Impact of Physical Climate Risks on Financing Costs of China’s Local Government Financing Vehicle Bonds

Physical climate risks significantly raise financing costs for China’s local government debt, with compound extremes posing a particularly severe threat. Analyzing 19,761 Local Government Financing Vehicle (LGFV) bonds from 2014 to 2023, this study uses extreme temperature and precipitation days to proxy for climate risk. Results show that the individual risks and the compound risk comprised of the two significantly increase bond issuance spreads. Crucially, the economic impact is dramatically amplified when risks compound, as with “heavy rainfall accompanied by extreme heat”, reflecting investor pricing of non-linear climate impacts. For a typical bond, a 1% increase in extreme temperature days raises interest costs by approximately CNY 6840. These conclusions withstand a series of robustness checks, including the reconstruction of climate threats using a regional exposure index. Mechanism tests confirm that heightened local fiscal risks and deteriorating debt sustainability are key transmission channels. The study underscores the urgent need to integrate physical climate risk into public financial management to safeguard sustainable development.