Interest Rates and Subnational Finance:How China’s Local Governments Manage Interest Rate Risk

Abstract

This paper analyzes how interest rates affect China’s local governments through their on-budget local government bonds (LGBs) and off-budget Local Government Financing Vehicles (LGFVs), and evaluates the main tools used to manage interest-rate risk. Using a policy-anchored case study drawing on fiscal documents, central-bank communications, and market research from 2021–2025, I trace four channels: refinancing costs, debt-service burdens, project valuation, and market access via spreads. I then assess the effectiveness of debt-refinancing programs and related governance frameworks. I find that the 2024–2025 environment of stable policy rates alongside targeted refinancing reduced average new-issue LGB coupons versus 2023, easing near-term cash-flow pressure. However, benefits are uneven: weaker LGFVs continue to face rollover constraints and limited access to derivative hedges, leaving residual vulnerabilities. The paper highlights implications for fiscal sustainability and outlines directions for microdata-based evaluation of risk transfers between budgets and LGFVs.