Regional Currency Overvaluation and Local Government Debt
59 Pages Posted: 2 Nov 2021
Date Written: October 28, 2021
China and the eurozone are alike in terms of their unbalanced regional growth and a common currency. Inland China, similar to Greece, with growth much slower than that of coastal China (similar to Germany), calls for a weak currency. However, the RMB, the common currency for entire China, cannot depreciate to match inland China's weak fundamentals and is thus overvalued from the perspective of inland China. Without monetary autonomy to devalue its overvalued currency, inland China has to turn to debt issuance, leading to higher inland China indebtedness. We then establish a link between regional currency overvaluation and local government indebtedness. Using Chinese data of 234 cities over the sample period of 2004 - 2013, we show that city-level currency overvaluation is positively associated with higher local government debt. Our findings suggest that a 1% increase in the overvaluation of RMB prompts the new issuance of local government debt by approximately 0.2%. This effect can be magnified by a higher degree of labor market immobility and spatial disequilibrium.
Keywords: Local Government Debt; Currency Overvaluation; Labor Market Mobility; Regional Differences
JEL Classification: F1; G2
Suggested Citation: Suggested Citation