BEIJING - China's State Council, or the cabinet, on Thursday published rules to strengthen the supervision and management of debts incurred by local governments.

It is the first document by the State Council aiming to manage and control risks posed by trillions of yuan in local government debts.

Auditing results indicated that risks from government debts are generally controllable, according to a brief statement posted on the official website of the Chinese central government.

Urgent supervision of shadow banking needed

Local governments 'need to refinance debt'

But there are some risks and problems related to borrowing, management and fund use that need to be addressed, the statement said.

The State Council required the establishment of an integrated management mechanism for local governments' debts, which will cover borrowing, use of funds, and repayment.

Late last year, China disclosed its total government debts. Auditing results showed that debt directly incurred by China's local governments totaled 10.88 trillion yuan ($1.77 trillion) at the end of June 2013.

The debt guaranteed by local governments at various levels amounted to 2.66 trillion yuan. Debt governments might have some liability for, or contingent liabilities, stood at 4.34 trillion yuan.

Putting the three categories of debt together, Chinese Finance Minister Lou Jiwei put total local government debts at about 12 trillion yuan at the end of last June. Four trillion yuan was borrowed through local government funding vehicles (LGFVs).

The State Council's statement came one month after the National People's Congress (NPC), the Chinese parliament, passed a long-awaited set of amendments to the country's Budget Law on Aug. 31. The revision marked an important milestone in fiscal reforms and paved the way for local governments to formally issue bonds on China's bond market.

The old version of the budget law banned local governments from issuing bonds. But in practice they sought back doors to raise funds by taking loans from banks and issuing bonds via their LGFVs. The money has been unsupervised.

According to the document, governments of the 32 provincial-level regions on the Chinese mainland will be allowed to borrow within a quota set by the State Council. The quota needs to be approved by the NPC or its standing committee.

Prefecture-level and county-level governments can commission the provincial governments to borrow, if necessary.

The document requires that local governments no longer borrow money through LGFVs or corporate channels.

Money raised through municipal bonds may only be used to fund public services and pay existing debt, but not government operations. Debts arising from bond issuance must be included in the local government budget, the document said.

The State Council will set up a system for assessing local government debt risks and establish mechanisms for early warning, emergency response and accountability, it said.

Over the past two years, the market has been worried by China's rising debt burden and leverage. Local government debt exploded during the investment and construction binge that was part of a stimulus in 2008 to buffer against the global financial crisis.

The abolishment of LGFVs and allowing local governments to issue better-regulated municipal bonds will provide them with more transparent, stable and lower-cost sources of financing, analysts said.

Qiao Baoyun, professor with the Beijing-based Central University of Finance and Economics, said LGFVs had failed to fully demonstrate the government's credit, and issuing better-regulated municipal bonds is less risky in comparison.

The new document is set to help clarify several important principles on how to manage local debt, set rules and divide liabilities, she said.