According to market research firm Capital Economics Ltd and BNP Paribas SA, the world's second-largest economy would need to resolve its local government's massive debt in order to free up interest rates. The financing units of China's municipal authorities has CNY9.7 trillion or USD1.6 trillion in debt in the middle of this year alone, based on figures by the China Banking Regulatory Commission. The staggering amount comprises 14% of all loans. Moody's Investors Service said in its report released on November 5 that most of the loans's credit profiles were weak. The report of the ratings agency also noted that a little over half of 388 companies it surveyed in June were liquid to pay their debts and interests this year without resorting to refinancing.

BNP Paribas Investment Partners Hong Kong-based senior strategist Chi Lo said, "(If rates are liberalized and advance quickly), it will make it very difficult for the government to roll over debt as the cost of doing that will be rising fast. (That's partly why) I won't bet on deposit rates being fully liberalized within the next year or two." Chi's firm manages EUR478 billion or USD642 billion of assets all over the world as of September this year.

Capital Economics Ltd London-based chief Asia economist Mark Williams said, "(Municipal debt) makes it much more difficult to reform banks and liberalize the financial system. If China is to liberalize interest rates and the financial sector before dealing with the implicit guarantee on state-owned companies and LGFVs, it would increase risk in the system." LGFVs stand for local government financing vehicles.

Bad debts at China Construction Bank Corp, Industrial & Commercial Bank of China Ltd, Bank of China Ltd and Agricultural Bank of China Ltd increased 3.5% in the third quarter this year to CNY329.4 billion, according to data compiled by Bloomberg from earnings reports of said banks. The banks' average bad-loan ratio had widened 1.02%.

China's Third Plenum communique had not addressed the adverse effects of the municipal debt. In a Bloomberg brief today, Chinese Academy of Social Sciences economist Zhang Ming thought that there might be no consensus among Chinese leaders regarding the much-anticipated reforms in the financial sector.