The mainland's Ministry of Finance has drafted a preliminary plan for a pilot scheme that would allow some local governments to issue bonds directly in order to address the imminent maturing of massive existing liabilities they may struggle to repay. Chinese budget law bans direct debt issuance by local governments unless the State Council specifies otherwise, according to sources. The first provinces to be granted the go-ahead are likely to include Guangdong and the eastern province of Zhejiang, whose solid economic foundations are seen as a safeguard. The scheme would give local governments permission to raise funds. Some economists warn it poses a challenge to the nation's credit rating and information release systems. In the past two years, the central government has issued a total of 400 billion yuan in bonds on behalf of local governments to fund stimulus projects during the global financial crisis. The central government has to repay such debts if local governments default. The National Audit Office revealed last month that local government liabilities swelled from 2.8 trillion yuan (HK$3.4 trillion) in 2009 to 10.7 trillion yuan at the end of last year, representing 27 per cent of China's gross domestic product. That generated widespread concerns over default risk and mounting calls to remove fund-raising constraints on local governments. Nearly 42 per cent of those liabilities will mature this year and in 2012, according to the auditor. The bond issuance proposal comes at a time when some local governments are feeling the squeeze. Beijing's measures to cool the overheated property market have hit local governments' major source of revenues. As a result, land transfer income has shrunk, raising question marks over whether local governments' cash flow is stable enough to service creditors. 'Opening the funding channel to local governments could help reduce their financing vehicles' loan problems,' said Li Huiyong, an economist at Shenyin and Wanguo Securities. Bad loans to financing vehicles, entities set up by local governments to borrow on their behalf from banks, are widely regarded as the biggest risk in the nation's banking system. Advocates of the scheme said bond issuance could help improve the pricing of debts and force local governments to increase transparency in the release of financial information. Others say an existing lack of transparency and a weak credit rating system could mean chaos. China should stop issuing local government debt altogether, He Keng, a financial commission member of the National People's Congress, wrote in the 21st Century Business Herald newspaper this week. 'The size of local government debts is already huge. (Further debt issuance) would mess (things) up if the government credit system is not well-established,' he said, adding that China should slow down infrastructure construction to reduce financing demand.