China to Maintain Expansionary Fiscal Policy in 2026 Amid Local Government Debt Stress

Summary:

China will continue its proactive fiscal stance in 2026, expanding budget spending to support economic activity, even as local governments struggle with mounting debt...

Beijing Doubles Down on Fiscal Expansion Despite Growing Debt Risks

In a move signaling continued state-led economic support, China’s Finance Minister Lan Fo'an confirmed that the country will pursue a more “proactive” fiscal policy in 2026. This stance includes further budgetary expansion aimed at sustaining investment intensity and stabilizing growth, amid weakening domestic demand and persistent structural headwinds.

However, this policy commitment unfolds against a backdrop of intensifying liquidity stress among local governments. These authorities, which shoulder a large share of China’s infrastructure and public service obligations, are increasingly relying on off-balance sheet financing, including a record volume of asset-backed securities (ABS) to address short-term funding shortfalls.

Record Surge in ABS Issuance Reflects Deepening Cash Strain

According to data from financial information provider Wind, as of December 24, 2025, China recorded 2,386 ABS issuances surpassing the previous high set in 2021. The total transaction value reached an unprecedented USD 2.3 trillion, the highest in four years. ABS instruments in China are often backed by revenue streams from public assets such as real estate leases, highway tolls, or utilities.

While ABS provide a short-term liquidity solution, their explosive growth also reveals a deeper structural problem: the saturation of high-quality underlying assets. Industry insiders report that most of the prime assets have already been securitized, leaving only lower-quality projects to be packaged many of which have questionable profitability or long-term viability.

This development introduces a significant risk correlation: as the quality of ABS collateral declines, financial system vulnerability increases, particularly if economic growth weakens or investor confidence in public-sector balance sheets erodes.

Local Government Debt Reaches Historic Highs

According to the International Monetary Fund (IMF), total local government debt in China including off-budget financing via Local Government Financing Vehicles (LGFVs) surged to 84% of GDP by the end of 2024, up from 62% in 2019. The Chinese government has already launched a USD 1.4 trillion debt swap program in an attempt to restructure and partially consolidate this burden.

However, analysts estimate that latent liabilities may still exceed USD 10 trillion posing long-term risks to financial sustainability and macroeconomic stability. The rising reliance on ABS, particularly those backed by low-yielding or unverified assets, may create feedback loops of hidden leverage and asset mismatches across the shadow banking sector.

Expansionary Policy: Short-Term Boost or Structural Gamble?

While the central government’s commitment to fiscal support in 2026 is designed to buffer China’s slowing growth trajectory, it also reflects a high-risk trade-off. In the near term, expanded public spending can support employment, stimulate investment, and stabilize regional economies. But in the longer term, funding these initiatives through opaque and unsustainable channels especially when driven by local authorities could lead to growing credit risks and eventual fiscal distress.

The sustainability of this fiscal approach is further complicated by China's uneven recovery in consumer spending and ongoing deflationary pressures in certain industrial sectors. The use of fiscal firepower to address cyclical downturns may be undermined if it fails to translate into durable productivity gains or structural reforms.

Fiscal Expansion Carries Opportunity and Fragility

China’s decision to extend its expansionary fiscal policy into 2026 underscores its commitment to stabilizing growth amid complex macroeconomic challenges. However, the increasing use of asset-backed financing by local governments especially from lower-quality assets raises red flags over long-term fiscal discipline and credit risk.

As Beijing navigates this delicate balancing act, its ability to manage systemic financial exposure while sustaining growth will be tested. Unless underpinned by reforms that enhance transparency, asset quality, and local governance, the current trajectory may offer short-term relief at the cost of long-term resilience.

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