Environmental regulation and local government debt risk

Mitigating local government debt risk poses a significant challenge for debt governance in developing countries. However, the causal link between environmental regulation and local government debt risk remains underexplored. This study examines the causal impact of environmental regulation on local government debt risk. We leverage China’s Blue Sky Defence War as a quasi-exogenous shock to environmental regulation. In a difference-in-differences framework with unbalanced panel data from 2,491 counties between 2015 and 2023, we find that environmental regulation significantly reduces local government debt risk. We then provide evidence suggesting that environmental regulation lowers local government debt risk by enhancing repayment capacity and optimizing the debt structure. Heterogeneity analysis shows that the effect is more pronounced in regions with more implicit government debt structure, superior government credit, advanced factor markets, and lower resource dependency. Further results reveal that environmental regulation effectively promotes high-quality economic development. Overall, our findings confirm the importance of environmental regulation in managing local government debt risk and enhancing its economic benefits.