Authorities denied media reports that China is going to write off trillions of yuan in local government debt to reduce mounting risks of local government bankruptcy.

A report by Reuters on Wednesday said Chinese central authorities are planning to shift 2 to 3 trillion yuan ($308 to 463 billion) of debt borne by local-level governments to the central government and banks from June to September, after years of liberal lending by State-owned banks led to massive amounts of bad debt.

The news agency quoted sources close to the government.

However, it was denied by Wu Xiaoling, a deputy director of the Financial and Economic Committee, National People's Congress (NPC), who said it was misinterpreted because the government was only trying to work out a clear map of debt borne by local governments, sina.com reported last night.

"It was not possible to make the huge transaction within three months," Wu was quoted as saying.

The Reuters report said the China Banking Regulatory Commission, Ministry of Finance and National Development and Reform Commission jointly worked out the plan.

To achieve that goal, the central government will buy local debt, banks will be ordered to take losses to wipe out some of the debt, and private companies will be allowed to invest in some fields that were previously only open to State-owned enterprises, sources said.

Provincial and city-level governments are permitted to sell credit to private companies, thus allowing them into previously closed sectors.

The move would be an indication that the central government is at last beginning to address a major problem that many economists regard as a threat to the stability of the world's second largest economy.

China's banks have for years lent freely to government projects, as government-led investment has always been seen as the major momentum behind China's economic development.

Figures released by the People's Bank of China, the central bank, showed that by May 2009, local governments had established more than 3,800 companies as financing vehicles to borrow bank money, with a total debt volume of 5.26 trillion yuan, equal to 161.35 percent of local government fiscal revenue.

An earlier report in January by Reuters quoted Yin Zhongqing, a deputy director of the NPC's Financial and Economy Commission, as saying that the total amount of debt in local governments could top 10 trillion yuan.

The pressure of default risks on local governments only increased after China launched a 4 trillion yuan economic stimulus package in late 2008 to counter the worldwide economic downturn triggered by the US financial crisis.

Local governments took advantage of the stimulus plan by making huge investments in massive infrastructure projects with the bank money, creating a hidden risk for the economy, Liu Shengjun, a deputy director of the China Europe International Business School (CEIBS), said on Wednesday.

In order to use up the borrowed money, as local governments were encouraged to do, many projects were initiated without being assessed for feasibility or profitability, resulting in failed investments, dead debts, and governments that were unable to pay the money back to banks.

However, no government officials were made to take responsibility or punished for these failed investments, nor were governments urged to cut spending to make up for the losses, as officials knew the central government would come to the rescue, Liu told the Global Times.

This resulted in a vicious cycle and a constantly growing debt ratio.

"After the bailout, those who caused such great losses in both banks and local governments should be held responsible. If not, the same problems will reappear," Liu said.

For Chinese banks, the move is seen as good news. The Industrial and Commercial Bank of China, China Construction Bank, Bank of China and Agricultural Bank of China are the largest banks in the country and four of the world's 10 biggest banks in terms of market value.

"As part of the transfer, it is assumed that potential losses on this debt will be shared by the central government, the banks and the local governments themselves," New York-based Bernstein Research analyst Mike Werner wrote in a research note.

"We consider their local government financing vehicles' exposures to be the greatest risk to the banks' credit quality," Werner wrote.

The dilemma also underlined the urgency of changing the growth pattern from an export and investment-driven economy to one more dependent on consumption, so as to quell the desperate demand to borrow money by local governments for investment, analysts say.

When exports and investment saw a drop as a result of the global economic downturn, policies were all aimed at boosting investment, making it harder to shift the growth mode to one that is stimulated by consumption, Liu said.

"There is an urgency to change the situation, but it's too difficult to fulfill in a short time," he said.