Fitch Today lowered China’s sovereign credit rating as it warns the world’s second-largest economy about the hardships ahead in its quest to change its growth model, reports FT.

China Credit Ratings

The credit rating firm slashed China’s long-term local currency rating from AA- to A+ owing to a number of reasons including “underlying structural weaknesses” in the Chinese economy, low average incomes, lagging standards of governance, and a rapid expansion of credit. China’s foreign currency debt has already been rated A+ by Fitch

The rating firm also warned about the rising risks from the expansion of the shadow banking. The agency said that total credit in the country could have reached about 198 percent of gross domestic product by the end of last year from 125 percent in 2008.

The rating firm also expects that China’s local government debt grew by 25.1 percent of GDP in 2012, bringing the total level of government debt to 49.2 percent of GDP. In 2011, the local government debt was about 23.4 percent of GDP.

 “The proliferation of other forms of credit beyond bank lending is a source of growing risk from a financial stability perspective,” said Fitch.

According to a former Finance Minister Xiang Huaicheng, China’s local governments may have more than 20 trillion yuan ($3.2 trillion) of debt. The figure from the former minister is almost double the figure given in a 2011 report by the National Audit Office. According to Xiang, the combined debt of China’s central governments and local government could be more than 30 trillion yuan.

Some of the experts are of the opinion that a significant rise in financing through the shadow banking system, from corporate bonds to trust loans, has rendered the government’s policy controls ineffective. Despite Beijing capping the increase in formal bank lending, the overall credit flows in the economy have been strong, growing 23 per cent last year.

Rival agencies Moody’s Corporation (NYSE:MCO) and S&P 500 (INDEXSP:.INX)’s sovereign rating for China is one notch higher than of Fitch’s.  The difference in the rating highlights that Moody’s and S&P believe that China still has the ability to repay debts while Fitch thinks the country is more susceptible to risks.

China’s concerns over high debt levels have been raised since 2009, when the state-owned banks went on a financing spree to boost the economy during the global financial crisis. Though, the surge in loans helped the economy to stay on the growth track, it also resulted in creating a bubble in housing prices and left the local governments with loads of loans that they are still struggling to repay.

Since then, the authorities have been trying hard to overcome the impact of unleashed loans with measures like raising mortgage down payments, barring people from buying second homes etc. Owing in part to these measures, last year, China recorded its lowest annual growth rate for a decade.