When it comes to estimating China's total outstanding debt, there has long been confusion about the real number with most putting the debt/GDP at around 250%, while the IIF last year calculated China's debt load as high as 300% of GDP.

Now, China watchers can one add another ~40% of debt/GDP to the total because according to S&P, China’s local governments have accumulated 40 trillion yuan ($5.8 trillion) - or even more - in off-balance sheet debt, suggesting the already record surge in defaults is set to accelerate further.

"The potential amount of debt is an iceberg with titanic credit risks", S&P credit analysts wrote in a report Tuesday, Bloomberg reported, with much of the build-up related to local government financing vehicles (LGFV), which don’t necessarily have the full financial backing of local governments themselves.

LGFV debt has emerged as a growing risk for China's economy, because with the national economy slowing, and as a result of a crackdown on shadow lending and a Beijing quota for issuance of local-government bonds not enough to fund infrastructure projects to support regional growth, authorities across the country have resorted to LGFVs to raise financing, according to S&P.

That’s left LGFVs “walking a tightrope” between deleveraging and transforming their businesses into more typical state-owned enterprises, S&P warned.

Meanwhile, debt vulnerabilities continue to rise as a result of the previously reported record surge in Chinese corporate defaults this year, as Beijing seeks to roll back a decades-old practice of implicit guarantees for debt.

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And while so far LGFV debt has avoided an event of default, several issues have come close, with local government bailouts taking place only in the last minute, adding to concerns about LGFVs vulnerabilities. Meanwhile, according to S&P the riskiest LGFVs include the following:

• Those tied to weaker prefectural, city or district-level governments with lax supervision over state-owned enterprises.
• Those focused on commercial activities - thus having diminishing importance to local governments.
• Those with significant refinancing risks thanks to large short-term debt or reliance on borrowing from the shadow-banking sector.

As Bloomberg notes, the focus on funding to sustain growth at the local level echoes a broader shift in the central government, which last year was focused on reducing leverage in the financial system. That phase is essentially over, thanks in part to an escalating trade war with the U.S., according to Citi. The result has been a sharp slowdown in China's debt-reliant economy.

“The markets are right, in our view, to feel more concerned about the sustainability of China’s debt and the increased financial risks", said Citi's chief China economist Liu Li-Gang, who also saw “renewed pressure” on the yuan as the currency continues to creep ever lower to the PBOC "red line" of 7.00.

Meanwhile, despite China's recently renewed shift toward the fiscal stimulus, S&P said that Beijing remains determined to "bring discipline to the financing practices of local governments and their LGFVs”. That may mean local authorities aren’t fully able to keep LGFVs afloat, however, and the bottom line is "the default risk of LGFVs is increasing". That said, the first LGFV default has yet to hit; how it will impact the broader market as yet another hub of moral hazard is wiped out remains to be seen.