China’s infrastructure plans aim to shore up economy, but experts say Beijing may first need to ease up on local debt

As China’s fiscal policy turns from contraction to expansion next year, infrastructure investment is expected to accelerate, but the risk of a rapid increase in debt remains
Financially strapped local governments have been reluctant to take advantage of special-purpose bonds, as these primarily go to infrastructure spending

China's economic recovery

Amanda Lee

Published: 2:30pm, 22 Dec 2021

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Beijing’s pledge to “front-load” policies that include infrastructure spending to shore up the economy next year will not be effective unless it also loosens its grip on local government debt, according to analysts.

At the tone-setting annual central economic work conference that concluded on December 10, China’s leaders emphasised the need to stabilise growth and promised to accelerate fiscal spending, allow the construction of new infrastructure and implement new tax and fee-reduction policies. Concerns have been mounting that Beijing’s firm stance on deleveraging the property sector could trigger a hard landing, dragging down China’s overall growth throughout next year.

Last week, China’s finance ministry said it had offered local governments an early allocation of 1.46 trillion yuan (US$229 billion) in quotas for 2022 special-purpose bonds to help spur investment and support the economy.

Larry Hu, chief China economist at Macquarie Capital, said that infrastructure investment would accelerate in the first half of next year as fiscal policy turns from contraction to expansion.

“But the pace will be modest unless policymakers loosen the controls on local government debt,” Hu said in a note on Thursday.

Economic pressure prompts fresh warning on China’s local government wastefulness

Beijing has kept its fiscal policy relatively tight this year, but Yu Yongding, a prominent Chinese economist and former central bank adviser, argued that China’s economy will benefit only if economic policy is significantly loosened. A tapering of stimulus policies to combat the effects of the coronavirus pandemic is “premature”, he said.

“China started to withdraw from expansionary fiscal policy in 2010. Based on the experience of China itself and the United States and other Western countries, I think it is too early for China to withdraw from expansionary fiscal and monetary policies, especially fiscal policies,” Yu said at a virtual seminar organised by Renmin University of China earlier this month.

Yu said that, despite the growing financial difficulties facing local governments, they have been reluctant to make use of the quota from special-purpose bonds, which are primarily used to fund infrastructure spending.

“Such issues [including a lack of motivation from local governments] are important, but they are beyond the scope of macroeconomic policies,” Yu said. “Infrastructure investment must be promoted by local governments. If local governments are not motivated, infrastructure investment will be difficult to carry out. Even if they are implemented reluctantly, it will be difficult to maintain quality and quantity.”

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The Evergrande theme park left derelict in China’s Jiangsu province

Fixed-asset investment has been on a downtrend trend since the start of the year, driven by a slower pace of infrastructure investment, which grew only 0.5 per cent in November compared with 1 per cent in October. Both the Ministry of Finance and the state’s economic planner, the National Development and Reform Commission (NDRC), have stepped up efforts to urge local governments to make use of special-purpose bonds since the second half of the year.

But initial progress had been slow, with only 61 per cent of the 3.65 trillion yuan quota for 2021 being taken up in the third quarter, according to the Ministry of Finance.

The NDRC said on Thursday that, since July, it has been coordinating with local governments to launch projects financed by special-purpose bonds. And, along with next year’s quota, the commission will provide “strong support” to infrastructure investment next year.

For now, the efforts by the NDRC and Ministry of Finance to complete the issuance of special-purpose bonds appear to have paid off.

The official Xinhua reported that special bond issuances totalled 3.42 trillion yuan as of last Wednesday, accounting for 97 per cent of the issued quota.

Can two of China’s wealthiest regions lead the way in debt reduction?

“The special-purpose debt has played an important role in driving the expansion of effective investment, and in maintaining the stable operation of the economy,” Xinhua quoted Ministry of Finance vice-minister Xu Hongcai as saying.

Indeed, some local governments such as Shenzhen have begun speeding up the construction of infrastructure projects outlined in a 2020-25 infrastructure plan that also falls under the nation’s 14th five-year plan spanning 2021-25. The southern tech hub of China has said it would speed up its plan to upgrade and construct new 5G networks, satellite communications, and computing power facilities.

There are 95 new infrastructure projects in the first batch, with a total investment of 411.9 billion yuan, according to a July notice from the Shenzhen government outlining its proposal. Shenzhen, home to tech firms Tencent and Huawei, will also serve as the nation’s pilot city for high-quality infrastructure development, the NDRC said in a notice last week.

But since economic development varies across China, not all provinces and cities would benefit from the same kind of investment. What’s more, China needs to learn from its mistakes when it comes to infrastructure spending that produces no returns, said Lu Ting, chief China economist at Nomura.

Even if both monetary and fiscal policy end up being very effective, the potential problem of an overly rapid pile up in debt remains

Natixis research note

“Infrastructure needs to pay off. Infrastructure projects shouldn’t be built in places where there is no return at all, and where no one uses them,” Lu said. “It’s not that [investment in] 5G is bad. In fact, as a developing country, there’s a lot of traditional infrastructure that hasn’t done so well.”

Beijing scaled back the fiscal-deficit ratio this year and strictly controlled local government borrowing in a bid to prevent wasteful spending and the misuse of public funds. In particular, the central government has increased scrutiny of local government financing vehicles (LGFVs) – the go-to funding channels for local governments for off-balance lending.

China’s overall debt was estimated at 272 per cent of gross domestic product (GDP) in 2020 after a strong stimulus to counter the fallout from the coronavirus pandemic, and the debt-to-GDP ratio declined to 265 per cent in the third quarter of this year, according to estimates from Natixis. Beijing has aimed to steady its overall leverage to below 270 per cent for the past few years.

Analysts said Beijing may not ease its grip on local government debt right away because policymakers are still concerned with the contagion impact from LGFVs on the state-dominated financial system after decades of rapid debt growth.

“Both monetary and fiscal easing will be further stepped up if the economy continues to slow down in the first half of 2022,” Natixis said in a note last Wednesday. “Even if both monetary and fiscal policy end up being very effective, the potential problem of an overly rapid pile up in debt remains.”

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