Asia Economy

China’s debt sentence, the biggest 'known, unknown' in 2014?

China debt: 2014's top 'unknown known'
China debt: 2014's top 'unknown known'

As China's local government debt levels balloon to $3 trillion, one analyst told CNBC that China's debt sentence is the biggest "known unknown" risk to global financial markets in 2014.

In a long awaited report, China's National Audit Office reported this week that local government debt had increased 67 percent from the end of 2010 to reach 17.9 trillion renminbi ($2.95 trillion) by the end of June.

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The report highlights concerns over the country's spiraling credit addiction at a time when it's struggling to sustain economic growth and avoid a financial crisis.

"China's debt is the biggest 'known unknown' of 2014. Because is it something that is going to balloon into an international issue and something that will affect the markets?" Richard Harris, CEO of Port Shelter Investment Management told CNBC Asia's Squawk Box on Monday.

"When you look at what the National Audit Office is really saying, they are talking about local government debt being up 70 percent, we are not talking about 10 or 15 percent, this is 70 percent," he added.

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Local governments in China borrowed heavily following the global financial crisis to help sustain the country's impressive growth rates by funding investment projects. The entities are not permitted to borrow from banks, so instead they set up special purpose vehicles to do so.

But analysts have expressed fears that many of these investments may never make enough returns to repay the interest and principal on the debt.

Port Shelter Investment Management's Harris told CNBC that China's rising local government debt was a huge issue.

"Local government debt is pretty much half of Chinese debt in total which is now over $5 trillion. This is now a big problem, we are no longer in a situation where china is a rich country we are now in a situation where china is an indebted country," he added.

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A bank teller counts Chinese currency yuan notes in Beijing.
Frederic J. Brown | AFP | Getty Images

However, Harris added that in his view the issue was "controllable" and China does have the tools to tackle the issue.

He pointed out that cutting down on lending would inevitably damage economic growth in China, but policy makers were at an advantage because they have not used quantitative easing before.

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"This is a big price tag but don't forget the U.S. can handle its debt issues at the moment, so I do think it's controllable," he said.

The U.S. government's debt pile currently totals around $17 trillion.

Harris added that Chinese policy makers needed to relax their grip on liquidity, tighten control on state-owned banks and take further steps to control the shadow banking sector.

"The biggest ace up their sleeve is the fact that the U.S. is growing and we are looking now at quarterly rates of 4 percent growth in the U.S....if that's going to continue China will be pulled along," he added.

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Including national debt, the audit office report found that China's total public debt pile stands at 30.27 trillion renminbi ($4.99 trillion) at the end of June, up from 27.77 trillion renminbi ($4.58 trillion) in December 2012. Analysts estimate that this figure equates to around 53 percent of gross domestic product (GDP).

By contrast, Japan's public debt totals over 200 percent of its GDP, while Greece's totals around 160 percent of GDP.

—By CNBC's Katie Holliday: Follow her on Twitter @hollidaykatie