Chinese local government funds run out of projects to back
The Sichuan Development Guidance Fund’s infrastructure investment has traditionally helped the Chinese government to meet its economic growth target.
Spending by it and similar local government-controlled companies has been an important source of stimulus whenever China’s expansion has flagged.
But Sichuan Development has a problem: the company, based in the southwestern city of Chengdu, is running out of profitable projects to fund. And that contributes to China’s wider economic woes.
The National Bureau of Statistics will on Friday unveil its estimate for third-quarter economic growth. Economists expect the expansion to come in at 6.1 per cent, compared with about 6.3 per cent during the first six months of 2019.
This is a disappointment: over the course of this year growth was officially predicted to come in at between 6 per cent and 6.5 per cent — itself a 30-year low.
“There are not many economically viable projects for us to take on,” an official at Sichuan Development told the FT. “We have plenty of bridges and roads already.”
The official, who asked not to be named, was speaking on the sidelines of a conference for local government finance vehicles last week in Nanjing. He and his peers had gathered to discuss the mounting challenges they face in helping the Chinese government to prop up growth.
On Wednesday China’s central bank injected Rmb200bn ($28bn) into the banking system in a bid to boost lending, reflecting policymakers’ concerns about an economy hit by a trade war with the US and slowing demand at home.
At the closed-door conference, local officials and the finance vehicles they control complained they were running out of growth-boosting, cash-generating public projects such as toll roads and bridges to fund. Alternative investments, such as water treatment plants and sewage pipelines, generate much smaller returns or even lose money.
That leaves them and the central government with an unpalatable choice: either continue to rein in investments, adding further pressure on to China’s slowing economy, or take on riskier projects despite a three-year campaign by Beijing to contain financial risks.
As recently as 2016, capital formation, including local government infrastructure investments, accounted for more than 40 per cent of China’s economic growth, according to NBS figures. But after Liu He, China’s economic tsar, launched a crackdown on financial risk that same year, this slipped to 33 per cent in 2017-18 and less than 20 per cent in the first half of this year.
State banks, traditionally a major source of funding for public sector infrastructure projects, are also becoming more wary. Medium- to long-term corporate loans fell 6 per cent over the first eight months of this year compared with the same period in 2018, after banks tightened lending standards.
“In the past, we lent to any public project that had government approval,” said a loan officer at Bank of China’s Chengdu branch. “Now we won’t work on a project unless it generates enough cash flow to pay off the loan.”
In the absence of easy credit from state banks, cash-strapped local governments are turning to bond financing to fund public projects. Local government revenue growth from taxes and land sales has slowed dramatically this year. Tax revenues are down 0.1 per cent and land sales up just 4.2 per cent over the first eight months of this year compared with the same period in 2018 — the lowest such figures in 10 years.
State-backed infrastructure investment grew just 3.2 per cent year on year over the first eight months of 2019, while bond issuance by municipal and county governments and their finance vehicles rose 38 per cent over the same period to Rmb5.1tn.
The surge in local government debt issuance included a raft of “special purpose” bonds, which are supposed to finance revenue-generating public projects and pay lower interest rates than traditional government bonds. The amount of these bonds issued over the first eight months of 2019 more than doubled to Rmb2.4tn, making them one of the biggest sources of public financing.
Beijing also moved in June to ease restrictions on the use of special purpose bonds, allowing the debt proceeds raised from them to be treated as base capital. That in turn makes it easier for local governments to convince local banks to lend to them.
“Special purpose bonds could provide an effective solution to financing public investment,” said Chen Shaoqiang, a researcher at the Chinese Academy of Fiscal Sciences, a think-tank under the Ministry of Finance.
Trade Secrets is the FT’s must-read daily briefing on the changing face of international trade and globalisation.
Sign up here to understand which countries, companies and technologies are shaping the new global economy
Some analysts, however, say such moves could prove dangerous. Wang Peng at Modern Consulting, which advises local governments on infrastructure financing, is worried that local governments are increasingly using the tools for projects that will struggle to generate revenues.
“This goes against the basic principle of special purpose bonds,” he said.
Local officials add that the proceeds from bond issuance still fall far short of what they need to revive investment and economic growth.
One official at Taiyuan Longcheng Development Investment Co, a finance vehicle based in northern Shanxi Province, said special purpose bond proceeds are just a “drop in the bucket”.
“We are still not allowed to issue as many [special purpose] bonds as we would like to,” he said.
Additional reporting by Xinning Liu