the risk of contagion from local financial institutions to local public finance.