Local government financing vehicles are selling bonds at the slowest pace in three years.

Issuance slumped 47 percent from a year earlier in the first two months to 66.3 billion yuan ($10.6 billion), data compiled by Bloomberg show. Municipal bond trials are still in an initial stage, raising concern over the ability of regions to raise capital for new projects and refinance debt due. The repayment bill of LGFVs will jump 49 percent to a record 416.1 billion yuan this year, China Credit Rating Co estimated.

Deutsche Bank AG and Bank of America Corp say a regional funding shortfall could be the biggest risk for the economy this year, while Barclays Plc predicts a bigger central budget deficit.

"Without central government backing, it's become much more difficult and complicated for financing arms to raise funds," said Zhou Hao, a Shanghai-based economist at Australia & New Zealand Banking Group Ltd. "Credit events are already increasing. If not managed properly, the funding shortfall could slow local-government investment and consequently hurt economic expansion."

Local authorities set up thousands of funding units to finance projects from sewage systems to subways after a 1994 budget law barred them from issuing notes directly. Their fundraising helped regional liabilities jump 67 percent from the end of 2010 to 17.9 trillion yuan as of June 2013.

The People's Bank of China cut its one-year deposit rate by 25 basis points to 2.5 percent and its lending rate to 5.35 percent. A gauge of manufacturing signaled contraction again in February.

The median estimate in a Bloomberg News survey of seven brokerages in January was for a 2.5 percent deficit ratio. A municipal bond sale trial conducted in 10 cities and provinces last year will grow, driving the total issuance to 650 billion yuan from 400 billion yuan last year, according to the survey.

China will adopt more proactive fiscal policy and expand tax breaks for small business, according to a Feb 25 summary of a State Council (cabinet) meeting hosted by premier Li Keqiang.

"It may be a signal that this year's proactive fiscal policy will be in the form of getting less fiscal income rather than spending more," Zhou said.

LGFVs' bond sales almost doubled last year to 1.5 trillion yuan, data compiled by Bloomberg show. Their outstanding debt was 3.2 trillion yuan at the end of 2014, with a sample study indicating 90 percent of such debt will seek refinancing, according China Credit Rating.

The yield premium for five-year AAA rated corporate debt, the most common grade for LGFVs, over sovereign notes narrowed to 227 bps on Feb 27, after reaching a seven-month high of 287 bps in December. The yield on the 10-year sovereign bonds fell to 3.34 percent on Feb 17, the lowest since August 2012, and is now at 3.36 percent.

China amended the Budget Law last year, stipulating that all government borrowings need to be brought into the fiscal plan. That move opens the door for local authorities to issue bonds directly, cutting off implicit State guarantees for LGFV debt.