China's state audit office uncovered 530 billion yuan (54 billion pounds) worth of irregularities with local government debt, leaving investors wondering how much work remains to be done to clean up after 2008's stimulus-fuelled credit binge.

The findings of the National Audit Office report published on China's central government website (www.gov.cn) reveal a litany of bad practice.

But the figure is barely a fraction of the 2-3 trillion of sour loans economists reckon are buried in the 10.7 trillion yuan of debt local governments had by the end of 2010.

It is becoming increasingly obvious that significant debt restructuring will need to take place at the local level, the scale of which has yet to be fully understood, Alistair Thornton, a Beijing-based economist with IHS Global Insight said in a note to clients.

The audit report, conducted for the 2010 budget year, found problems including 46.5 billion yuan worth of irregular credit guarantees, 73.2 billion yuan worth of loans secured against irregular collateral, 35.1 billion yuan spent on stocks, houses and polluting plants and 132 billion yuan worth of expenditure not made by its approved deadline.

A fifth problem is the fraudulent and underpayment of registered capital in financing vehicles, which amounted to 244.15 billion yuan, the report said.

The local governments involved have been ordered to correct wrongdoings, but the clean-up work remains less than half done in some areas, the report shows.

Of the 46.5 billion yuan of problematic guarantees, only 22 billion yuan had been corrected by the end of October, while just 23 billion yuan of the 73.2 billion yuan linked to irregular collateral had been resolved through re-negotiating terms with banks.

Meanwhile only 98 billion yuan of the 244.2 billion yuan of unpaid capital had been corrected by the end of October, despite measures such as capital injections by local governments and the introduction of strategic investors.

Around half of the 10.7 trillion yuan local government debt pile was amassed after Beijing launched its massive economic stimulus programme to counter the 2008/09 global financial crisis, with thousands of local government financing vehicles mushrooming up and borrowing big -- often from state-backed banks.

Stanley Li, a banking analyst with Mirae Asset Securities in Hong Kong, said much of what is owed has been rolled over.

Banks are extending the loans to local governments so that non-performing loans won't surface, Li said.

Although there will be no massive defaults, headlines about individual default cases will pop up, and that will be a long-term negative fact for bank share prices, Li said.

IMPAIRED ASSET ESTIMATES

The scale worries investors, because if the 2-3 trillion yuan estimate of impaired assets is right, there's much more left to be admitted to and it could rock the banking system.

Most borrowing funded massive infrastructure projects that have created pristine empty highways, auditoriums without audiences and ghost towns of uninhabited apartments.

Yao Wei, an economist for Societe Generale in Hong Kong, was not surprised at the findings from the National Audit Office and said the basic issue was clear: Even there is no corruption, it will be very difficult for local governments to make interest and principal repayments.

Yao said the investment returns of most local government projects were too low to be commercially viable.

Down the road, they will hit the rock, she said.

Even projects that were properly sanctioned and costed and not part of the audit investigation are running into trouble.

The National Aquatics Centre -- the iconic Water Cube in which Michael Phelps swam to eight gold medals at the 2008 Beijing Olympics -- is now in financial difficulty as revenues are insufficient to cover maintenance costs.

Yang Qiyong, a manager of the venue, told local media last week that running the Water Cube resulted in 11.3 million yuan losses in 2011.

WORKING ON A PLAN

The audit office said China's cabinet was still working on an overall plan on how to resolve the debt mess.

The State Council is studying proposals to enhance local government debt management and to address fiscal and financial risks, the audit office said in the report, which ranged widely beyond the local government debt issue.

The Ministry of Finance and the banking regulatory commission have sought to assure investors that the local debt problem is under control.

Zhao Xijun, a professor with the People's University of China in Beijing, said that the Chinese government has vast resources to prevent systematic risks, such as a local government default on a massive scale.

Fresh financing channels are being opened, like local government bond issuance, and the door can be opened wider if the trials prove successful, Zhao said, referring to China's decision in late October to allow Shanghai, Shenzhen, Zhejiang and Guangdong to sell bonds.

The nationwide check of China's budget implementation in 2010 has resulted in 139 criminal cases, administrative and intra-party punishment for 699 offenders and imprisonment for another 81, the audit office said.

(Reporting by Zhou Xin and Kevin Yao; Editing by Nick Edwards)