China's Local Government Debt: Implications for U.S.-China Competition

RAND Corporation | Howard J. Shatz, Robin Wang, Linda Zhang, Timothy R. Heath, Anthony D'Arrigo

China accumulated at least $12 trillion in local government debt by 2024, representing 64 percent of gross domestic product and threatening long-term economic stability. Off-balance-sheet borrowing through local government financing vehicles accounts for more than $5 trillion of this total. A sharp downturn in property land sales severed a main revenue source for local authorities managing about 85 percent of government spending.

Overall credit pushed China’s national debt-to-GDP ratio to 315 percent in June 2025. Domestic commercial banks absorbed much of the expanding debt, with government bonds accounting for 22 percent of new bank assets over the past five years. Debt swaps offer temporary relief. Special refinancing bonds reduce near-term interest costs but fail to resolve underlying structural deficits. Debt pressures will not slow Beijing's military buildup. Fiscal strain instead forces China to rely on aggressive export-led growth and ongoing technology competition to sustain national development.

Comment

China's preference for insulating People's Liberation Army procurement from sub-national debt distress reveals how ring-fenced military allocations operate independently of provincial balance sheets. While local government financing vehicles shoulder trillions in off-balance-sheet liabilities, central defence appropriations flow directly through the Ministry of Finance to the Central Military Commission. This dual-track financial structure protects state-owned defence enterprises like the Aviation Industry Corporation of China from municipal fiscal shortfalls. Major naval expansion programmes at Jiangnan Shipyard remain shielded from provincial credit constraints.

However, prioritising central military expenditure during regional fiscal contraction compels provincial authorities to shift internal security and civil defence costs onto commercial banks. As financial institutions absorb low-yield sovereign bonds to stabilize local budgets, private-sector capital allocation for dual-use technological innovation narrows. The resulting credit crowding forces state laboratories under the Chinese Academy of Sciences to rely on targeted central subsidies rather than commercial venture capital.

Strategic Question for Discussion

Which factor will exert greater influence on long-term Chinese defence modernisation: the central insulation of People's Liberation Army procurement budgets, or the contraction of commercial credit supporting dual-use research at the Chinese Academy of Sciences?

The available evidence points toward central fiscal insulation dominating the near-term trajectory of People's Liberation Army capital expenditure. However, persistent credit contraction across provincial commercial networks inevitably constrains downstream commercialisation of emerging dual-use systems. My assessment is that Beijing will maintain primary platform production at yards like Jiangnan while accepting software integration delays in advanced autonomous projects.

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