BEIJING - Borrowing by thousands of companies set up by China's local governments to fund construction is the nation's equivalent of the United States' subprime mortgage crisis, said Cheng Siwei, a former deputy head of the country's top legislative body.

"Our version of the US subprime crisis is the lending to local governments, which is causing defaults," Cheng said at the World Economic Forum in the Chinese city of Dalian on Friday. He served as vice-chairman of the standing committee of the National People's Congress from 1998 to 2003.

Cheng's comments contrast with statements by government officials and Chinese executives who have sought to allay concerns that 10.7 trillion yuan ($1.7 trillion) of outstanding local government debt will saddle banks with soured loans and derail economic growth. The President of China Merchants Bank Co, Ma Weihua, this week said the chances of "large scale" non-performing assets are "impossible".

Local governments in China, barred from directly selling bonds or taking bank loans, have set up more than 6,576 companies to raise money for roads, sewage plants and subways.

A June report by the national auditor warned of repayment risks and said some authorities had offered illegal guarantees for these companies, known in China as local government financing vehicles.

On Friday, Cheng said it would be the "wrong practice" for the central government to bail out these companies even though it has the capability to do so. Local governments that don't have a lot of debt should not rescue those that have become highly indebted, said Cheng.

No need to 'panic'

Government officials have sought to ease concerns that local authorities' debt problems will boost banks' bad loans to a level that may require state support.

They include Xu Lin, head of the department of fiscal and financial affairs at the National Development and Reform Commission. Xu said on the planning agency's website last month that there was no need to "panic" about government debt.

In the port city of Tianjin on Friday, Vice-Mayor Cui Jindu told a briefing that the municipality's financing vehicles would have "no problem" repaying debt this year. The city has already paid off 33 billion yuan of the 39.5 billion yuan of principle due in 2011. Loans maturing next year will rise to about 60 billion yuan.

Funding problems

"If the government doesn't tighten its policy too much, there shouldn't be any problem," he said. "But if we end up not getting a single new loan, there could be problems" such as projects that won't be able to be completed.

Borrowing by Tianjin's 144 local government financing vehicles may slump by as much as 140 billion yuan in 2011 from last year's level as banks curb risks and boost funding for small and medium-sized companies, Cui said. The companies have borrowed about 20 billion yuan so far this year, he said.

In a sign that financing vehicles in some provinces are having difficulties repaying local debts, the auditor of northeast Liaoning province estimated in July that about 85 percent of such companies in the region had insufficient income last year to cover all their debt-servicing payments, according to a transcript of his speech in the Liaoning Daily newspaper on Sept 5.

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