Shanghai became the first local government in China to issue bonds directly in almost two decades, a reform that lies at the heart of attempts to clean up the troubled finances of its cities and provinces.

Local governments have amassed large debts through off-balance sheet borrowing and, at more than 25 per cent of gross domestic product, these debts are seen as one of the big risks looming over the Chinese economy.

By allowing bond sales, the hope is that the market will impose discipline and transparency on local governments.

The first auction drew strong demand that would be the envy of many European governments.

Shanghai on Tuesday sold Rmb3.6bn ($560bn) of three-year bonds at a yield of 3.1 per cent and Rmb3.5bn of five-year bonds at 3.3 per cent. They were both more than three times subscribed, according to the official Xinhua news agency.

Analysts cautioned that the sale amounted to a tiny step in the right direction.

“I don’t think they’ve solved the fundamental problem, [which] is a lack of local revenue generation capacity,” said Stephen Green, head of China research at Standard Chartered.

Cities and provinces remained over-reliant on land sales and fiscal transfers from Beijing , he said.

Guangdong province will be next to tap the markets, with an auction scheduled for Friday, followed on Monday by Zhejiang.

China’s national finance ministry will pay both the interest and the principal on the bonds. Local authorities will be responsible for transferring corresponding funds to Beijing but analysts said the arrangement amounted to an explicit central government guarantee for the bonds.

“It is just the beginning of the beginning,” said Zhu Ning, deputy director of the Shanghai Advanced Institute of Finance, a business school.