The ability of the mainland's local governments to repay their debt is being questioned, with analysts warning that the liabilities may be underestimated.
Increased use of irregular financing activities such as trust loans, leases, wealth-management products and project financing pose a risk to local government finances, Moody's analyst Debra Roane said in a report.
She said such funding from such channels was not being recorded as debt on the balance sheets of local government financing vehicles (LGFVs), adding "a further layer of complexity in determining an individual regional local government's debt level".
The National Audit Office said on June 10, a public holiday, that the debt of 36 local governments had risen 12.9 per cent to 3.85 trillion yuan (HK$4.9 trillion) in the two years to the end of 2012. LGFVs racked up 45.7 per cent of that new debt.
The audit office found that funding via non-bank channels increased rapidly as the central government tightened up on banks' lending to LGFVs.
The research said funds raised via trust loans, leases, sale-lease-back agreements and wealth-management products added up to 109 billion yuan in six provinces and seven prefecture-level cities. Total local government debt was 12.1 trillion yuan, according to the audit office's 2010 research.
Huatai Securities' analysts said in a research note that total debt could have reached 15.3 trillion yuan at the end of 2012 and may total 16.3 trillion yuan by the end of this year, considering local governments' contributions to national gross domestic product growth.
The use of irregular financing highlighted the risks of shadow banking, or unregulated credit offered by non-bank financial institutions, said Chen Xingyu, an analyst with Phillip Securities in Shanghai.
Chen estimated total local government debt could reach 20 trillion yuan if shadow banking lending was taken into account.
A Shenzhen-based analyst, who asked not to be named, said: "There are hidden risks as the actual amount lent via irregular financing is still unknown, and the repayment ability of local government is, therefore, a concern. Refinancing pressure is mounting as the time to repay loans has arrived."
Decreasing revenues will add to the difficulties of local governments.
Analysts said the economic slowdown would dent their ability to repay loans. Huatai Securities' analysts said a drop in income from land sales would add to repayment pressures. A report by Industrial Securities said lower returns from toll road investment would add to their troubles.
According to the audit office's research report, income generated by land sales equated to 54.6 per cent of the debt repayments made by local governments as of the end of 2012.
Chen said the default risk remained low in the short term but that it would "increase if fiscal income continues to drop amid the sluggish economy".
Moody's lowered its outlook for China's sovereign credit rating to stable from positive in April, citing local government debt and credit expansion.