  The deep financial turmoil in China caused by the COVID-19 pandemic has
exacerbated fiscal shocks and soaring public debt levels, which raises concerns
about the stability and sustainability of China's public debt growth in the
future. This paper employs the Markov regime-switching model with time-varying
transition probability (TVTP-MS) to investigate the growth pattern of China's
public debt and the impact of financial variables such as credit, house prices
and stock prices on the growth of public debt. We identify two distinct regimes
of China's public debt, i.e., the surge regime with high growth rate and high
volatility and the steady regime with low growth rate and low volatility. The
main results are twofold. On the one hand, an increase in the growth rate of
the financial variables helps to moderate the growth rate of public debt,
whereas the effects differ between the two regimes. More specifically, the
impacts of credit and house prices are significant in the surge regime, whereas
stock prices affect public debt growth significantly in the steady regime. On
the other hand, a higher growth rate of financial variables also increases the
probability of public debt either staying in or switching to the steady regime.
These findings highlight the necessity of aligning financial adjustments with
the prevailing public debt regime when developing sustainable fiscal policies.
