Europe’s Fiscal Lessons Offer China a Roadmap for Managing Rising Local Debt

An ADB study finds that Europe’s decades of experience with fiscal rules offers important lessons for China as it seeks to manage rising provincial debt, emphasizing that debt sustainability should be linked to growth, fiscal capacity, and financial stability rather than rigid debt limits. The report urges policymakers to strengthen local revenues, improve debt transparency, and adopt flexible, province-specific fiscal frameworks to reduce risks while supporting long-term economic development.

A new study by the Asian Development Bank (ADB), authored by Barry Eichengreen of the University of California, Berkeley, and ADB economists Akiko Terada-Hagiwara and Yothin Jinjarak, argues that China can learn important lessons from Europe's experience in managing government debt. The report comes as Chinese provinces face mounting fiscal pressures due to rising borrowing, weakening land-sale revenues, and growing spending obligations.

China's local governments are responsible for funding infrastructure, education, healthcare, and other public services. However, most major tax revenues are controlled by the central government. This gap has forced many provinces to rely heavily on borrowing, often through Local Government Financing Vehicles (LGFVs), creating significant debt risks across the country.

Why Europe's Experience Matters

The study finds strong parallels between China and the European Union. Just as Eurozone countries share a single monetary policy while maintaining different fiscal positions, Chinese provinces operate under a common monetary system despite having widely varying debt levels and economic conditions.

Europe has spent decades refining fiscal rules designed to keep government debt under control. While these rules initially focused on strict debt and deficit limits, repeated economic crises showed that rigid targets often fail to reflect economic realities. Over time, European policymakers shifted toward more flexible frameworks that assess debt sustainability based on growth prospects, revenues, and spending needs.

For China, this suggests that debt management should focus less on meeting fixed numerical targets and more on whether debt can be serviced without harming economic growth.

Looking Beyond Debt Numbers

One of the report's most important findings is that not all debt is equally risky. The researchers found that provinces with higher debt levels generally face larger interest payment burdens. However, debt used to finance productive infrastructure and revenue-generating projects tends to be more manageable than borrowing that does not create future economic returns.

This has direct policy relevance. Instead of focusing solely on reducing debt levels, policymakers can prioritize improving the quality of borrowing. Investments that boost productivity, economic growth, and local revenues can make debt more sustainable over the long term.

The study also suggests that public spending may be a more practical tool for managing debt than strict deficit targets because governments have greater control over expenditure than revenue.

The Link Between Debt and Financial Stability

The report warns that local government debt is not only a fiscal issue but also a financial stability concern. Banks, regional lenders, construction firms, and private businesses are closely tied to provincial finances. If heavily indebted provinces face repayment difficulties, the impact could spread throughout the financial system.

China has already taken steps to address these risks through debt-swap programmes that replace expensive short-term liabilities with lower-cost long-term bonds. According to the study, these measures help reduce immediate repayment pressures and support financial stability. However, they do not eliminate the underlying causes of local government debt problems.

For policymakers, the message is clear: debt restructuring should be combined with broader fiscal reforms that improve local government finances and reduce dependence on borrowing.

What Policymakers Can Learn

The study concludes that successful debt management requires more than fiscal rules. Europe's experience shows that rules are difficult to enforce when economic conditions deteriorate or political priorities change. Effective fiscal governance depends on flexibility, transparency, and strong institutional support.

For China, the report recommends strengthening provincial revenue sources, improving debt transparency, and adopting a debt-sustainability framework tailored to local conditions. Provinces differ significantly in income levels, growth prospects, and fiscal capacity, meaning a one-size-fits-all approach is unlikely to work.

The broader policy implication is that sustainable debt management should support, not hinder, economic development. Rather than relying on arbitrary debt ceilings, governments should evaluate debt in relation to growth, revenue generation, spending responsibilities, and financial risks. As China seeks to balance growth with fiscal stability, Europe's experience offers a practical roadmap for building a more resilient and sustainable fiscal system.