A financial report by the Chinese Academy of Social Sciences predicted that by 2012 local governments' debt service ratio may hit 26.6 percent and won't fall below 20 percent before 2014, the Shanghai Securities News reported.

A local government's debt service ratio refers to the ratio of debt payment (principal + interest) to the government's disposable fiscal revenue of that year. A higher ratio reflects a weaker ability to pay the debt.

The report raised concern over government ability to repay banks' debts. It pointed out that bad loans may occur due to tightened credit policies. Also, local fiscal revenues are usually unstable because land sales account for at least 20 percent of fiscal revenue.

To cope with these risks, the report suggested local governments be more cautious about further investments.

Investments in overcapacity and high-polluting industries should be stopped and private capital could be used in some financing methods, the report said.

China's cabinet on May 27 ordered a review of local governments' financing platforms in a bid to prevent bad loans amid heavy lending.