The Ministry of Finance (MOF) has recently launched a pilot program allowing local governments of Shanghai and Shenzhen, and Zhejiang and Guangdong provinces, to issue bonds for the first time.

The MOF said it will pay the principal and interest on the bonds to investors after the debt matures, and the local governments then repay the ministry. Half of the debt sold in the program will be three-year and the other half in five-year bonds.

The international credit rating firm Moody's said the move may yield benefits for local governments seeking access to capital market funding, help develop a municipal bond market, and is therefore credit positive for China as it will enhance fiscal transparency and discipline.

China's local governments were not allowed to directly get loans or issue bonds, and many have set up special investment vehicles to finance infrastructure projects. As those financing vehicles mushroom and local government indebtedness grows, worries abound about a possible debt crisis in the country.

By the end of 2010, debts of China's local governments totaled 10.7 trillion yuan ($1.69 trillion), around 26.9 percent of GDP.

Jia Kang, Director of the Research Institute of Fiscal Science, a think tank affiliated with the MOF, said the pilot program will take some financial pressures off local governments and strengthen transparency of their debts.

Moreover, it will help local governments wean off reliance on land transfer fees as a major source of fiscal revenues, said Shao Yu, an analyst with the Orient Securities Co. Ltd.

China has been struggling with skyrocketing house prices in part because local governments are reluctant to lower land prices.

"But it is still necessary to take a cautious approach to the bond issuance, and keep alert over possible risks." said Lu Zhengwei, chief economist with the Industrial Bank Ltd.