The Ministry of Finance has vowed to strengthen the management and monitoring of local government debt, and a mechanism for debt financing is under consideration to help prevent a potential default.

The ministry identified management of the debt as one of its priorities for the remainder of 2011, according to a statement on its website.

Economists said that better monitoring of the debt shows the government's determination to supervise and handle it.

Jia Kang, director of the Research Institute for Fiscal Science under the ministry, insisted that China's public debt is still in the "safe zone" considering the country's huge GDP of nearly 40 trillion yuan ($6.2 trillion).

Finance ministry focuses on local government debt

The National Audit Office said in late June that the debt of local governments - provincial, prefecture and county - by the end of 2010 stood at 10.7 trillion yuan, a figure that exceeded the year's revenue of 8.3 trillion yuan.

A total of 46.4 percent, almost 5 trillion yuan, was raised from local government financing platform companies. These are financing vehicles set up by local authorities.

Of the 6,576 companies audited, approximately 20 percent were found to have defects in management, involving 244 billion yuan.

Concerns were raised that debt default would result in these platform companies facing capital shortfalls. A default would also increase bad debts for banks and see projects delayed or abandoned.

The Ministry of Finance said on its website that it will "properly handle debt payment and the follow-up financing of projects under construction, and continue to clean up and regulate financing platforms.

"Meanwhile, a sound system of debt information, as well as a regular reporting mechanism on the statistics, should be established to implement dynamic monitoring over local government debt."

Jia said the central and local governments are working together on the details.

Zhuang Jian, a senior economist with the Asian Development Bank, said it is not too late to act on local government debt, although it would have been better if action had been taken two or three years ago.

"Although local governments may experience problems in raising money, it is good for the overall health of the economy in the long term," he said.

Chen Chenzhao, deputy director of the audit office's local government debt team, told Xinhua News Agency last month that, in general terms, local government debt has not yet exceeded the ability to manage it.

According to the Ministry of Finance, total fiscal revenue in the first six months was 5.68 trillion yuan, representing an annual growth of 31.2 percent.

The audit office's report suggested that more than 20 percent of prefecture governments are facing a debt ratio higher than 100 percent.

Meanwhile, local governments have provided irregular warranties for 46.4 billion yuan of debt.

Ma Guangyuan, an economist with the Chinese Academy of Social Sciences, said that to eliminate debt risk, the tax system must be reformed to reduce reliance on land sales.

Qu Hongbin, China chief economist and co-head of Asian economics research at HSBC, said while the debt, of which about 80 percent is in bank loans, poses a potential risk to China's banking system, Beijing can and will act to tackle the risk of nonperforming bank loans in the coming years.

"Money borrowed by local governments mostly goes to investments. So the local governments' assets increase along with their debt," Qu said.

"The problem is a lack of transparency, and a mismatch between the maturity of these debts and the long payback period of the projects that they have been invested in."

The Ministry of Finance will have a bond issue of 46.6 billion yuan in August. The issue, on behalf of local governments, will be made up of two parts, 22.6 billion yuan for three years and 22 billion yuan for five years.

It is the second issue of the year but its success is far from certain after the first round in July failed to excite much investor interest.

Stephen Green, an economist with Standard Chartered Plc, wrote in a research note that local government loans mostly have terms of 3-5 years. And the pressure for repaying the principal has not yet hit, but it will begin in 2012 to 2013, he said.

One way to restructure the debt is for local governments to issue bonds with a longer maturity period to replace short-term loans, Qu said. This will boost transparency as bonds, which are sold openly in the market, have a greater degree of disclosure to entice investors.