ON FAST TRACK: The Guangshan Highway combining Guang'an of Sichuan Province with Qipanguan of Shaanxi Province is opened on May 23. Most local government debt is invested in infrastructure projects like new highways and railways (LIU REN)

Yunnan Highway Development and Investment Co., a provincial government highway contractor in southwest China's Yunnan Province, recently surprised bankers that invested in its infrastructure projects: The company would be unable to repay some of the 90-billion-yuan ($13.84 billion) debt it had borrowed from 10 banks because of tepid cash flows. Government subsidies that eventually ran up dry also left the company strapped for cash, reported Beijing-based Caixin Century magazine, citing unnamed bank and government officials.

The Yunnan-based company's loan default is only the tip of the iceberg in China where a growing number of local government funding platforms are mired in debt and unable to repay borrowed money, said a report in the 21st Century Business Herald.

Soaring investment in local highway projects over the past two years, despite providing modern infrastructure in China's underdeveloped regions as well as providing a boost for local economies, has quickly become a burden as a wave of stress befalls provincial governments, said the report.

To get a clearer picture of just how bad the debt situation is, the National Audit Office deployed more than 40,000 auditors nationwide in the first half of 2011 to investigate 79,000 local government agencies, 6,500 local government-backed financing vehicles, 370,000 projects and nearly 1.9 million lending agreements.

The National Audit Office on June 27 released the result of the investigation, which showed that local governments, from the provincial level all the way down to the county level, had amassed 10.7 trillion yuan ($1.65 trillion) in debt as of the end of 2010.

Among the total local government debt, 42 percent will be due in recent two years. Nearly 8.5 trillion yuan ($1.3 trillion) was from bank loans. Certain regions had debt ratios greater than 100 percent after borrowing money to fund projects for infrastructure, hospitals and colleges.

Heavy burden

Local government debt can be broken down into three categories: debt with repayment obligations, contingent debt with guaranteed obligations and contingent debt for which local governments have obligations to render assistance. The first type, for which local governments are obligated to pay in full, accounted for 60 percent of the total sum.

Even if local governments were forced to repay the entire 10.7 trillion yuan, the debt burden, which accounts for more than 20 percent of China's GDP, would still fall below the country's panic level of crisis.

Much of the debt began piling up during the Central Government's two-year stimulus package to combat the effects of the global financial crisis, said Yi Xianrong, a researcher with the Institute of Finance and Banking of the Chinese Academy of Social Sciences (CASS).

While the debt may be rooted in the Central Government's initiative, it has a stronger correlation with the GDP-oriented evaluation mechanism on local governments, said Gao Peiyong, Director of the Institute of Finance and Trade Economics of the CASS.

"We used to appraise local government's performances based solely on the GDP and economic development of the region, but this only encouraged them to become obsessed with spending on infrastructure construction in spite of the potential risks of being unable to eventually repay those loans," said Gao.

China also lacks a unified financial budget, with different sectors managing their own finances. This means local governments can invest in massive public projects without considering the overall financial situation, Gao said.

"What's more, local governments are not independent financial entities in that their income is decided by how much the Central Government decides to give them. Since the local governments have no say in their balance sheets, they often borrow regardless of their ability to repay loans at a later time," Gao said.

The current debt situation, said Jia Kang, Director of the Research Institute for Fiscal Science under the Ministry of Finance (MOF), was caused by a lack of transparency that allowed debt to build up and hidden debts to form.