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While investors have focused on China's volatile stock market, some analysts have been eyeing what they see as possibly more worrisome — a rapid increase in local government debt.

The latest figures on regional and local Chinese government debt show a 34 percent increase from June 2013 to 24 trillion yuan ($3.7 trillion) at the end of 2014, Moody's Investor Service said in a September report. That's 38 percent of China's 2014 GDP, Moody's says, and analysts fear the ballooning debt will be a hindrance to growth as regional governments spend it on underperforming infrastructure projects and struggle to find ways to repay it.

"Debt accumulation is a mistake the Chinese government needs to avoid," said Tai Hui, chief market strategist for Asia at JPMorgan Funds. The question is, "how do you grow the economy without relying on debt?"

Workers labor in front of the Oriental Pearl Radio & TV Tower at a construction site in the Lujiazui district of Shanghai.
Tomohiro Ohsumi | Bloomberg | Getty Images

In 2009 and 2010, a lot of shorter-term debt was used to build infrastructure that would offer return only over the long term, said Nicholas Lardy of the Peterson Institute for International Economics. That "should have been financed from the budget, not short-term debt, inevitably (creating) a problem. It is a risk and it is a worry."

The problem lies in the pace, not the level. Authorities still have enough borrowing power to deal with financial risk given the relatively low ratio of roughly 55 percent overall government debt to GDP, according to McKinsey estimates.

JPMorgan's Hui pointed out that much of China's growth from 2000 to 2012 was accompanied by a very rapid acceleration in debt. Now it's unclear that, as China slows, if a similar pattern of debt expansion is able to support the economy's transition from a manufacturing to a consumer-driven one.

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In "a scenario where they remain dependent on investment, they have to become more efficient in investment rather than relying on debt," Hui said.

Much of the concern lies in regional government debt used to fund projects such as bridges and trains that haven't always produced sufficient income to pay off the loans. Last year, China implemented a debt swap program to ease the burden on the struggling local governments by turning bank loan debt into bond market issuance, which generally have longer maturities and lower interest rates. The program was intended to be coupled with income-generating policies such as tax reform.

Provinces swapping maturing debt into RLG bonds (as of Aug. 31, 2015)

Source: Moody's, bond prospectuses

Some say that as soon as sometime in the next year, the financial condition of one of China's wealthiest provinces, Jiangsu, could indicate whether the program is successful.

"They have to make sure local governments are able to generate enough revenue to pay off those bonds when they come due," said Scott Kennedy of the Center for Strategic and International Studies.

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If China keeps rolling over debt, he said "what looks like a debt program now could become a bailout program."

Outside of local government debt, overall debt levels have risen. Total social financing, which includes bank loans and corporate bonds, increased 13 percent in August from the year prior to 1.08 trillion yuan, and has generally increased double-digits year over year every August since the U.S. financial crisis in 2008, according to government figures compiled by Wind Information. That compares with a 107 percent year-over-year increase in August 2007.

The People's Bank of China reports the data as "aggregate financing to the real economy."

"They're beginning to reach the limits of their balance sheets. There's no magical number to say they're pushing their balance sheet. There is a debt issue. They can handle it. They haven't gone beyond the limits of their balance sheet," said John Mauldin of Mauldin Economics. The firm released last Wednesday a documentary, China on the Edge, which highlights the critical state of China's debt issues.

Aggregate financing to the real economy

In addition to the increase in debt, China's missteps this year in the stock market intervention and shock currency devaluation raise questions on the leaders' ability to steer the economy towards growth.

"They have all the ingredients to execute a successful transition," said Arthur Kroeber, head of research at Gavekal Dragonomics. "The question is whoever is making decisions, does he know what he is doing? Leadership wants to execute this in a highly centralized way and we just don't know if that can be done."

Goldman Sachs estimated in early September that the Chinese government spent 1.5 trillion yuan (about $236 billion) to support the collapsed mainland A share market, which fell 45 percent from peak-to-trough this summer despite the capital injections. The U.S. government, when it was dealing with the financial crisis, committed $475 billion on bank bailouts and rescuing the auto industry.

Amid the devaluation of the yuan on Aug. 11, China's foreign reserves saw a that month to a two-year low of $3.56 trillion. UBS Investment Bank forecasts foreign exchange reserves will fall at least $500 billion by the end of 2016.

To be sure, that would still leave China with more than $3 trillion in reserves. China is also already on track with the economic transition. Growth in the services sector has outpaced that of manufacturing in the last two years, a trend that trend keeps many investment analysts bullish on China in the long term.

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In the near-term, China's massive size means the much of the world will feel the pain of a bumpy economic changeover regardless of the ultimate result.

"China's OK internally within its boundaries," Mauldin said. "The rest of the world is going to have to adapt because they are not going to have debt-fueled commodity growth. That's a huge adjustment."