China Translated

Local government debt is back in the headlines.  Today, I attended a presentation by Prof Victor Shih, who has just finished some fairly extensive research on the debt taken on by local government investment entities.

The starting point for Prof Shih’s argument is that last year’s massive economic stimulus was massively underfunded by the central government.  Local governments were left with colossal spending obligations but no obvious way to pay for them.  The solution for many local governments was to set up local government investment entities to borrow the money on their behalf.

The process is quite simple.  Local governments set up a financial company and give it some land.  Using the land as collateral, the financial company, which is wholly owned by the local government, borrows money form the banks.  That money is used to fund local government’s investment projects.

Prof Shih’s calculations suggest that money owed by these finance vehicles now adds up to around CNY11trln - or about 1/3 of Chinese GDP.

This money will now have to be paid back.  If, as seems likely, the revenue stream from the projects in which it has been invested are not sufficient, some other way will have to be found.  Land sales, higher taxes, or reliance on a bail out from the central government are the most likely options.

The government might have kept the majority of economic stimulus spending off balance sheet, but the bill will still have to paid.

Chinese economists are also alive to the problem of local government debt.  These are the main points from a recent blog post by Guo Tianyong:

‘Many of the projects funded through local investment vehicles are not commercially viable.  A visit to local areas revealed projects that will not generate revenue for 5 or even 10 years.

That will mean that responsibility for repayment falls back at the door of local government, which has acted as guarantor of the loans.

If the real estate market wobbles and land prices fall, the repayment ability of local government will also come into question.

Properly understood, local government finance risk and bank credit risk are now two sides of the same coin.

A more sensible approach for the future would be for local government to invite bids from the private sector to build local infrastructure.  If projects are commercially viable, there should be no problem.  If the project fails, the private sector is left with the debt, and its no burden for the government.’

You can see Guo Tianyong’s blog post here.  Prof Shih’s research has been getting a lot of play and you can see a summary of it here.

Banking, Financial Crisis, Fiscal Policy, Infrastructure, Property, Regional

For millions of migrant workers, Chinese New Year is a time to head home to reconnect with family and friends.  Getting there, however, is something of a challenge. 

With almost two weeks still to go before the beginning of the festivities, Dongguan Railway Station is already feeling the pressure.  Here are some photographs of scenes from the railway station, taken today. 

The caption on the top picture says: ‘Spring travel hasn’t even started, and passengers are like a wave: Dongguan Railway Station expects 87,000 travellers a day in the run up to the holiday’

Culture, Infrastructure, Labour markets, Social Policy

Chongqing and the rest of central and western China is to the coast what China as a whole is to the rest of the world – cheaper and less developed, but moving faster. It feels like a different country sometimes, and this thought occurred to me last week just as our taxi maneuvered gingerly around a giant excavator fitted with a jackhammer, which was trying to break up the street as we were trying to drive on it. Our city taxi was on a search for a CNG station, which are relatively common in urban Chongqing but quite rare in the suburbs where we were. We were following a local taxi which had promised to lead us to the only local station, and so when he went around the excavator down a very unpromising-looking back street, so did we, literally darting past when the big arm pulled its drill back for another try. That might have happened in Shanghai ten years ago, but Shanghai is more first-world now, and you would expect to see traffic barriers and a flagger to wave vehicles through. Suburban Chongqing isn’t there yet.

CNG stands for “compressed natural gas,” and many vehicles in Chongqing run on it, not only most (if not all) buses and taxis, but also many others, including the black sedan that took me to the airport the day I left. They can also use gasoline, but gas is more expensive, so drivers will take some trouble to get CNG – I personally experienced several lengthy detours, and saw several long lines at CNG stations of mostly taxis that were willing to wait to get the cheaper fuel. As a gas, CNG takes up more space than gasoline, so taxis have to refuel several times a day, even though the tanks take up a good part of the trunk. On the other hand, CNG is much less polluting than gasoline, and in Chongqing’s famous smog this is a big plus.

However, it probably wasn’t the environmental benefits that originally pushed natural gas vehicle development, but fuel availability. Sichuan, which borders Chongqing and used to administer it, was the site of the world’s first industrial use of natural gas. Gas was found in sites that had salt springs and, as early as the Western Han dynasty (221 BC – 23 AD) was piped through bamboo tubes to fuel boilers that reduced the brine to obtain salt. Transport links to coastal China were weak until very recently, despite the city’s strategic river location, so development of vehicles that could use the locally available fuel was an obvious choice.

There are actually many places in the world that rely on CNG as a supplementary fuel to gasoline; China is only in 7th place by number of vehicles (Pakistan, Argentina and Brazil are the top three.) Many more use “autogas,” also referred to as liquefied petroleum gas (LPG,) which is a mix of butane and propane (the proportion varies by the season, for reasons known to chemists. Like CNG, it’s cheaper than gasoline, but it has fewer environmental benefits and is produced from petroleum.) There are attempts to promote CNG cars in the developed world, but these run into the problem we encountered in Chongqing – you have to find a place to fill them up. There is a chicken-and-egg problem common to all “new” automobile fuel schemes, including not only CNG but also electric and hydrogen: nobody wants to built a network of filling stations for cars that don’t exist, but nobody wants to buy a car they can’t fuel. Chongqing is hardly unique in having a second fuel infrastructure, but if you come from the United States, being in Chongqing is like visiting a future in which a large number of cars are not running on gasoline, and doing it semi-successfully. Only semi-, because while the fleet is large the infrastructure is still clearly lacking – CNG shortages played a role in a Chongqing taxi strike in late 2008, after which the government promised to increase supplies, but my anecdotal experiences show that problems remain. The private automobile market in Chongqing is booming, but it’s not likely that many of the new cars hitting the road will be CNG vehicles until you don’t have to spend so much time on the road just looking for a fillup.

