Local government debts and corporate bond spreads: Evidence from China

Using a comprehensive dataset of Chinese corporate bonds that existed during 2011-2018, we find a significant positive relationship between local government debts and the credit spreads of local firms. By matching their debt maturity, we find that long-term government debts have an obvious effect on the spreads of long-term corporate bonds. Moreover, with the expansion of local government debts, local firms reduce their debt financing in response to the rising borrowing cost. These findings show that a crowding out effect does exist between local government debts and local corporate bonds. The effect is attributable to the decrease in the capital supply in the credit market, the weakened implicit guarantee from the government, and the increasing investment cost for local firms, which are all correlated with the expansion of local government debts.