Infrastructure comes at a cost

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Infrastructure investment financing has been ‘largely debt-financed’ by local governments, according to a report by ratings agency Fitch, pointing out that local government financing vehicles, taking on those debts, might not always get a bailout from the state.
Projects such as the upcoming Hong Kong-Zhuhai-Macau Bridge and the Guangzhou-Shenzhen-Hong Kong Express Rail Link – instrumental in the central government’s plan to link the Pearl River Delta into a ‘Bay Area’ – contribute to the growing percentage of local government debt (by region) which is at 71 per cent of the total Chinese public debt, which hit 52 per cent of the Mainland’s gross domestic product in 2015, notes the report.
The group points out that it ‘does not believe the overall level of public debt is a credit weakness’ to the country, given the ‘offsetting factors such as a strong external position and high savings rate.’
However, this building debt comes without a ‘blanket implicit guarantee […] although the government would possibly address some individual fiscal stress situations.’
Neighbouring Guangzhou Province Governor Ma Xingrui notes that the group plans to see GDP growth of 7 per cent year-on-year in 2017, involving a RMB540 billion investment in projects including infrastructure – in particular regarding rapid transit networks like railways.
“Improving the rail systems, especially in less developed eastern, western and northern Guangdong, can help to link these areas with the Pearl River Delta and thus increase the efficiency of the whole province’s economic growth,” noted
Lin Jiang, head of Sun Yat-sen University’s public finance and taxation department, as cited by the state run China Daily.
‘China’s local public sector is made up of four tiers with a strict vertical hierarchy where each level reports to the upper level,’ notes the report. ‘The provincial level has the most power and authority, with better access to banks and central authorities, followed by the municipal, county and township tiers,’ it reads.
‘Each local government entity has its own responsibilities and should be regarded as legally autonomous and there is no assumption that a higher tier implicitly guarantees a lower-tiered local government if it encounters distress,’ notes the report, pointing out the rapid growth of the country has ‘generated or reinforced deep inequalities among provinces’ – noting that those such as Guangdong ‘host the bulk of China’s advanced industries, offer richer services and enjoy higher tax bases.’

LGFVs
Local government financing vehicles (LGFV) – traditionally created through an asset injection by the local government and enhanced through bank loans, the bond market or ‘high-interest trust products’, be it in land or capital – have funded over 7,000 infrastructure projects on the Mainland over the last 20 years, notes Fitch.
These vehicles are primarily used to fund ‘roads, rail and water networks, as well as urban development, including economic zones, housing and real estate’ although only ‘a small fraction of LGFV debt benefits from a guarantee by the relevant local government whereas a ‘large proportion of LGFVs debt is issued on behalf of the local government and, as such, can be considered the local government’s direct obligation.’
These are classified as ‘category 1’ debt, more present in the municipal and county level, however, making up about one-third of provincial debt, according to the data.
‘Since LGFVs are critical for local governments to achieve their economic and policy objectives, and more broadly to achieve the country’s general economic goals, LGFVs continue to increase their activities and their debt outstanding,’ notes the report. However, since China’s Ministry of Finance confirmed that ‘debt issued by LGFVs after January 2015 should not be serviced by local governments, this ‘increases risks for investors,’ notes the rating group, pointing out that ‘local governments could legitimately argue that debt raised by LGFVs with a commercial purpose, such as real estate, and without a clear policy related objective is pure private debt.’
This is contrasted by the group’s viewpoint that the governments cannot ‘simply ignore LGFVs in fiscal stresses’ given that it was raised on behalf of the governments.’
‘Local governments have posted fiscal deficits since 2009 because the transfers they receive from the central government and their limited tax proceeds are insufficient to fund the investment components of their budgets,’ notes Fitch. ‘This means local governments must find finite or non-sustainable resources, such as land right sales or borrowing to bridge the investment gap,’ meaning that the governments are also exposed to land sales, which financed an average 30 per cent of the local public sector revenue between 2008 and 2015.
‘Local governments promised to repay 40 per cent of debt using land sales on average,’ notes the report, so as debt mounts the potential land dwindles.