There have been signs since October’s Party Congress that China’s infrastructure boom was about to cool off as the leadership seeks to contain debt levels and focus on the quality not the quantity of growth. Subway building is one sector which has seen some high-profile project cancellations. In mid-November 2017, Caixin reported that China’s top economic planning authority, the National Development and Reform Commission, was “raising the bar for subway proposals” – increasing scrutiny in terms of fiscal conditions, population and GDP. In recent weeks, we’ve seen two large subway projects shelved, one in Hohhot, the capital city of Inner Mongolia (worth 27 billion Yuan) and another in Baotou, another Inner Mongolian city (worth 30 billion Yuan). As Caixin noted.
The cancellation of the Inner Mongolia subway projects is having a ripple effect in other cities. Several city governments, including those of Xianyang in Shaanxi province and Wuhan in Hubei province, said in statements that their subway plan are unlikely to win immediate approval under the central government’s crackdown on financial risks related to borrowing for such projects.
The crackdown on local government debt, a key source of infrastructure financing, will have a knock-on effect on Chinese GDP growth. A difficulty for China’s central planners is that the infrastructure share of Chinese fixed asset investment has been on a rising trend, surpassing 20% during 2017 versus just over 15% in early 2014. While we’ve been expecting China’s infrastructure spend to slow next year, we are surprised by the rate of slowdown estimated by Bloomberg, which surveyed a large number of forecasters.
China’s frenzied construction of roads, bridges and subways is set for a major slowdown, adding a headwind to economic growth in 2018. The nation’s fixed-asset investment in infrastructure will grow 12 percent next year, according to the median estimate in a Bloomberg survey, down from almost 20 percent in the first ten months this year. All 18 economists in the survey anticipated a moderation, adding to reports by Morgan Stanley, Goldman Sachs Group Inc. and UBS Group AG predicting a similar trend.
The cooling construction fever is taking shape as authorities renew a pledge to focus on debt management following the Communist Party Congress in October. In a rare move, China has suspended subway projects in some cities, and scrutiny has also toughened on public-private partnerships -- until now a widespread way to fund projects. The easing could even threaten global capital expenditure growth, as China represents one-fifth of the world’s total investment, according to estimates by Oxford Economics.
Infrastructure investment "grew much faster than other investments in the past five years," Larry Hu, chief China economist at Macquarie Securities Ltd. in Hong Kong, wrote in a note. "Policy makers might be able to accept slower growth for infrastructure spending from next year, as the growth in the past five years is unsustainable."
Slowdown or not, the scale of spending on Chinese infrastructure remains vast, about $1.7 trillion during January-October 2017. The pick-up in spending during the last two years followed efforts by the authorities to promote PPP (public-private partnerships) to finance infrastructure projects as one way to limit the growth in local government debt. As is the case with many things related to investment in China, the policy was quickly subject to abuse. In the majority of cases, the “private” partner in PPP projects turned out to be a state-owned firm, which merely added to the state’s debt burden via a different route. Eight local governments have been reprimanded by the finance ministry and the National Audit Office for “disguised borrowing”. We can only imagine the degree of abuse when local governments guaranteed returns on PPP-funded projects. According to Bloomberg.
The Ministry of Finance last month banned local governments from guaranteeing returns for private investors in PPP projects or backing a project’s debt. The national watchdog for state-owned enterprises also published rules to regulate state companies’ participation -- a potential blow to a major source of funding.
"A change in central government’s attitude towards PPP does not bode well for infrastructure in 2018," according to Yao Wei, chief China economist at Societe Generale SA in Paris. "A slowdown from the rapid pace this year looks inevitable."
The challenges for Xi Jinping and his top bureaucrats are mounting, as 2018 looks like it will see the convergence of a host of major reforms of which slower infrastructure spending and altering PPP funding arrangements are a small part. Other major ones include cooling the property market, reducing overcapacity in heavy industry, pollution control, continuing the crackdown on corruption, deleveraging and reforming the out-of-control shadow banking sector.
The China bulls will undoubtedly downplay the scale of these challenges, expecting little deceleration in Chinese growth, helped by a near seamless transition from investment to consumer-led growth. We will be
amazed very impressed if Xi can pull it off.