(Yicai Global) July 26 -- China’s central government will likely introduce a swap scheme for hidden local government debts to help address the issue, according to financial experts.

The central government's new package of solutions may include swapping out the hidden debts of local governments to help them extend their repayment period and lower their interest costs, a source familiar with local government finance told Yicai Global.

Hidden debts are those taken on by local governments through their investment and financing vehicles. Because the borrowing process is not very transparent, these debts are a major risk for local authorities.

At its meeting on July 24, the Political Bureau of the Central Committee of the Communist Party of China, the country’s top leadership body, called for the effective prevention and resolution of local debt risks and the development and implementation of a comprehensive debt reduction plan.

While some experts have called on the finance ministry to issue treasury bonds to raise funds to directly pay off some local debt, many others are strongly opposed. A popular alternative is to allow local governments to use a new special refinancing bonds tool to raise funds only to repay their respective hidden debts that have met certain criteria.

But fiscal experts interviewed by Yicai Global believe that there is a clear limit to this scheme because the central government has already set an overall upper limit on local debt, and with local governments already deeply in debt only about CNY2.6 trillion (USD363.5 billion) of special refinancing bonds can be issued at present, clearly not enough to address the massive hidden debt problem. So a more market-based approach is very much needed.

The actual debt relief package will probably have three main planks -- central government support, financial institutions' profit sharing, and partial settlement of local debt -- according to Yang Yewei, chief fixed income analyst at Guosheng Securities.

The central government can issue national bonds to take over some local government debt, and commercial banks can help reduce the debt burden on these governments by extending their debt repayment periods and cutting their interest rates, Yang noted, adding that, at the same time, local governments can focus on clearing non-standard debts that do not pose a systemic risk.

Market-oriented solutions, such as debt swaps, rollovers, restructurings, and refinancings, should be considered in the policy package to address the local bond risk, said Hu Hengsong, deputy general manager at Caida Securities.

The central government should advance fiscal and tax reforms to support local authorities, and asset managers at the central and local levels should participate in the debt restructuring through a market-based approach, Hu noted.

It is necessary to specifically identify the causes of the debt and formulate corresponding solutions to prevent local governments from relying too much on the central government, Hu pointed out.

Editors: Tang Shihua, Futura Costaglione