Risk Assessment Of China’s Local Government Debt Based On The KMV Model

With the sharp debt expansion of local governments in recent years, relevant risks are also beginning to loom large. The insolvency of Detroit in2013sounded the alarm bell for Chinese local governments with large scale of debts. Debt issues improperly handled may escalate into debt crisis, which may even cause adverse effects on the macroeconomic operation and social stability in our country. How to mitigate the debt risks of local governments has become an issue of great social concern and represent a thorny problem for local governments. Therefore, in the new Central Economic Working Conference, to avoid and control debt risks was listed as one of the main tasks of the economic working in2014. The key prerequisite for preventing and solving the problem of debt risks is the scientific evaluation for the risks. What is the present situation of the debt risks of Chinese local governments? And how much debt can the local governments afford in2014? These are the questions this paper tries to answer.By integrating some newly issued audit data pertinent to governmental debts, this paper briefly sums up the debt situation of Chinese local governments and their debt risks. On the basis of previous research results, the paper also analyzes the main causes of the debt risks. Taking the annual data from2000to2013of ten provinces and cities as the sample, the paper empirically analyzes the expected default probability of Chinese local governments and the debt scale they can afford by adopting panel data analysis and KMV model. The final part of the paper proposes some corresponding suggestions and discusses the outlook for future studies based on the analysis process and results of the paper.The paper finds that affected by the system of financial decentralization, Chinese local governments are suffering from insufficient financial resources. In order to make their ends meet, they often have to resort to debt financing. Moreover, the present regulatory system can hardly restrict excessive borrowings of local governments. Especially with the impetus of current macroeconomic policy, the debt scale of Chinese local governments has become very huge after the rapid expansion for successive years. Although the overall debt risk is controllable, the debt scale in some local areas may have grown beyond the local government’s repayment ability. Based on the estimation of the model, to make the expected default frequency no higher than0.4%, the debt repayment of Chinese local governments should not exceed3081.412billion Yuan in2014.The analysis is based on the newest governmental audit data and extends the risk assessment objects of the KMV model from bonds issued by local government to the debts they are liable to repay, which may be an innovation achieved by the paper.