China’s local governments may have accumulated 40 trillion yuan (Dh21.3tn) of off-balance sheet debt, or even more, suggesting further defaults are in store, according to S&P Global Ratings.

“The potential amount of debt is an iceberg with titanic credit risks,” S&P credit analysts led by Gloria Lu wrote in a report Tuesday. Much of the build-up relates to local government financing vehicles (LGFVs), which don’t necessarily mean local governments themselves are on the hook for paying off the obligations.

With the national economy slowing, and a Beijing-set quota for issuance of local-government bonds not being enough to fund infrastructure projects to support regional growth rates, authorities across the country have resorted to LGFVs to raise financing, according to S&P. That’s left LGFVs “walking a tightrope” between deleveraging and transforming their businesses into more typical state-owned enterprises, the S&P analysts said.

The continued focus on funding to sustain growth at the local level echoes a broader shift in the central government, which last year was focused on reducing leverage in the financial system. That phase is essentially over, thanks in part to an escalating trade war with the U.S., according to Citigroup analysts.

“The markets are right, in our view, to feel more concerned about the sustainability of China’s debt and the increased financial risks,” said Liu Li-Gang, chief China economist at Citigroup in Hong Kong. He also saw “renewed pressure” on the yuan.

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Separately, forced stock sales are making matters worse for China’s tech hub, where investors are already facing their steepest losses in a decade.

The Shenzhen Composite Index lost 1.9 per cent Tuesday, extending a four-year low. At least two more companies on the gauge - Jilin Zixin Pharmaceutical Industrial and Dalian Zeus Entertainment Group - said overnight their shares were at risk of forced liquidation. The sell-off spread to Hong Kong’s equity market, dragging down Shenzhen-based Tencent by as much as 3.4 per cent. The drop accounted for about half the losses on the Hang Seng Index.

“There’s a liquidity crisis in the stock market, and pledged shares are again starting to sound the alarm,” said Yang Hai, analyst at Kaiyuan Securities. "Stocks in Shenzhen typically bear the brunt of loss of confidence in the stock market because of their higher valuations.”

Tuesday’s drop comes even as China took further steps to rein in risks of share-backed loans, a sign regulators are having limited impact. Insurers are being encouraged to invest in listed companies to reduce liquidity risks connected to such loans, the China Securities Journal reported over the weekend. China in June told brokerages to seek approval before selling large chunks of stock that have been pledged as collateral for loans, according to sources, while the top financial regulator in August warned the industry that it’s closely watching corporate stock pledges.

The Shenzhen gauge has fallen 34 per cent in 2018, in line for the most since the 2008 global financial crisis, when it finished 62 per cent lower. About one-fifth of the gauge’s more than 2,000 stocks - most of them privately-run start-ups - have lost at least half of their value.

“If there are no real policies to cure the array of problems and ailments in our market, no one will be willing to take the risk,” said Mr Hai.

“Authorities keep saying that there is room for more polices, but where are they?”