In September last year, the National Development and Reform Commission – China’s economic planning body – approved infrastructure projects worth more than one trillion yuan ($157 billion) – or around 2.1 percent of the nation’s economy. The vast sum underscores Beijing’s push to stimulate the economy by building railroads, subway lines, highways and other infrastructure. “To strengthen infrastructure development is key to promoting recovery and achieving sustained and stable growth,” said former Chinese President Hu Jintao at an Asia-Pacific Economic Cooperation conference in Russia. “Governments should play an important role in infrastructure building and step up financial support for infrastructure development,” Hu added.

To help step up support, Beijing has sped up approvals for key projects that are already in the 12th Five-Year Plan, which differs from the four trillion yuan ($641 billion) stimulus programme it launched during the global financial crisis, says Zhu Liting, partner at JoinWay Law Firm. This time, a combination of private and public investment would fund the programme, while a majority of the financing may come from bank loans or bond sales.

But regardless of the sources of funding, a surge in infrastructure work will greatly help ailing businesses. Both foreign and domestic machinery manufacturers in China have struggled as the economic slowdown has battered profits, and forced many to seek new clients elsewhere. However, economic data from the end of 2012 points towards growth in China’s manufacturing, trade and industrial sectors, spurring an uptick in share prices and optimism.

Law firms too stand to benefit. Maoyuan Zhu, a senior partner at Zhong Lun Law Firm, notes that the firm’s construction group has recently experienced steady growth in infrastructure and engineering-related areas, with most work coming from traditional real estate investors. For his part, JoinWay’s Zhu notes that while government-driven projects do not require legal services as much as those by private businesses, the sheer size of the investment will surely increase demand for private practice lawyers.

Overinvesting

However, questions remain about whether the government’s pockets are deep enough to fuel such expansive infrastructure projects. International Monetary Fund (IMF) researchers estimated in November last year that China overinvests at a cost of 4 percent of GDP a year – or $303 billion – and said it needs to reduce investment by 10 percentage points of GDP to keep its economy stable. Industry analysts stress that relying on investment for growth can create waste, build up debt, and stifle domestic consumption. “Massive investments in infrastructure projects will generate problems like resource wasting, caused by redundant construction and construction without thorough investigation and analysis,” says Zhu from Zhong Lun. “Furthermore, local governments will have to finance the projects through debt, which will increase their liability,” he adds.

Critics of China’s aggressive spending point to the 10.7 trillion yuan in local government debt accumulated after the global financial crisis as evidence of potential risks. Take the Chinese city of Nanchang as an example. In Nanchang – with a population of just three million – the government had a budget surplus of 11.2 billion yuan in 2011 as a result of transfers from Beijing and revenues from land sales. But analysts say that figure is misleading. Like many of its peers, Nanchang's government uses shell companies to borrow on its behalf to fund off-budget expenses and fuel the local economy. Nanchang’s government has at least two such financing vehicles, which are both deeply in debt, Reuters reports. The Nanchang Municipal Public Investment Holding Co Ltd had a total debt of 13.5 billion yuan in 2011, nearly 28 times its operating cash flows. The second, Nanchang City Construction Investment Development Co Ltd, had negative cash flows of 155.6 million yuan last year and a total debt of 10.6 billion yuan.

Following Beijing’s most recent announcement, Nanchang is planning to build two subway lines spanning more than 51 kilometres by 2015 at a cost of 27.4 billion yuan – or 10 percent of its 2011 GDP and 67 percent of 2011 fiscal revenues. Furthermore, the city intends to construct three additional lines stretching 117 kilometres by 2020.

Nanchang stands as just one example of the risks involved with overinvesting. Investment accounted for 54.2 percent of the country’s 9.3 percent expansion in its economy last year, but economists say more developed economies rely on consumption for 60 percent to 75 percent of their economic activity. While Beijing’s spurt of infrastructure spending helped pick up the economy after seven straight quarters of slowing growth, consumption's contribution to growth fell in the fourth quarter of 2012 for the third straight quarter.

