CHINA - Defaults on local government-backed infrastructure projects are among the principal risks facing China's banks, according to an IMF country report on financial sector stability.

While the report categorised as medium-risk banks' direct exposure to local government financing platforms (LGFPs), it said the "very rapid expansion" of borrowing for large infrastructure projects had created sizeable risks through a build-up of non-performing loans.

"Some projects may not generate sufficient returns to make loan payments," the report said.

A more severe risk would come from a sharper-than-anticipated correlation in real estate prices that could spill over to local infrastructure projects and test the resilience of the banking sector. 

Much of the current risk originates with the stimulus programme instituted in 2009 that enabled local governments unable to borrow directly to undertake infrastructure projects via LGFPs using state-owned assets, including land, as collateral. 

Support for those platforms was heavily predicated on cash flows from the real estate market, dampened by recent policy tightening.

The report cited "non-trivial" RMB7.7trn (€890bn) lending to local governments to June 2010 - equivalent to 23% of GDP.

In the medium to long term, said the report, "the risk posed by the real estate sector depends on whether the fundamentals behind the real estate price increases are addressed by policy measures".

It advocated measures including a broad-based property tax to promote the orderly development of the real estate market.

The IMF report also obliquely pointed to the poor quality of official data. 

Although stress tests suggest risks associated with local government infrastructure projects were manageable, the report pointed to the need to use limited and ambiguous results data on central government support for local government projects carefully.

Fiscal "complexity" between local and national government would make agreement on burden-sharing in the event of default difficult to achieve, the IMF said.