But report urges more reform of financing system

China's government debt situation is unlikely to become critical in the short term, a top think tank said, as it urged quicker reform of the public finance system to strengthen the fiscal position of local governments.

The Development Research Center of the State Council, a think tank under the cabinet, said the net value of China's government liabilities as of the end of 2010 stood at 11.3 trillion yuan ($1.85 trillion).

The asset-liability ratio of the public sector was at the "middle" level by international standards, and the possibility of a short-term debt crisis was low, the report said.

But it noted that as China's economic growth moderated, fiscal revenue growth would also slow significantly. The gap between revenues and expenditures would widen and the asset-liability ratio would rise.

The report said that using conservative calculations, government debt as a proportion of GDP would reach 26 percent by 2020. Under a high-risk scenario, the figure would be 30 percent, still within the margin of safety.

As concern over local governments' debt has increased, the State Council last month ordered the National Audit Office to conduct a new survey of all government debt.

In 2011, the NAO carried out an audit across the country and concluded that local government debt stood at 10.7 trillion yuan at the end of 2010.

There's been no official nationwide survey since, but local debt is believed to have surged in the intervening years, following a government spending boom.

A June sampling survey by the NAO found that as of the end of 2012, nine provincial capitals' debt-asset ratios had exceeded 100 percent. The highest debt ratio was 188.9 percent. The NAO didn't identify the cities.

Yu Yongding, a former member of the Monetary Policy Committee of the People's Bank of China, said at a recent conference that China's debt risk was still "controllable", given the country's high household savings level and massive State assets, which he estimated to be 100 trillion yuan.

But he said that local government debt was an issue that policymakers must be "highly alert" to because the government actually "had no idea" how much debt there was.

"Why am I so concerned about the debt issue? Because based on my experience of dealing with local governments, I am skeptical whether they are willing and are able to repay the debts," Yu said.

To address the local debt issue, the Development Research Center offered four recommendations: foster new growth opportunities, accelerate public finance reform, control public spending and establish a hedging mechanism for possible debt risk.

On the subject of public finance reform, the report suggested an expansion of the value-added tax reform to all sectors. The VAT replaces an existing business tax, which went to local governments.

Although VAT reform threatened to reduce local governments' revenue in the short term, it could give a boost to the economy and thus raise future tax revenue.

The report suggested reforming the current VAT-sharing arrangement, raising the local governments' portion to 30 percent from 25 percent.

Kong Shuhong, a public finance professor at the University of International Business and Economics in Beijing, said raising local governments' share of tax revenues was very necessary because of the large disparity between their revenues and their spending responsibilities.

"The central government takes a large portion of the national tax revenue, but its spending responsibility is very limited. Local governments face huge financial pressure, which is why their debts accumulated rapidly in recent years," she said.

The report also suggested imposing a property tax on all homes, which it said would build a solid taxation source for city- and county-level governments.

Few proposals for reforming the tax system have gone that far, with most urging property tax only for newly purchased homes.

"I don't think that proposal is practical, because it faces huge resistance," said Ding Jianchen, a fiscal and financial professor at the university.