For their part, supporters of the investment growth model note there is room for more investment. In China, investment in capital goods – of which infrastructure spending is a big component – per person is only 6 to 7 percent compared to that of the United States, a study by GaveKal-Dragonomics, a macroeconomic consulting firm, finds.

Careful planning

To further encourage growth and help solve funding issues, industry experts believe that local governments should attract new investors for future infrastructure projects. “I see a lot of foreign investors and operators who are very keen to enter the Chinese market for these infrastructure projects. However, it is very difficult for them to obtain new projects due to government issues,” says Stephen Lin, counsel at Fangda Partners. “The government should consider more sophisticated foreign or domestic individual investors and operators, who are very experienced in these areas, to fund and bring in more operational expertise,” he adds.

Zhu from Zhong Lun agrees: “China should also create a better environment of fairness for the non-state-owned economy, and therefore stimulate its development, which will be more helpful to the stable growth of the Chinese economy in the long run.”

“The government should be more open to rely more on market competition for these projects. If the market can be competitive, the government will surely benefit from lower prices and more investment,” adds Lin.

But the most important issue, stress Zhu and Lin, is for the government and administrative bodies to efficiently and carefully plan infrastructure projects to mitigate risk and waste. To offer an example, Lin speaks of the newly constructed high-speed railway between Beijing and Tianjin which saves people barely 10 minutes in travel time, yet cost both local governments about 180 million yuan per kilometre. “You can see that is not economical,” he adds.

Bond market reform

China’s approval to spend $157 billion on infrastructure seems minimal when compared to Beijing’s proposed 40 trillion yuan ($6.4 trillion) urbanisation programme to buoy economic growth and narrow the country’s wealth gap. According to the United Nations Development Programme, about 13 percent of China’s population still live on less than $1.25 per day, while average urban disposable income is just 21,810 yuan a year. Meanwhile, China has 2.7 million millionaires in dollar terms and 251 billionaires, according to the Hurun Report’s annual China Rich List.

Urbanisation and infrastructure development could help remedy China’s economic imbalances and steer it away from investment and export-driven initiatives, and on to a path to domestic consumption-led growth. “However, the new government needs to impose certain supporting policies to mitigate the risks,” says Lin. Others echo his view, stating that urbanisation must go hand in hand with market reform in order for China to achieve its goals. “The focus should not just be on construction. They should also focus on creating a market,” said a senior financial diplomat to Reuters. “If they fail to create a market, they will end up with an urban poor much worse off than the rural poor,” the diplomat added.

To tackle this issue, China’s new leadership under President Xi Jinping and Premier Li Keqiang plans to implement major bond market reform to raise the money needed for the urbanisation programme. China’s economy relies heavily on state-directed bank lending to fund investment projects. But the colossal 40 trillion yuan urbanisation outlay is far beyond the means of the current system. Beijing’s economic stimulus programme of 2008 – just a 10th of the size of the urbanisation programme – badly strained bank credit quality.

Currently, China lacks a properly functioning municipal bond market and is only just developing high-yield bonds, both of which would be needed to attract the investment capital sought. Furthermore, Beijing’s qualified foreign institutional investor rules stop dedicated overseas bond funds participating in the market by insisting that as much as half the money they plan to invest goes into equities. The People’s Bank of China data finds that total debt outstanding in China’s bond market at the end of January 2013 was 26.4 trillion yuan, or barely a sixth of the size of the U.S. bond market.

Central and local governments, as well as bank loans, will fund the costs, sources with leadership ties told Reuters. But, sweeping reforms to create a fully-functioning municipal bond market, boost corporate and high-yield bond issuance and actively steer foreign capital into the sector, are crucial to raising the sums of money China will need. Meanwhile, Beijing remains set on boosting its economy through investment-led growth, much to the delight of large state-owned businesses. Whether a continued reliance on heavy investment to spur growth is the best strategy for China, only time will tell.

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