Concerned over the $1.7 trillion debt of local governments, China said it will take steps to guard against possible defaults which could cause extensive damage to the financial stability of the country’s banks.

China will boost the clean-up of thousands of millions of local government’s debt in 2012, to guard against possible defaults that would hurt its banks, the country’s banking regulator said today.

To start with, efforts will be made to focus on cleaning up old loans made to local government financing vehicles (LGFV) while tightening new debt issues and raising cash to debt coverage ratios, China Banking Regulatory Commission (CBRC) said.

The CBRC will strictly control the use of LGFV loans, while giving priority to key projects that are under construction, it said.

The regulator will also improve risk monitoring and reclassify LGFV loans to relieve pressure from banks.

Local government debts had risen to 10.72 trillion yuan ($1.7 trillion) by the end of 2010, accounting for about 26.9 per cent of China’s gross domestic product, according to data released by the National Audit Office.

Earlier, state-run Shanghai Daily reported that the debt level has touched $1.69 trillion.

Besides the local debt, China’s foreign debt has increased to $697.16 billion at the end of September last year up from $548.9 billion in 2010.

Short-term debt hit $507. 63 billion, 72.81 per cent of the country’s total foreign debt, while mid- and long-term debt amounted to $189.54 billion, accounting for 27.19 per cent of the total debt, the State Administration of Foreign Exchange.

Officials say that the debt is manageable as China is backed by $3.20 trillion foreign exchange reserves.

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