Mainland Chinese cities build their way to growth

Concerns rise over mounting bad debts as local governments turn to municipal bond issues to fund their infrastructure projects

PUBLISHED : Monday, 11 November, 2013, 5:17am
UPDATED : Tuesday, 12 November, 2013, 5:02pm

Luxury hotels and state-of-the-art shopping centres, central financial districts and high-technology industrial parks … the names vary, but the components are similar in most of the 14 industry clusters under construction in Zhejiang province as local governments across the mainland embark on another investment rush.

Many are hoping the central government will allow them to issue municipal bonds to pay for the work.

"We have increased loans from banks to ensure the financing for the construction of our 110.3 square kilometre 'modern service cluster'," said Chen Lizhong, the head of the cluster in Jiaxing. "Also, we are waiting for approval from the National Development and Reform Commission to sell 1.2 billion yuan [HK$1.5 billion] of bonds for the project."

Zhejiang cities like Jiaxing are competing to raise funds to build the industrial clusters - with an average area of 70 sqkm - by 2020 as part of a provincial government development blueprint.

Jiaxing is being positioned to serve neighbouring Shanghai and Hangzhou, Zhejiang's provincial capital, with logistics and financial services, while in Hangzhou the focus is on developing a "high-technology future city".

The future city, costing tens of billions of yuan, will consist of hi-tech companies, venture-capital firms, universities and a Communist Party school for provincial cadres.

Just 8.3km away, the city of Linan has broken ground on construction of the Qinshan Lake Hi-tech Zone, also aiming to attract universities and technology companies.

Linan vice-mayor Yan Mingchao said it planned to issue bonds to finance the "promising projects".

Zhejiang, which has announced plans to attract 10 trillion yuan in investment for the five years to 2017, is not alone.

Sichuan province has unveiled a 4.3 trillion yuan investment plan for this year and next, and the neighbouring municipality of Chongqing plans to invest 1.5 trillion yuan in the three years to 2015.

"Once again, local governments are relying on investment to drive economic growth, which is a very wrong direction to go," said Yuan Gangming, a researcher with the Chinese Academy of Social Sciences. "Local governments want investments to push [gross domestic product] higher quickly, but they usually ignore the efficiency and quality of the projects. Waste, redundant projects and opaque local finances are what I worry about."

Municipal bonds, issued to finance such projects, could be "very dangerous" investments, Yuan said, just like bank loans to local government financing vehicles (LGFVs) in the lending binge after the 2007-08 financial crisis that went sour.

The mainland's budget law prohibits local governments from raising debt directly, except in special circumstances approved by the State Council. However, the governments have been skirting around the law by asking LGFVs to borrow or resorting to trust firms to raise funds for local projects.

Since 2009, the central government has also been offering a helping hand by issuing bonds on behalf of selected local governments and bearing the ultimate responsibility to repay if they default.

A reform roadmap proposed by the State Council's Development Research Centre says the mainland should begin issuing municipal bonds to "improve transparency" of local finance, "broaden funding avenues" for local governments and introduce institutional investors, including insurers and pension funds, to the scheme.

Many economists support that call. Such a programme, along with a reduction in local governments' recourse to indirect financing through LGFVs, would be beneficial to the sector because it would enhance monitoring and regulation of indebtedness by local governments, Moody's Investors Service analysts said in a report on October 31.

"It would also improve local governments' accountability for their own investment and borrowing decisions and discourage them from engaging in non-transparent irregular financing activities through their LGFVs," they said.

But Beijing Institute of Technology economist Hu Xingdou said bond sales would lead to a further increase in leverage in the financial system, which has been rising since 2008.

The liabilities of local governments are estimated to have doubled to 20 trillion yuan since 2010 as they sought to prop up economic growth by financing roads, railways, airports and urban infrastructure.

Fitch Ratings predicted the mainland's credit-GDP ratio at the end of 2017 would be close to 250 per cent, compared with 130 per cent in 2008.

Meanwhile, bad loans in the banking system climbed for seven consecutive quarters to the end of June, with more bad loans believed to exist in the less-regulated shadow banking system.

"No financial system can sustain rising leverage indefinitely," Fitch analysts said in a report in September.

"Eventually, swelling debt burdens will constrain economic activity as greater resources are directed into debt servicing and further investment exacerbates overcapacity."