Fundamentally, debt is an overdraft of credit, and almost all countries are confronted with some form of debt risks.

Currently, China tries to curb the rising debt risks through deleverage, which has gone on to cause the additional problems of a surge in financing costs and a structural squeeze in social liquidity. A solution should be found to treat both symptoms and their root causes.

On December 30, the National Audit Office (NAO) unveiled that government debt at all levels amounted to 20.7 trillion yuan ($3.4 trillion) by June 2013. Debt risks, though being kept under control, remain formidable.

The liquidity risk of local government debt is mainly reflected in the maturity mismatch of local governments' balance sheets and their low assets income. As old debts are reduced and new debts are controlled in a more efficient way, shorter maturity of new debts will have rising financing costs. Local government debt risks will have a big impact on society as a whole.

Currently, 54 percent of local government debt is valid for five years. From 2011 to 2015, large amount of such debt will come into a period of repaying capital with interest. At the end of 2010, 24.49 percent and 17.17 percent of local government debt would expire in 2011 and 2012 respectively, while 11.37 percent, 9.28 percent and 7.48 percent of local government debt held at the end of 2010 will expire in 2013, 2014 and 2015, respectively with a further 30.21 percent doing so in 2016.

Despite repaying old debts with new bank loans, an absolute cash flow gap will appear after 2015.

In 2013 and 2014, due to limited growth of fiscal revenue, local governments and financing platforms will find their debt risks to be looming closer. In controlling new debt, authorities should optimize existing liabilities, and establish a long-standing mechanism to confine debt problems.

In addition, local governments' stock assets, such as roads, bridges, tunnels and tap water factories, should be transferred to corresponding investment groups as fixed assets.

"Bad debt banks" should be set up to dispose of local government debt and non-performing assets through debt restructuring and external transfers. At the same time, an infrastructure property right exchange market should be put in place to improve the exit mechanisms for government-invested projects, to vitalize the assets of a local government financing platform, and to launch new projects financed through asset securitization.

Moreover, the government should establish a management and reserve system of land-transfer fees and compile balance sheets for local governments. First, government departments concerned with land reserves, finances, taxation and asset management need to set up special accounts for land-transfer fees, ensuring that income can be included into the system immediately. Second, a performance evaluation system for land expropriation should be created and improved to realize a balance between fiscal expenditure and revenue. Third, the National People's Congress and the NAO should play a stronger role in supervision and auditing of land transfers by local governments. Fourth, the budgets of local governments should become more transparent by compiling balance sheets and publishing all the debt generated by legal guarantee.

More importantly, because of local governments' insensitivity to financing costs, their debt is deemed as a kind of low-risk but high-yield assets. Especially after the global financial crisis, fund-thirsty local governments have been committed to expanding investment through off-balance sheet loans and inter-bank debt financing. Therefore, funds have flooded into local government financing platforms and government-driven investment projects.

In this sense, only if the implicit governmental guarantee system is phased out, the cash basis is replaced by accrual basis, and an asset-liability management system is set up, can China's increasing debt risks be alleviated.

This is an edited excerpt of an article by Zhang Monan, an associate researcher of China Center for International Economic Exchanges, originally published in National Business Daily