China economy

Does halting of subway project mark end of line for China’s infrastructure building boom?

Baotou, in Inner Mongolia, broke ground on two lines costing 30.5 billion yuan but Beijing had second thoughts

PUBLISHED : Monday, 04 December, 2017, 11:53am
UPDATED : Monday, 04 December, 2017, 3:54pm

With China preparing its annual blueprint for tackling its economic challenges, the South China Morning Post has sent journalists to check on three of the ‘grey rhinos’ threatening the world’s second biggest economy. In the first story in the series we look at the problem of local government debt.

The unprecedented suspension of a 30.5 billion yuan (US$4.6 billion) subway project in the Chinese city of Baotou in August shocked residents and construction workers alike.

During a decade-long subway construction boom in China, no one had ever seen a project halted after construction had begun. Now they are wondering whether Baotou marks the end of the line.

China has built more than 3,000km of new subway lines since the global financial crisis in 2008 – more than all the subway lines in the United States and Britain put together – as part of an infrastructure drive encompassing 50-odd cities that also included high-speed railway lines, motorways and airports.

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All that government investment helped prop up the country’s economic growth rate and redefine China’s urban landscape. But Baotou, an industrial city in Inner Mongolia with a population of 2.8 million, may signal a change in direction.

Its plan to build two subway lines with a total length of 42km by 2022 seemed modest in a country that, according to the China Association of Metros, has 5,770km of subways and intracity railway lines under construction.

But a visit to the city this summer by Yu Zhengsheng, the fourth-ranked official in China’s ruling Communist Party at the time, showed the economic winds were changing.

Shortly before Yu’s visit, party chief Xi Jinping had told cadres at the five-yearly national financial work conference to be alert to debt levels and financial risks. Debt-fuelled construction was highlighted as a particular risk and local government officials were warned they would be held responsible debts accumulated on their watch, even after they moved on to other jobs.

Two sources who read an internal briefing on Yu’s meeting with local officials told the South China Morning Post he was not impressed by Baotou’s urban development plans. He told them the subway was too expensive for a city with annual fiscal revenue of 27 billion yuan and would become a liability because it was unlikely to make any money. Yu said Baotou would be better off halting construction and using the money to meet more pressing needs such as health care and education.

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“If you don’t seriously study the central leadership’s ideas, you will deviate from the right path,” the sources quoted Yu as saying.

Xi laid out his priorities for his second five-year term at the party’s national congress in October, with one important message being that China would no longer be obsessed with gross domestic product (GDP) growth. He broke with tradition when he neglected to set a long-term GDP growth target in the work report he delivered to congress delegates, instead emphasising the importance of environmental protection, efficiency and fairness.

Xi is expected to begin translating his ideas into actionable policies at this month’s central economic work conference in Beijing. And that has fanned speculation the end could be dawning for an infrastructure investment frenzy that saw China use more cement between 2011 and 2013 than the US did in the entire 20th century.

Frederic Neumann, co-head of Asian economic research at HSBC, said China’s infrastructure spending was likely to level out.

“Chinese officials have struck a new path, one underlined by President Xi Jinping’s address [at the party congress]: quality over instability, sustainability over short-sightedness,” Neumann said.

The economy of Baotou, 550km northwest of Beijing, is dominated by state-owned steel plants and rare earth mines but the city has been relying on infrastructure spending to maintain growth. The local government said infrastructure investment – including preliminary spending on the subway – rose 35.4 per cent last year, contributing 8.6 percentage points to a headline growth rate of 7.6 per cent. In other words, the local economy would have shrunk without it.

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However, the city has to had to rely on borrowing to finance infrastructure spending, and its debts now total about 90 billion yuan

It’s fiscal revenue of 27 billion yuan last year compared with government spending of 41 billion yuan, 80 per cent of which was spent on items directly related to people’s daily lives, such as education. Without funds transferred from the central and regional governments, Baotou would no longer be afloat.

The local government had said it would contribute 40 per cent of the 30.5 billion yuan budget for the subway project, a move that would have seriously exacerbated the city’s financial woes.

A subway line would make Baotou’s long and bitter winters, with temperatures plunging to as low as minus 25 degrees Celsius, more bearable. But the project was otherwise hard to justify in a city with few traffic jams. A town plan drawn up by technocrats from the Soviet Union gave it roads as wide as 120 metres but it was home to just 513,000 cars at the end of last year and already has a well-established bus network. More than 40 bus routes operate from 6.30am to 8pm and, compared to Beijing, traffic flows smoothly even during the Friday afternoon rush hour.

