The secret to China's success? A huge, unreported accumulation of debt. Scattered around China are 20 cities that want international airports, glistening skyscrapers, five-star hotels, six-lane highways, world-class universities and cultural centers, Prada stores, Mercedes-Benz showrooms and ample housing. It is the largest urbanization in modern history.

This building boom is taking place quietly, largely beyond the control of Beijing and financed with easy credit and local debt issuance. The surge of loans by banks to local authorities may spark a wave of bank failures that hobbles economic growth. The jump in local debt, which is tough to measure, increases the risk of default around the nation and leaves Beijing with a touchy question: Must it bail out local governments that went too far?

Cities and provinces can't borrow directly from banks, so they set up more than 8,000 investment companies to skirt regulations. Fitch Ratings predicts that, because of lending to these vehicles and to real estate developers, bad loans might reach 30 percent of the total at China's banks.

Eoin Treacy's view In Beijing last year, I chatted with the spouse of one of Mrs. Treacy's friends who explained how easy it was to set up a special purpose vehicle for investment purposes in China. He was explaining it in the context of setting up a hedge fund but said it was exactly the same for local governments. At least part of the reason the central government has been so adamant banks increase their reserve requirements is to make allowances for the risk that much of the stimulus package was misallocated. The reserve ratio for major banks is currently 21% and 18% for smaller banks which is way above that required of banks in other countries. Monetary tightening remains an additional obstacle for the Chinese stock market. This is likely to remain the case as long as inflation fighting is a priority for the central bank.

A subscriber kindly forwarded this article by Chris Oliver for MarketWatch which may be of interest. It reiterates a point we have made on a number of occasions; that the scheduled release of non-tradable shares has almost ended. This has acted as a significant headwind for the Chinese domestic stock market over the last 22 months but will have run its course by the third quarter.

The FTSE Xinhua A600 Banks Index has been ranging below 10,000 for a year and has fallen to test the lower side. A clear upward dynamic will be required to check the decline and indicate demand is returning in this area.

The Shanghai A-Share Index steadied in the region of the January lows, near 2800, but needs to hold a rally at least above 2900 to indicate demand is returning beyond the short term. Over the medium-term a sustained move above 3200 would be needed to break the 22-month progression of lower rally highs. .

The Shanghai B-Shares Index steadied briefly in the region of the 200-day MA but has since fallen below it and accelerated somewhat today. A clear upward dynamic would be required to check the short-term downtrend.