China's Ministry of Finance Thursday announced a trial program that will allow four selected local governments to issue bonds for the first time, a move that could help narrow local financing shortfalls and ease debt defaults fears.

The four governments are cities of Shanghai and Shenzhen, and provinces of Zhejiang and Guangdong, all of which will be allowed to issue three- and five-year bonds on their own, the Finance Ministry said in a statement on its website yesterday without giving detailed bond sale size for each locale.

A report by Caixin Magazine said the size which the ministry has approved for the four governments to issue bonds: Shanghai, 7.1 billion yuan; Guangdong, 6.9 billion yuan; Zhejiang, 6.7 billion yuan; and Shenzhen, 2.2 billion yuan.

The proceeds of the bond sales will go into a special account at the ministry, which will oversee the payment of interest and principal, the statement said.

The ministry will pay the principal and interest on the bonds to investors after the debt matures, and the local governments then repay the ministry. The pilot program could bring hope for additional financing vehicles for local governments, allowing them to roll over debt and meet their obligations.

Numerous financing vehicles across the country rolled out by local governments after the global financial crisis in 2008 have mired local authorities in a total debt of about 10.7 trillion yuan (US$1.7 trillion), equal to 27 percent of the country's gross domestic product last year, the national audit office said at the end of 2010.

Most of the financing vehicles were to support construction projects that aimed to spur the country's economy. Issuing local government bonds would help them to honor those obligations.

The financing vehicles owned by local governments are due to pay a total debt of about 1 trillion yuan annually starting from this year through 2013, and an outbreak of default could peak during the period, China International Corp warned in an earlier note.

What's more, China is likely to raise interest rates in its sustained fight against inflation, which means local governments may have to pay trillions of yuan more in interest, the leading Chinese investment bank said, adding that the banking system may face a disastrous hit in such a scenario.