After three decades of spectacular growth, Guangdong's boom town of Dongguan is on the brink of bankruptcy. Up to 60 per cent of its villages are running up deficits and will soon need a bailout from the township, researchers at Sun Yat-sen University have discovered. It is a dramatic turn of fortune for Dongguan - one of the richest cities in China - and could foreshadow a wider fiscal crisis as the country's economy cools. Local government debt hit 10.7 trillion yuan (HK$13.16 trillion) nationwide at the end of 2010, equivalent to about 27 per cent of gross domestic product. Credit rating service Moody's estimates the actual figure could be about 14.2 trillion yuan. Bai Jingming, a senior researcher at the Ministry of Finance, estimated in 2009 the total debt of village authorities could total 10 per cent of the country's GDP, but there is no official data. Bai said many village chiefs he interviewed had no idea how much debt they had. Yet their failings could bring serious political and financial instability at higher level government right down to the grass roots. Experts have found Dongguan's village debt woes stem from two factors: a tightly-bound landlord economy, plunged into crisis by failing factories in the global downturn, and political pressure on local village chiefs to pay generous "dividends" to voters under the immature rural election system. "The financial problems of the villages are much more serious than expected," said Shao Gongjun, the owner of a printing company who blogs on Dongguan's economy. Shao attributed much of the crisis to the local authorities' dependence on rental incomes. A backwater farm town until the late 1980s, as China boomed Dongguan was transformed into one of the most important hi-tech manufacturing centres in the world. An IBM vice-president famously said a mere 15-minute jam on the expressway there would be enough to cause worldwide fluctuations in computer prices. As industry thrived, the population swelled from 1.8 million in the '80s to more than eight million. Most of the peasants cashed in and built matchbox homes on their land, letting the flats to migrant workers. Village authorities leased community land to factories and collected rent as their main source of income. This worked perfectly until the recent downturn. Shao said many factories had either closed or moved out over the past five years to inland provinces with lower costs. The number of Hong Kong-backed factories has dropped by 15 per cent since 2007. As factories and migrant workers left Dongguan, rents nosedived. "I'm so worried that before long I will lose my tenants and the flats would be left deserted," said a 61-year-old woman surnamed Luo. She put together two million yuan from her life savings 10 years ago and with bank loans built a six-storey apartment building in Luowucun in Zhangmutou county. Her family occupied the first floor and let the rest out to migrant workers. Luo used to collect about 15,000 yuan a month in rent - nearly 10 times what an average worker earned. But rents have dropped by a third since 2007. The fall in rental values forced 60 per cent of the 584 villages in Dongguan into budget deficits, the study by Professor Lin Jiang of the finance and taxation department of Lingnan College at Sun Yat-Sen University found. Lin's estimate is based on a study of 30 villages in relatively well-off counties, such as Tangxia, Houjie and Humen, in May. The figure may not reflect the whole picture, but it gives a good snapshot of the problems authorities face. "They are in deficit because their incomes are shrinking while their expenses are going up," Lin said. This is an unexpected sideeffect of China's fledgling grass-roots democracy. While competitive elections are still absent at almost all levels of government, Beijing has started to let villages choose their leader through universal suffrage. These elections have been getting increasingly competitive, and candidates often promise to pay generous "dividends" to villagers to attract votes. "In some rare cases, the leader-elect promised to give each household 10,000 yuan per month," Lin said. The money would come from the village community "investment" - effectively, the rent they collected from factories. Lately, village chiefs have found it difficult to fulfil such election pledges. But instead of reneging on their promises and sparking the anger of villagers, they turn to the rural credit co-operatives - the de facto local banks - for short-term loans at interest rates as high as 30 percentage points. Banks are willing to lend, because they know that the township government would have to bail villages out if things go wrong. "Some village leaders are now really worried that the bank may come to call in the loans," Lin said. "If the villages default, the burden would be transferred to the county or the township government." The Dongguan government is in poor shape to handle a crisis. Its GDP growth slowed to 2.5 per cent in the first half of the year. The average growth in the past eight years was about 11 per cent. Xu Jianghua, Dongguan's party secretary, urged villages last month to stop raising money to pay dividends. Few took heed. Village chiefs may argue paying dividends are not the sole cause of their debt. They also have to pay for local fire and police services - even though these are supposed to be the local government's responsibility. For years, the township government underinvested in such services, knowing they would be taken care of by the cashed-up village authorities. Eddy Li, president of the Hong Kong Economic and Trade Association, said in some counties police would refuse to investigate a crime unless it involved more than 20,000 yuan. Shao estimated Zhangmutou county authorities alone have accumulated a total of 1.6 billion yuan in debt. Annual revenue is only 600 million yuan. Shao said the Dongguan government needs structural reform to end its reliance on rental income. He proposed the township give residency to migrant workers so they can contribute more to the local economy. "Without a radical change in the social structure, the economic transformation will never succeed," he said.