A new report from Citigroup Inc (NYSE:C) on the macro outlook for China does not have good news for investors in the country. The analysts did their research on a field trip in China, and it looks like the cost of credit in the Asian giant is rising, and investment momentum is slowing as it becomes more expensive.

China shadow banking

According to the authors of this report, Shuang Ding, Minggao Shen and Enjiang Cheng, there are several problems in China that could lead to poor outcomes for investors in the future. The main trends they discuss are slowing growth, increasing cost of capital, hidden risks, and the use of privatization to pay off debt.

China problems swirling

Many investors and analysts have predicted that China is on the edge of a cliff in recent years, and none have been right so far. The ingredients for a crisis are still there, however, and the problems appear to be getting worse. The basic problem is that growth in the country is slowing down and debt levels are high.

The analysts visited three cities in China: Chengdu, Changsha and Wuxi. They found that Wuxi, in the east of the country, has seen growth decline to 12 percent in the last five years from more than 15 percent per annum in the early years of the decade. That region is leading the way in declining growth, and new sources of expansion have proved difficult to identify.

While growth appears to be hitting a wall in some parts of the country, all three areas studied were seeing a higher cost of credit and a resultant lower propensity to invest. Mortgage loans for first-time buyers are no longer subsidized, and Local Government Funding Vehicles, or LGFVs, have seen borrowing costs rise above 10 percent.

These trends are bad for China, and they may be intensified by some of the Asian giant’s hidden risks, according to the Citigroup analysts. The amount of non-performing loans is likely obfuscating through the use of Evergreen loans. At the same time, “special mention loans,” those in some kind of trouble, are increasing rapidly. A large proportion of those debts are believed to be non-performing, but listed as “special mention” to hide that fact.

China crisis coming

The Citigroup Inc (NYSE:C) analysis suggests that local government agencies are relying on the privatization of publicly held land in order to pay off the debts they owe through LGFVs. As borrowing costs rise, and non-performing loans likely send those costs higher, less investors will be willing to buy that land. The situation could end poorly for China.

China may have a debt crisis on its hands in the coming months, though that possibility has been mentioned again and again over the last two years. The country’s government has proved more versatile than most believed and it is working on cutting corruption and deflating the property bubble slowly.

The Citigroup Inc (NYSE:C) report does demonstrate some structural problems that cannot be ignored and will need to be remedied if China wants to thrive.