Risk analysis

"There have been concerns about a possible hard landing for the Chinese economy, as well as systemic financial risks, based on the overflow of local government debts," said Li Yang, Vice President of the CASS. "This disclosure will ease these concerns."

That's not to say there aren't local government debt risks, but they're not as serious as some perceive, Li said.

According to the Maastricht Treaty, formally known as the Treaty on the European Union, the government debt-to-GDP ratio must not exceed 60 percent. Given China's whopping GDP of 39.8 trillion yuan ($6.12 trillion) in 2010, the 10.7-trillion-yuan debt is well within that threshold.

Cao Honghui, Director of the Department of Financial Markets under the Institute of Finance and Banking of the CASS, said that it will not cause systemic risks as long as China effectively deals with the non-standard and high-risk portions.

But to the country's banking industry, large-scale debt is a test. Bank loans accounted for nearly 80 percent of the 10.7-trillion-yuan debt. Financial analyst Ye Tan believes the default rate of the current local government debt may far exceed the previous size of banks' bad loans.

"Even though borrowing by local financing platforms could add significant potential liabilities, the overall condition for governmental financing is strong," said Huang Yiping, a professor at the National School of Development of Peking University.

At present, Chinese banks have very low rates of nonperforming loans but high capital adequacy. Last year Chinese banks' nonperforming loan ratio was 2.4 percent and the capital adequacy ratio for major banks was over 10 percent, Huang said.

"Even if we include all the contingent liabilities, including nonperforming financial assets, deficits and local government liabilities, total debt burden is about 50 percent of GDP. This ratio is still much lower than the 100 percent, a ceiling set by advanced countries," said Huang. "Given this, the risk in local government debt will not cause financial or fiscal crisis in China in a short run," he said.

Repaying

The real problem is how local governments will repay the 10.7 trillion yuan. Liu Jiayi, Auditor General of the National Audit Office, said local governments' debt burdens have not extended beyond their ability to pay it back.

The State Council said during an executive meeting that the problems relating to debt repayment and follow-up financing of local government projects under construction should be handled properly under the principle of making classifications and taking different approaches to different problems.

The Central Government will continue to strengthen supervision over local government financing units. Financial institutions should step up risk identification and management, strictly observe borrower admittance conditions and perform review and approval procedures according to commercial principles. Illegal loan guarantees should be banned. Meanwhile, it is necessary to research and establish a standardized borrowing and financing mechanism for local governments.

In terms of addressing the hidden local government debt issue, Jia said that the key is how to turn secretive rules for local government financing practices into transparent ones.

Jia stressed the necessity of establishing a transparent local government financing system. Audit departments have already incorporated such contents, including the establishment of a local government bond system and the revisions to related laws and regulations. Local governments may issue municipal government bonds that are matched with local projects to make local government debt transparent and subject to other types of supervisory systems.

Liu Shangxi, Deputy Director of the Research Institute for Fiscal Science under the MOF, said that local governments should not only establish an overall local government debt management framework, monitor and analyze various classes of local government debt, but also clarify and define the relationship between financing platforms and local governments.

Local governments should try to repay the most urgent debts by cutting expenditures, said Tang Min, Vice Chairman of the China Social Entrepreneur Foundation. Tang also suggested that local governments should sell assets to repay debts.

The excessive local government debt was a result of a lack of financial funds. Actually, the MOF should issue treasury bonds for local governments, said Li Daokui, member of the Monetary Policy Committee of the People's Bank of China and Director of the Center for China in the World Economy at Tsinghua University.

The open issuance of treasury bonds will improve the transparency of local financial system, Li said.