Managing Debt Risk Accumulation: Empirical Study on the Debt Consequences of Local Government Guarantee From China

Purpose: This paper aims to examine debt accumulation between enterprises and debt repayment of local government which is linked with local government guarantee that acts as a debt transferring mechanism. The purpose is to illustrate that it is essential to pursue a sustainable fiscal policy of local governments so that decrease debt dependence during the processes of promoting economic growth. Design/methodology/approach: The channel of how the partial debts of non-financial enterprise to be transferred into the debt repayment of local governments is explicated by the theory of soft budget constraint and the mechanism of debt transferring - local government guarantee. The feasible generalized least squares regression model is used to test the hypotheses. The sample data include debts of non-financial industries, bad loans of commercial banks and debt repayment of local governments in nineteen provinces that are published from the official database of national Ministries over the period from 2007 to 2016. Findings: The results demonstrated that there is a positive relationship between enterprise debts and the debt repayment of local governments. In addition, there is symbiotic phenomenon between corporate debts and debt repayment of local government, that is, the current patterns of industrial investment and financing of local governments may cause production overcapacity and enterprise debt accumulation on the one hand, and shift enterprise debt and bad loans to the debt repayment of local governments through the debt transferring mechanism on the other. Originality/value: This research verifies the positive relationship between enterprise’s bad loans of bank and the debt repayment of local governments through introducing debt risk transferring mechanism, and thus provides empirical evidence for central government to prohibit the debt guaranteed of local governments and to enforce hard budget constraints.