The mainland's fiscal position is weaker than official data shows but not significant enough to cause alarm, the IMF said in a report released yesterday.
The International Monetary Fund also warned that the mainland was now "more vulnerable to a macroeconomic shock" because of its higher debt and bigger deficit.
It estimated that the mainland's augmented fiscal debt, which mainly refers to borrowing by local governments, rose to about 45 per cent of its 51.9 trillion yuan (HK$66.6 trillion) gross domestic product in 2012.
"The rise in augmented fiscal debt, however, is indicative of underlying challenges in local government finances," the report said.
The biggest challenge for the central government, it added, was setting up a better framework to manage and monitor local government borrowing in order to prevent the accumulation of additional risks and ensure adequate financing for priority social and infrastructure spending. Other challenges included reducing local governments' reliance on land sale revenues to pay off their debts.
Local government borrowing shot up between 2008 and 2010 as the central government implemented a massive stimulus package to ward off the impact of the global financial crisis. However, some local governments have been unable to repay their debts.
The latest statistics from the National Audit Office show that total local government debt had risen to 17.9 trillion yuan by last June compared with 10.7 trillion yuan at the end of 2010.
The National Development and Reform Commission said last month the debt risks of local governments were under control in general, but conceded that "there are potential risks in some places".
The IMF report said the mainland's augmented fiscal debt was still at a manageable level, but added that the report's estimates excluded the local governments' contingent liabilities and the liabilities of state-owned enterprises.
"China has already started the reforms to strengthen fiscal management, especially over local government finances. … There is still room to use fiscal policy to support demand as needed while following a path of gradual adjustment of its augmented fiscal deficit," the report said.
Mainland authorities have taken various steps to contain local government fiscal risks. State media have reported that the Ministry of Finance is working on a credit rating system for local governments, which is expected to help the State Council issue the first management regulations on local government debt.