Total debt in the world's second-largest economy stands at 280 percent of gross domestic product (GDP), much of it owed by entities owned by or related to the government, potentially leaving Beijing on the hook for a portion of these loans, Moody's said in a report.
China's actual government debt is more modest at around 40 percent of GDP with state-owned entities (SOEs) owing 115 percent of GDP, higher than any other rated sovereign, Moody's said.
Moody's estimated that that liabilities worth 20 percent to 25 percent of GDP could potentially require restructuring. Not all of this restructuring will strain the government's balance sheet though. The government would potentially support some SOEs though engineering mergers, injecting equity or reducing their size, the ratings agency said.
Concerns over a surge in debt and the health of China's bloated SOEs have been raised by private economists in recent months as the economy starts to slow after more than two decades of stellar growth. Now it seems even the government is paying heed.
The ruling Communist Party's paper People's Daily published a front-page interview with an unnamed "authoritative figure" who said high debt levels are leading to risks in the foreign exchange, stocks, bonds, and real estate markets, adding that China should make deleveraging a priority.
The "fantasy" of stimulating the economy through monetary easing should be dropped, the person added.
Investors hoping for a quick rebound in growth, which slowed to a 25-year low of 6.9 percent in 2015 will be disappointed: The source said China's economy will follow a L-shaped path in the coming years.
The term "authoritative figure" in the paper usually refers to high-ranking officials who are unable to go on record. State-run media in China is often viewed as mouthpieces for the government and scrutinized for any insights into opaque policymaking in China.
Influential investors such as and George Soros have warned of a credit crisis in China, with Bass noting the presence of "ticking time bombs" in China's banking system.
Hong Kong brokerage CLSA said last week that the ratio of non-performing bank loans to outstanding credit is 15 to 19 percent--much higher than the official 1.6 percent.
The source in People's Daily added China's economic growth has been stable and "within expectations," but warned of problems such as a real estate bubble, industrial overcapacity, an increase in non-performing loans, local government debt and risks in the financial market.
Rather than hiding bad loans which are on the rise, the country needs to be proactive in dealing with them, the source added.
China will also avoid a massive stimulus plan to boost growth, which could be positive in the short-term, but damaging in the longer-term, the source said.
Hong Kong-based Nomura analyst Sophie Jiang said in a note Monday that the interview indicates that non-performing loans may accelerate, but "in a positive way".
"We see this as a positive sign supporting our view that we're probably reaching the inflection point for change of the playbook."
Nomura is forecasting a slowdown in bank loan growth to 12 percent on-year in December from 15 percent on-year in March and an acceleration in non-performing loans from the second quarter of the year.
The interview also signals that there will be no further rate cuts from the People's Bank of China, said ING Financial Markets's Asia research head, Tim Condon.
"Supply-side structural reforms are the main policy instrument, not counter-cyclical macro policy," he noted.
ING, which is currently forecasting two 25 basis point policy rate cuts by the central bank by year-end, may review its estimates to pencil in fewer cuts. A basis point is 1/100th of a percentage point.