The mainland's top economic planning agency has ordered a nationwide investigation of how proceeds of bond sales meant to finance affordable-housing projects have been used, said two people with direct knowledge of the matter.
Local branches of the National Development and Reform Commission were sent notices this month instructing them to complete the checks by the end of April, said the people, who asked not to be identified because they weren't authorised to speak publicly about the investigation.
Firms and local governments found to have misused funds will face suspensions of their ability to sell debt, the people said.
Beijing has sought to curb local government borrowing for infrastructure projects amid concern poor returns on some projects will leave banks saddled with bad loans - a risk Fitch Ratings highlighted this week when it cut the mainland's long-term local-currency debt rating.
Fundraising for subsidised housing had been excluded from those limits as part of Beijing's attempts to control home prices.
The Ministry of Finance said on December 31 that regional governments were increasingly using "illegal and irregular" methods to finance projects and must correct their conduct.
The plan to build 36 million affordable homes in the five years to 2015 has been funded primarily by financing companies set up by local governments.
Provinces and cities, barred from directly taking bank loans or selling bonds, have set up more than 10,000 such financing units, the central bank estimated in 2011.
Financing companies found to have misused funds and to have failed to correct such abuses will have their right to sell bonds suspended, the people said.
If a local government is found to have misused money earmarked for affordable housing, all of its financing units will have their ability to issue debt frozen, they said.
China's local governments may have more than 20 trillion yuan (HK$24.8 trillion) of debt, former Finance Minister Xiang Huaicheng said on April 6 at the Boao Forum for Asia. That is almost double the 10.7 trillion yuan figure given in a 2011 report by the National Audit Office.
Fitch said on April 9 that it had cut its rating on China's long-term local-currency debt by one notch to A-plus, the fifth-highest grade, citing rising risks to the country's financial stability given the lack of transparency in borrowing by local governments.
The ratings agency estimated that total credit in China's economy, including various forms of so-called shadow banking, may have reached 198 per cent of gross domestic product at the end of 2012, rising from 125 per cent four years earlier.