What triggered China's urban debt risk? Snowball effect under the growth target constraint

The root causes and governance of subnational debt are intensely discussed in regional and policy research. This study contributes to literature by using the growth target constraints as a lens to investigate the boom of urban debt under political incentives. A theoretical analysis framework of growth target constraints and urban debt is constructed from the perspective of the full cycle of debt operation (financing–investment–repayment). Using the new-caliber urban construction investment bonds data of 270 prefecture-level cities from 2007 to 2015, we find that the competition for growth of subnational governments is the endogenous root of the boom of urban debt. The growth target constraint triggers subnational governments to carry out irrational debt financing through the leverage amplification effect of land leasing and mortgage, and to invest a large amount of financing in infrastructure construction. Unfortunately, these impulsive investments have low returns in terms of efficiency, which ultimately affects debt repayment. Accordingly, urban debt has shown considerable growth in this debt-stimulated model, which we attribute as the “snowball effect” of urban debt risk. This study provides empirical evidence of damage on urban finances caused by political incentive distortion. From these findings, reflections on governance policy for subnational debt in the context of China are drawn.