The paper investigates the institutional mechanism behind increasing local government debts and default risk in the last decade in China. Using prefectural‐level data from 2010 to 2017, we study the default risk on local government debts through the lens of spatial interactions. Empirical results identify positive spatial interactions of default risk among political neighbouring cities, but not for merely geographic or economic neighbours. Moreover, the spatial interactions vary with local leader's political incentives. These findings altogether suggest the spatial interactions of default risk is driven by political competition among local leaders. The study also rules out alternative explanations such as resource flow effects.