The Big Problem With China’s Bridge and Tunnel Addiction

Public-private partnerships are in vogue in Beijing—and unstable.

Beijing is eyeing a 50 percent expansion of China’s high-speed train network.

Photographer: ImagineChina

With a global portfolio that includes Club Med and Cirque du Soleil, as well as assets in real estate, insurance, and pharmaceuticals, Fosun Group is one of China’s most active dealmakers. Still, the 46.2 billion-yuan ($6.7 billion) railway project it unveiled in September was noteworthy. The Shanghai-based conglomerate announced it was taking a controlling stake in a proposed 270-kilometer (168-mile) high-speed rail line linking the eastern cities of Hangzhou and Taizhou. The deal, which also attracted investment from two Chinese automakers, is part of a new government strategy to have private companies take the lead in major infrastructure projects.

China spent more than $10.8 trillion on infrastructure from 2006 to 2015, according to Bloomberg calculations. Outlays for roads, airports, ports, railways, and the like rose 17.4 percent last year, far outpacing the country’s 6.7 percent expansion in gross domestic product.

With economic growth projected to fall to 6.5 percent this year, the lowest rate since 1990, President Xi Jinping’s government is ever more dependent on the stimulus infrastructure projects provide. Beijing will invest 3.5 trillion yuan in railways by 2020, which among other things will pay for a more than 50 percent expansion of the country’s high-speed network, the State Council Information Office said in late December. The central government also has pledged 3.4 trillion yuan for rural water, road, electricity, and communication projects through 2020, the official Xinhua News Agency reported on Feb. 17. “There’s just an absolute boatload of infrastructure investment going on,” says Tom Orlik, chief Asia economist at Bloomberg Intelligence. “In some respects, it’s almost like the classic Keynesian example of paying someone to dig a hole and paying someone to fill it up.”

The relentless spending on new construction is weighing on China's public balance sheets. Total debt was about 260 percent of GDP in 2016, up from about 160 percent in 2008, according to calculations by Bloomberg Intelligence. “The pace at which China has taken on debt rings alarm bells,” Orlik and fellow Bloomberg Intelligence economist Justin Jimenez wrote in a report published on Feb. 23, noting that precipitous increases in debt in other countries have been a prelude to a financial crisis.

China’s central and local governments “need more help so they’re not only funding projects by themselves,” says Gabriel Wong, head of the China corporate finance practice in Shanghai for PwC. That’s why the country has begun experimenting with public-private partnerships (PPPs) in which private investors supply a large portion of the financing for a project in exchange for a promised stream of payments, either from the government or from users. China’s National Development and Reform Commission announced PPPs worth 4.23 trillion yuan from May 2015 to October 2016, Xinhua reported in October. The Finance Ministry announced a roster of more than 500 projects valued at 1.2 trillion yuan in October, according to China Daily.

Whether the new model will alleviate the stress on government finances is uncertain. Persuading private investors to join PPPs is a challenge: At least 40 percent of the companies involved in PPPs are state-owned, according to a Dec. 16 report by BMI Research, “making the projects less of a public-private partnership and more of a mostly public partnership.” With returns on Chinese projects typically ranging from 5 percent to 8 percent, most PPPs are not appealing to private investors, according to Fitch Ratings. Also, companies need to be wary of teaming up with debt-ridden local governments that may not be able to make their promised contributions. “We are concerned about local governments’ fiscal strength as the economy slows,” says Li Chuan, vice president of China Railway (Shanghai) Investment Co., a unit of publicly traded construction company China Railway Group Ltd. “If development of regional economies isn’t sustainable, PPP models won’t be sustainable.”

Investors in PPPs also run the risk that public entities will alter the terms of an existing partnership, exposing them to losses. That’s a particular concern in China, where the combination of a weak legal system and single-party rule discourages many investors from seeking redress through the courts. “There isn’t enough legal protection to ensure stability of government policy,” says China Railway Investment’s Li. “Government ministries have announced a lot of measures to support PPP development, but there hasn’t been legislation for PPP.”

Some economists say the effort is misguided, because the payoff from these projects is limited. Researchers at the University of Oxford’s Saïd Business School examined 95 large-scale road and rail projects in China and found that more than half destroyed—rather than created—economic value. “Overinvesting in unproductive projects results in the build-up of debt, monetary expansion [and] instability in financial markets,” according to the report. It also diverts government resources from other important needs, such as education and health care, says Atif Ansar, one of the authors. “China has really become addicted to infrastructure investment,” he says. “Every time the business cycle slows down, the government has tended to press down the accelerator.”

Moreover, many projects are in remote regions where there’s not enough demand to support them, making them unattractive to would-be investors, Ansar says.

Some say China is making the same mistake as Japan, which spent trillions of yen on infrastructure projects that did little to reverse economic stagnation after the collapse of the 1980s property bubble. Many of the proposed projects in Central and Western China “are not going to make money for five years or even 10 years,” says Matthew Li, China economist with consulting firm IMA Asia in Sydney. “All of the low-hanging fruit has already been picked, so in the future more and more projects will tend to be nonprofitable, bad projects.”

The bottom line: Eager to contain public debt, Beijing blessed hundreds of new private partnerships last year.

—With assistance from Judy Chen, Jing Zhao, Jing Yang De Morel

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