Riding China’s infrastructure boom

China knows that its model for financing infrastructure is broken. Now opportunities are emerging for private and foreign investment to step in.

Tony Abbott famously declared he wants to be known as an “infrastructure Prime Minister”.

China, it is worth noting, has had infrastructure leaders for well over 20 years. Since 1992, China has on average plowed over 8.5 per cent of its annual GDP into infrastructure – far exceeding what any other region or country spends. 

In absolute terms, China’s annual infrastructure spending now surpasses that of United States and European Union. And there appear no immediate signs of this slowing down. Under China’s current 5-year plan (2011 - 2015) the government intends to invest as much as RMB 7 trillion (AUD 1.2 trillion) in urban public facilities. An additional RMB 3 trillion (AUD 550 billion) is planned for its national rail network.  

Last year Beijing devoted over RMB 630 billion (AUD 114 billion) to spending on a range of capital works projects. In just one city, Wuhan, there are plans to spend over RMB 2 trillion (AUD 360 billion) over the next five years.  

China’s consistently impressive growth figures are in a large part due to government-directed investment in ‘infrastructure’, broadly defined. Investment – of which infrastructure investment forms a dominant part – contributes up to 50 per cent of China's GDP. 

To a large degree, one’s opinion of the China story depends on one’s assessment of the success of this infrastructure-driven growth – and the monetary and fiscal settings that support it.  It is certainly not hard to be impressed with some of what has been built: from high-speed rail networks to world-record long bridges to power plants and massive dams.

But it is worth remembering that the success of infrastructure is ultimately determined not by whether something is awe-inspiring from an engineering perspective, but rather whether what has been built actually produces a net economic benefit. There is, after all, no point investing public or private funds in a project if the return on investment (properly defined) is less than what you put in.  

So how do China’s plans measure up on this front?

Some have been rather over the top in their assessments.

“I don’t believe China is at risk of emulating the ‘bridges to nowhere’ phenomenon some other countries have experienced”, pronounced Australia’s then ambassador to China, Geoff Raby, back in 2010 – after China's enormous infrastructure binge fiscal stimulus project of 2008 – 2009. 

What is a ‘bridge to nowhere’? The origin of the catchphrase comes from a notorious $US 300 million project to connect to sparsely populated towns in Alaska. It was picked up during the US Presidential Election of 2008 as an emblematic example of infrastructure investments made more to satisfy political considerations, than based on their economic benefit.

Have there really been no examples of this type of thing in China?

Even to the casual observer this would seem unlikely. Pictures of China’s ‘ghost cities’ have, after all, become internationally well known.  If a span in Alaska counts as a ‘bridge to nowhere’, then surely vast empty metropolises in the middle of the Gobi Desert do too.

But China’s ‘ghost cities’ are really just the tip of the iceberg. From $US 4.8 billion dollar theme parks in Tibet, to an economically dubious $US 23 billion dollar railway from Lanzhou to Xinjiang, to ridiculously excessive government buildings resembling the US Capitol Building or (according to taste) the Kremlin, to Tianjin’s ‘replica Manhattan’ championed by China’s then President Hu Jintao – there are no shortage of questionable projects across the country. There has also been no shortage of collapsing bridges in recent years.

Shrewd observers of the China scene typically have their own favorite examples of government-directed boondoggles and white elephants. The truth is such projects exist in almost every town across China if you know where to look.

Indeed, given the political environment of China – where corruption is endemic, where decisions about government projects are often determined to meet political rather than commercial imperatives, and where infrastructure is rolled out at speed – it is remarkable that many projects do turn out to be economically beneficial.

Even accepting many malinvestments, there is still a case that in aggregate China’s infrastructure investment to date has been largely beneficial. Economist Arthur Kroeber is probably one of the best proponents of this view.

At the same time there are others, Charlene Chu (formerly of Fitch) is one of the more prominent, who argue that the rapid expansion of government-directed lending to infrastructure projects poses a real systemic risk to China's financial system.

What is agreed is that the model for financing China’s infrastructure needs to change and could be much better.

China’s infrastructure to date has almost been completely domestically financed – estimates currently put foreign investment in Chinese infrastructure at less than 1 per cent. Equally it has been financed overwhelming from the public purse rather than through Chinese private investment.

China’s various levels of government provide, for example, over 96 per cent of general infrastructure finance; 99 per cent of funding for urban and airport projects; 80 – 85 per cent of power, water and port projects.

It is also true that at least some in the Chinese leadership have belatedly recognized that the infrastructure-led growth model is not sustainable – as the amount of bad debts in the state-owned banks pile up.  

The upshot is that there now appears to be a greater openness in China – explicitly encouraged in China’s current 5-year plan – to allow greater participation of foreign investment in future infrastructure projects.

In Beijing alone the municipal authorities last year invited foreign participation on over 126 projects valued at $US 55 billion and are making soothing noises about ensuring foreign investors get a reasonable return. 

Conceivably, in future some existing projects in China could even be privatized or handed over to foreign consortia to manage.

Despite past poor experience with foreign investment in certain infrastructure projects in the late 90s and early 2000s, bona fide opportunities are again emerging for foreign project finance expertise in China.

The appetite certainly exists among certain fund managers who, despite the risks with China, are attracted by the range of projects but also the usage numbers of proposed infrastructure which in many case are far more compelling than projects in their own jurisdictions.

In theory there is no reason why, if prudently handled, opportunities could not arise to replicate the success achieved elsewhere in the region.

Australia’s Treasurer Joe Hockey has made developing alternative models for future infrastructure investment a focus of the latest Finance Minister’s G20 meeting in Sydney. Details are still emerging about what he is proposing and whether it will be genuinely innovative.

What is clear is that that there is a much more receptive audience for alternative models for infrastructure investment not only in Australia but also in China. What is also clear is that better infrastructure financing models hold the key for putting the Chinese economy on a lot more sustainable path. 

Dan Ryan is the managing director of Serica Services, a China-focused corporate advisory firm.

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