Audit targets local government debt (2)

But this year's task will not be easy, as the scope of the audit might be broadened to include village governments.

Du said local conditions were really "complicated".

"Some village heads borrowed in their own names for public spending because they're more reliable than the village council," he said, adding that local government financing channels are quite diverse.

Jiang Chao, chief analyst of the debt market with Haitong Securities, estimated that the amount of local government debt was around 15 trillion yuan — 9.5 trillion yuan in loans, 3 trillion yuan in trust funds, 2 trillion yuan in city investment bonds and 0.65 trillion yuan in local government bonds.

He warned that infrastructure investment might stall if financing via trust funds is halted, as the investment is mainly supported by off-balance sheet borrowings.

Zhang Houqi, vice-president of China Asset Management, said on his micro blog that the audit will unveil many irregularities in local government account books.

"It is definitely bad news for the stock market and may even turn into a significant event for the economy this year," Zhang wrote.

Zhao from the Fiscal Science Research Center said that although local governments will not go bankrupt, as Detroit did in the US, local officials will be removed for fiscal failures. But Zhao said the NAO's move was one of a series of measures to digest China's debt risks.

On July 18, the Finance Ministry issued a notice asking each province to submit an action plan to tighten budget execution and control cash management by the end of the month, reflecting the government's commitment to quickly improve fiscal practices at the local level.

"The central government has been proceeding in measured steps as it seeks to balance its twin objectives of granting local governments more autonomy with respect to their financing needs and of maintaining strong controls to ensure that debt levels are affordable," said Moody's Investors Service in a report.

Ultimately, a local government bond market would help improve monitoring and regulation of local governments' indebtedness, improve accountability for their investments and borrowing decisions, and discourage them from engaging in irregular financing activities, Moody's said.

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