This story is part of Governing's annual International issue.

China has pledged greater transparency in its local debt market. But leaders first must get a handle on just how much debt the country’s local governments actually have on the books. A national audit released in December revealed that local governments’ debt (which includes debt explicitly and implicitly guaranteed by the government) totaled 17.9 trillion yuan, or $2.95 trillion USD.

While perhaps not an alarming number -- borrowing in the U.S. municipal market currently totals $3.7 trillion -- what’s startling is the fast growth. A previous estimate for 2010 pegged China’s local debt at 10.7 trillion yuan. In just three years, the country’s local debt had grown by a staggering 67 percent as local officials were driven by a job-promotion system based on local economic growth through large-scale infrastructure projects. By comparison, it took the U.S. municipal borrowing market 10 years to increase by the same portion. (Neither of these debt estimates include long-term liabilities like pensions.)

The audit also highlighted concerns that officials both inside and outside China already had: that local governments are taking on far more debt than they can actually afford. One provincial capital outlined in the report has amassed debt equal to 220 percent of revenues, once debt guaranteed by the city is included; nine other cities have debt of more than 100 percent of revenues. These local governments can get bailed out by the Chinese central government, but the appetite for that in Beijing has lessened in recent years. In fact, even before the report was released, the Communist Party plenum in November pledged a series of national reforms, including strengthening government fiscal reporting frameworks.

Since the 2008 recession, both the U.S. and Europe have enacted greater fiscal oversight in an effort to flag troubled cities before they hit the skids. But China is essentially starting from scratch. For one thing, China’s local debt is not consolidated in one line item in government financial reports (as it is in the U.S.). That means the real total of the local debt remains a big unknown. And unlike many of its global counterparts, China doesn’t have a municipal market in which governments sell debt publicly to investors. Instead, governments in China borrow indirectly through local government financing vehicles and other entities. This kind of borrowing, says a recent Moody’s Investors Service analysis, obscures “the amount of any individual local government’s debt outstanding and creates uncertainty regarding debt payment responsibility.”

There is perhaps one reform area on which U.S. municipalities and China can relate: A key part of the coming reforms, which include establishing a municipal market, will be changing the mentality of local officials when it comes to finances. In the U.S., local and state officials are dealing with a highly constrained growth economy and louder-than-ever calls for belt tightening and accountability in spending. It is becoming clear today that past officials overpromised on benefits like pensions that are now coming due in huge annual bills. In China, no longer will local job promotion hinge upon economic output and flashy infrastructure projects. Moody’s Senior Credit Officer Debra Roane says China’s job-promotion system was an incentive that tended to spur officials to embrace large undertakings that boosted economic growth in the short term, but raised fiscal risks over the long term.

“Local governments’ pursuit of the overarching economic growth imperative,” she wrote in December, “produced a surge in local level liabilities that are largely responsible for the increase in central and local government debt in the wake of the global financial crisis.”