A report from Standard & Poor's Ratings Services has claimed fiscal reform in China's public sector will be key to the effectiveness of the country's Chinese yuan (CNY) 4 trillion stimulus package.

The report - China's Stimulus Plan: Local Governments Get More Fiscal Freedom, But Can They Unleash Productivity? - examines current practices, in which local governments have run up an estimated CNY1 trillion in off-budget debt, often pushing state-owned enterprises (SOEs) to borrow outside their core activities in order to fulfill social policy objectives.

Kim Eng Tan, credit analyst at Standard & Poor's, said: "We see two aspects as particularly important. First, strengthening the governance structure of public enterprises. Second, allowing local governments greater room to maneuver in managing their own fiscal affairs.

"Taking the opportunity of these turbulent times to enact these public sector reforms, in our opinion, will not only improve the effectiveness of the delivery of the stimulus, it will lay a better foundation for sustainable growth.

The report said SOEs have significant advantages over their private counterparts and yet often have poor profitability. It claimed the private sector's under-representation in many sectors of the economy suggests there is substantial potential for productivity gains in China.

Tan added: "Granting local government more authority over their fiscal affairs could enable the reforms of SOE governance to move forward. By granting local governments greater ability to raise tax revenue (as opposed to diverting SOE expenditure), we believe that the local governments would be more accountable to their citizens and would deliver services more efficiently."