What might China’s government debt audit reveal?

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China's audit of local government debt may find that borrowings have ballooned to 17.5 trillion yuan ($2.85 trillion) currently from 10.7 trillion at the end of 2010, according to Societe Generale, representing a rise of over 60 percent.

China's State Council on Sunday ordered the National Audit Office to conduct a broad audit of debts incurred by government agencies, which would be the country's second-ever comprehensive review of nationwide spending as Beijing steps up efforts to contain risks surrounding leverage in the world's second largest economy.

"Coming out only several days following the announcement of several easing measures, the audit request seemed to us another message from the leadership of its resolution to contain debt risk despite rising concern over growth," Wei Yao, China economist at Societe Generale wrote in a report on Monday, referring to the mini package of fiscal stimulus measures to bolster growth the government unveiled last week.

"This is nonetheless a sensible choice, in our view. However, such a restrained easing stance supports our call for further growth deceleration in the near term," Yao said.

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Local government debt is regarded as a key risk to the financial stability in China, with ratings agency Fitch cutting the country's long-term local currency credit rating to A-plus from AA-minus earlier this year.

Since the onset of the 2008 global financial crisis, many local governments have embarked on a borrowing spree to fund construction projects. However, there are growing concerns about their ability to repay the debt as many of the investments not generating returns. This is reflected in the country's vast areas of unoccupied housing, also known as "ghost cities," and the many "roads to nowhere," or bridges built under the premise of boosting infrastructure but which are barely used.

Kerry Series, chief investment officer at Eight Investment Partners said the government is sending a clear message that they are serious about clamping down on local government debt risks.

(Read more: China orders audit of government debt)

"We all know it's an issue. The encouraging point is that they are addressing the issue; they are getting on top of it. Hopefully it's a start of that process," he said.

Uncertainty over what the audit may reveal rattled domestic investors on Monday, sending the Shanghai Composite down 1.7 percent.

"Chinese traders are clearly nervous ahead of the debt review taking place across the country, and by all accounts will focus on debt levels as low as village level. We wait in anticipation of the results," said Chris Weston, chief market strategist at IG Markets.

(Read more: Is China's debt nightmare a province called Jiangsu?)

According to Eddie Tam, chief investment officer at hedge fund Central Asset Investments, while climbing local government debt levels is a problem, it is still controllable.

"The total government debt will be around 45-60 percent of GDP. Comparing to the West, it's still a manageable problem," he said.

U.S. government debt stands at more than 100 percent of the country's gross domestic product, while Japan's debt is now around 240 percent of its economic output.

—By CNBC's Ansuya Harjani. Follow her on Twitter: @Ansuya_H.