“It’s a pity we won’t have a subway,” Baotou taxi driver Wang Tianhang said. “The introduction of the subway might have made my business worse, but I’d still prefer having it because it could have made life more convenient and given Baotou a modern touch.”

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Baotou’s subway plan was approved by the central government’s National Development and Reform Commission in September last year and the city government established a company, Baotou Metro Investment Group, to guide its development.

A big, fresh Baotou Metro logo still adorns the wall of the four-storey building that houses the company and the city government’s intracity rail transport office, along with a blueprint for the six lines initially envisaged.

But an official working there, who declined to be named, said: “All subway work has been put on hold, and that’s all I can tell you.”

The ground floor of the building was turned into an exhibition hall to showcase Baotou’s subway plans, which date back to 2010. Several display boards tell how local officials strove for approval from the NDRC and the country’s environment watchdog and what they had planned for the subway network and the development of areas around stations.

Along the subway’s No 1 line, where tunnelling had begun, some structures remain visible above ground. But no workers or machinery can be seen at the proposed Century Deer Park station, near the city government headquarters, where beaming local officials broke ground on the project in May. The excavators and cranes have been removed, with a few guards left to take care of the site, which has been sealed off since August.

Beijing has also called a halt to subway plans in other cities where construction work had yet to start, including the Inner Mongolian capital Hohhot, Xianyang in Shaanxi and Wuhan in Hubei.

“Beijing is seriously concerned about local government debt and showing its disapproval of white elephant projects,” said Professor Zhao Jian, an economist and urbanisation expert at Beijing Jiaotong University. “Baotou does not need a metro system as it already has an advanced transport network, and investment in such a project would be a waste of money and a drag on the local coffers.”

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Beijing has had a hard time reining in local government debt because local officials, in their quest to boost economic growth, keep finding new ways to accumulate it. China’s total debt soared from 141 per cent of GDP in 2008 to 258 per cent of GDP this year and the International Monetary Fund warned in August that China’s non-financial-sector debt would exceed 290 per cent of GDP by 2022.

A survey by the National Audit Office in 2013 found Chinese local governments had 17.9 trillion yuan in direct and indirect debts at the end of June that year, while figures released by the Ministry of Finance indicated that confirmed local government debt was 15.3 trillion yuan by the end of last year.

However, Swiss bank UBS estimates China’s local government debt at 33 trillion yuan, including quasi-fiscal spending via platforms not recognised by the government.

A report by China International Capital Corp, an investment bank, last year said that apart from a few lines in Beijing and Shanghai, all China’s subway lines were loss-making, with low ticket prices and a dearth of retailers at stations unable to offset high construction and operation costs.

Zhou Xiaochuan, China’s central bank governor for the past 15 years, warned in an article published last month that the country had deep-rooted problems that could lead to financial troubles down the road. One was that local governments were constantly putting pressure on the central bank to ease monetary policy, regardless of economic conditions.

The NDRC’s approval of Baotou’s subway last year coincided with a fresh burst of infrastructure spending as small cities rushed to begin projects in the first year of a new five-year plan.

Hu Xingdou, an economist at Beijing Institute of Technology, said subway projects were expensive and offered low returns but were favoured by local government officials because the huge investment involved could boost the economy, their presence could make a city look modern, the government debts would be left to their successors and the loans that went bad were a problem for the banks.

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Subway projects have also been a hotbed for corruption. In June this year, the State Council, China’s cabinet, said a company that had made substandard electrical cables used in subways in Xian, the capital of Shaanxi province, had faked test reports for its product and bribed subway contractors and supervisory officials. The company, Shaanxi Aokai Cable, also supplied subways in some other cities and some sections of China’s high-speed railway network. The case has seen 122 local officials punished for taking bribes or violating party discipline.

“Those cases partly explain why there has been a subway construction boom … and the rapid rise of local government debt,” Hu said.

Chen Long, a Beijing-based economist with consultancy Gavekal, said a slowdown in infrastructure construction would be a short-term problem for place such as Baotou.

“China is not saying it would stop all infrastructure construction approvals,” he said. “After all, infrastructure accounts for a large part of China’s investment. It’s just balancing the goals of development and risk control.

“I don’t think China will continue to halt infrastructure projects if the economy slows more than expected next year.”

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Baotou’s economy could use a boost. Even though the city sits on huge reserves of rare earths, which are used in many modern technologies, it lacks the technology to process them and exports them cheaply to countries such as Japan.

Wang Guiping, a China Railway Construction Corp worker dressed in a padded cotton jacket and dirty boots, was sitting on a mound of earth outside the abandoned Century Deer Park station construction site, basking in the sun with several colleagues.

“There is no work to do here,” he said. “But who knows, maybe the construction project will come back to life in a few months.”