BEIJING (Reuters) - China's plan to spend $6.5 trillion on urbanization to bolster the economy is running into snags, sources close to the government said, as top leaders fear another spending binge could push up local debt levels and inflate a property bubble.
Premier Li Keqiang has rejected an urbanization proposal drafted by the National Development and Reform Commission (NDRC), seeking changes to put more emphasis on economic reform, according to the sources, who are familiar with the matter.
Many local authorities have already lobbied to get funding for projects, ringing alarm bells among top leaders in Beijing.
State-owned China Development Bank recently pledged to lend 150 billion yuan ($24.47 billion) to southeastern Fujian province to support its urbanization and channel 30 billion yuan into urban projects in central Anhui province, according to Chinese media.
"The urbanization plan could be delayed. Top leaders have seen potential risks if the program cannot be kept on the right path," said an economist at a top think-tank which advises the cabinet.
"The leadership aims to jumpstart reforms, but local governments see this in a different perspective - they view this as the last opportunity to boost investment," said the economist who requested anonymity due to the sensitivity of the issue.
China plans to spend some 40 trillion yuan ($6.5 trillion) to bring 400 million people to its cities over the next decade as leaders such as Li try to sustain economic growth that slowed to a 13-year low of 7.8 percent in 2012.
Li, the driving force behind urbanization, has turned more cautious following warnings from leading academics over the risks, said the think-tank sources who are involved in the policy discussions.
The NDRC is racing against the clock to amend the long-term plan in a bid to publish it by the end of June.
Beijing is still nursing a hangover from its 4 trillion yuan stimulus package launched in 2008 to counter the global financial crisis, which left local governments under a mountain of debt and sent house prices rocketing.
To fund the urbanization plan, local governments would issue long-term bonds to finance spending on roads, housing and social safety nets, Reuters reported in March, quoting sources with ties to the leadership.
But a fiscal overhaul is needed because local governments don't have steady tax revenues to back the issuance of bonds. Under China's tax structure, in place since 1994, the central government gets most receipts while local governments do the spending, forcing them to rely on land sales for survival.
To support the process, Beijing needed to overhaul its land and tax codes as well as free up the rigid residency registration, or "hukou", system to give migrant workers access to education, health and other services where they work, experts have said. Li wanted more detail on these sorts of reforms in the plan, the sources said.
"The focus of the urbanization drive should be land and hukou reforms. It's doomed if China continues to rely on local government spending to support urbanization," said Yi Xianrong, senior economist at the Chinese Academy of Social Sciences (CASS), a leading government think-tank in Beijing.
Ratings agency Fitch estimates local government debt at 13 trillion yuan, or a quarter of GDP. Government data puts the number at 10.7 trillion yuan.
China's housing inflation accelerated to its fastest pace in April in two years, despite stricter measures by Beijing to calm a frothy real estate market.
The government hopes 60 percent of China's population of almost 1.4 billion will be urban residents by 2020.
China's official urbanization rate is near 53 percent, but the real level is only around 35 percent as millions of migrant workers have been artificially included in the urban population, sparking criticism of "fake urbanization".
Some analysts are looking for guidance from a key meeting of the ruling Communist Party, expected in October, that will set the agenda for the next decade. Others are not so sure.
"I don't expect any policy breakthroughs this year as government departments still have different views," said Xiang Songzuo, chief economist at the Agricultural Bank of China.
"I feel that the top leadership may not have a clear idea on how to proceed with the urbanization strategy," said Xiang, who has been advising the government on urbanization issues.
Li Yining, the premier's former teacher at Peking University, recently said Chinese banks could be dragged into another spending binge that could spark a financial crisis.
But Premier Li is unlikely to backpedal on the urbanization drive, with his interest in the issue seen as far back as the early 1990s when he wrote a doctoral thesis on the subject. One of his key arguments was to reform the hukou system.
"It's like riding a tiger - it's not easy to get off once you're on," said a government economist who declined to be identified. ($1 = 6.1311 Chinese yuan)
Editing by Dean Yates