The central government said yesterday it had cleaned up nearly half the 530 billion yuan (HK$649 billion) worth of local government debt from 2010 found to have irregularities during an investigation.
Economists, however, said the effort to correct financing problems affecting 259 billion yuan - or 40 per cent - of these loans would do little to address the mainland's underlying debt problem.
In June, the National Audit Office said local government debt had reached 10.7 trillion yuan by the end of 2010 - or roughly a quarter of the mainland's economic output.
The National Audit Office detailed the moves in a report published on its website. The report outlined common problems with the local government debt, including 73 billion yuan in loans secured against insufficient collateral and 244 billion yuan in loans secured against 'fake' or inadequate registered capital.
The office said steps had been taken to correct irregularities with 23 billion yuan of loans in the first category and 98 billion yuan in the second.
'These two types of irregularities pose great risks to banks and could cause a rise in bad loans,' said Michael Werner, an analyst with Sanford C. Bernstein.
Werner said city commercial banks and rural credit co-operatives had a higher risk of exposure to such problems than big listed banks such as Industrial and Commercial Bank of China, which had stricter lending standards.
The audit office's report came as a follow-up to a June report that first brought to light details of the explosive local debt problem resulting from excessive borrowing to bolster the economy in the wake of the 2008 global financial crisis.
Economists said cleaning up 40 per cent of the irregularities found does little to reassure that the underlying debt problem has improved.
'We should place a question mark on what does 'clean up' mean,' said Stephen Green, head of greater China research at Standard Chartered Bank. He said the debt was still outstanding and the government had not said how the problem would be resolved.
Other problems discovered include 46 billion yuan in 'irregular credit guarantees', 35 billion yuan spent on stocks, houses and polluting factories, and 132 billion yuan in expenditures not made by deadlines. Some 138 billion of loans in these categories were fixed.
About 5 trillion of the 10.7 trillion in credit the audit office says was issued went to local government financing vehicles (LGFVs), companies set up to borrow money from banks on behalf of local governments who are themselves usually restricted from doing so. Both figures are still subject to debate, as many economists have higher estimates.
Economists believe most of the loans to the LGFVs are not going to be paid back because many of the projects that they funded, such as infrastructure construction, do not generate enough money. This means the government would be ultimately responsible for their repayment.
Green said: 'At the bottom of the problem, it is a fiscal risk.'