China said it is looking into ways to regulate local government borrowing after ratings agency Moody's said the proportion of bad loans could be higher than previously thought.

The National Audit Office last week said authorities owed 10.7 trillion yuan ($1.65 trillion) as of the end of 2010, equivalent to about 27 percent of China's 2010 gross domestic product and warned of a risk of some default.

But on Monday Moody's said the NAO may have understated the debt burden by as much as $541.6 billion and the ratio of bad loans could be as high as 8-12 percent, compared to its own previous calculations of 5-8 percent.

State Council, or cabinet, issued a statement saying it would continue to "clean up local government financing platforms" and look at setting up a mechanism to regulate the way authorities raise money.

"The ability of some areas and industries to repay debt is weak and there are hidden risks," said the statement, which was dated Wednesday and released after a meeting chaired by Premier Wen Jiabao.

"These problems have exposed system and management loopholes and need close attention."

Excessive borrowing by authorities to fund infrastructure and other projects has sparked concerns among China's leadership about the risks the loans pose to the financial stability of the world's second-largest economy.

Moody's -- which had checked the NAO figures against reports by Chinese banking regulators -- said it was concerned by the differences between figures given by government agencies and the banks' publicly stated lack of concern.

The NAO had said 108.3 billion yuan of total loans had been issued or used improperly, citing methods such as providing fraudulent collateral or diverting the funds raised into capital or real estate markets.

Chinese banks last year loaned huge amounts to provincial financing vehicles -- intermediary agencies through which local governments take out borrowings because they are officially banned from assuming debt directly.

The credit was used to fund construction projects after Beijing called for nationwide efforts to spur the economy after the global financial crisis.

The massive debts have hampered official efforts to rein in inflation, which hit a near three-year high of 5.5 percent in May and is expected to pass six percent in June.

Although Beijing has raised interest rates five times since October -- the latest coming on Wednesday -- it has done so with some reluctance partly because it is worried about local governments defaulting on their loans.

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