Subnational Debt of China: The Politics-Finance Nexus* HAOYU GAO, HONG RU and DRAGON YONGJUN TANG September 12, 2017 Abstract Using comprehensive proprietary loan-level data, we analyze the borrowing and defaults of local governments in China. Contrary to conventional wisdom, policy bank loans to local governments have significantly lower default rates than commercial bank loans with similar characteristics. Policy bank loans are relatively more important for local politician’s career advancement. Distressed local governments often strategically choose to default on loans from commercial banks. This selection is more pronounced after the abrupt ending of the “four trillion” stimulus when China started tightening local government borrowing. Our findings shed light on potential approach to hardening budget constraint for local government. JEL Codes: G21, G32, H74 * Haoyu Gao, Central University of Finance and Economics, 39 South College Road, Haidian Dist., Beijing 100081, China;
[email protected]. Hong Ru, Nanyang Technological University, 50 Nanyang Avenue, Singapore, 639798;
[email protected]. Dragon Yongjun Tang, University of Hong Kong, Pokfulam Road, Hong Kong;
[email protected]. We thank Warren Bailey, Patrick Bolton, Anna Cieslak, Jinquan Duan, Di Gong, Brett Green, Zhiguo He, Harrison Hong, Sheng Huang, Liangliang Jiang, Bo Li, Hao Liang, Jose Liberti, Ruichang Lu, Wenlan Qian, Jay Ritter, Jose Scheinkman, Victor Shih, Michael Song, Mark Spiegel, Chenggang Xu, Xiaoyun Yu, Weina Zhang, Li-An Zhou, Hao Zhou, staff at China Development