- Don Johnson

Energy, Environment, Guest contributor, Infrastructure, Regional

One of the sleeper issues for the Chinese economy is local government debt.  With little concept of fiscal responsibilty, and a hand-in-glove relationship with local banks, county and township governments have been racking up debt at an alarming rate. 

The National Development and Reform Commission (NDRC) has announced the results of new research which put the local government debt level at CNY5trn.  2008 GDP was CNY30trn so that puts local government debt at 16% of GDP - lower than some other estimates I have seen. 

Xu Lin of the NDRC points out that according to Chinese company law, a company can’t take on debt that adds up to more than a percentage of its total assets or average annual profit.  This way of controlling credit risk could usefully be applied to local government.

He also says that credit agencies give excessively optimistic ratings to borrowers backed by local government guarantees, which means that they can borrow too easily.

Xu Lin also says that according to the latest estimates there are 3,800 local government investment vehicles managing CNY8trn in debt.  (I assume the point is that this debt is guaranteed by local government and is additional to the CNY5trn they have on their own books).

He also notes that debt issued by local government investment vehicles accounts for 38% of total debt in the first half of the year, vastly more than the 13% of the total in the same period of 2008.  One implication of this is that local government borrowing is crowding out borrowing by the private sector (though a more optimistic reading would be that, in the downturn, government is picking up the slack from the private sector).

Xu concludes that there is a risk that local governments will not be able to repay the money they borrowed.  That’s certainly a conclusion I agree with.  Local governments borrow against the future revenue stream from tax income and land sales, as well as revenue from their investment projects - for example tolls from use of roads or other infrastructure built with the loans.

What we have seen in the fiscal data so far this year is that tax revenue has collapsed and it is non-tax revenue from land sales and elsewhere that is propping up local exchequers up and down the country.  What we have also seen is a massive infrastructure build out which many people believe is running way ahead of demand - a fact which bodes ill for infrastructure projects’ ability to generate the revenue necessary to repay loans.  Land sales have been a mainstay of local government revenue, but they are dependent on the state of the housing market - an area where many people believe the stimulus has only delayed a serious correction in prices.

None of this spells imminent catastrophe, but it does call into question the revenue stream on which local governments rely to repay their debts.  If local governments start to default, first the banks and then, if the problem is sufficiently severe, the national government, will end up footing the bill.

You can see a news report based on the NDRC work here.

Banking, Financial Crisis, Fiscal Policy, Infrastructure, Regional

I was in a meeting not long ago with local officials in a county-level city in Chongqing municipality. Chongqing is moving fast – according to official numbers its economy has grown 14% this year, approximately twice the national average. There are natural reasons for this: Growth has been moving inland from the coasts, while at the same time the city has been fairly insulated from the international recession. But the main reason for the boom, as everyone there cheerfully admits, is government support. The central government is very anxious to even out the huge development gap between the coasts and the interior, and Chongqing has been designated a “growth pole” for western China. It has been a recipient of favorable policies and public investment at least since it was split off from Sichuan province and made a provincial level municipality twelve years ago. Most recently, Bo Xilai, formerly head of the Ministry of Commerce, son of former Politburo member Bo Yibo and a high profile official, was made party secretary of Chongqing, and it’s understood that his brief for the job is to open the throttle on economic growth.

In Chongqing city itself the boom is most apparent in the new downtown taking shape across from the historic center, on the north bank of the Jiading river, and in the new high class towers and hotels shooting up on the other side in the Nan’an district. As with much new construction in China, the scale of development is overpowering. As you drive down the immense boulevards between one half finished patch of towers after another, the unavoidable question is, “Who is going to use all this?” But for all its Brobdingnagian scale, it’s not Chongqing’s new downtown that gives me pause. I worry instead about the new downtowns of the small city where I was, an hour’s drive away through the rugged hills, and its cousins all across China. It seems nearly every city in the country has a “new city” or “new district,” often at least as large as what’s already there. I don’t know how to estimate the amount of planned space in all the new districts across the country, but I guess it would give economists and government planners a cold sweat.

Of course, planned is not the same as built. But a significant amount of space in these new districts is in fact under construction. Some of it is government offices, some is public facilities, some is relocation housing for people whose former homes are becoming reservoirs, highways, railroads, or denser and more expensive housing. And a lot is market rate housing. Chinese demographics can support an immense amount of housing development. The population is simultaneously growing and urbanizing, and the average living space per person is still quite low. Sure enough, there is an immense amount of housing being built – but there is reasonable doubt whether it matches the demand. Despite the dizzying amount of construction, China’s major cities have a housing affordability problem, and during the recent downturn developers showed they were generally more willing to sit on empty units than to lower prices. In vacation markets (existing, planned and hopeful) luxury villas and second home condominiums are everywhere.

Still, all this new housing is finding buyers. After a bumpy couple of years, the housing market is sharply up this year. But how many of the units sold are just speculative investments, subject to a western-style price collapse? The Chinese public has a high savings rate and is simultaneously facing very low interest rates and fears of inflation. With almost the only alternative investment vehicle available the notoriously fickle and opaque domestic stock markets – and with the government determined to support the housing industry as a bulwark against recession – intense speculation in the housing market is hardly to be wondered at. As previously noted here, a lot of the tremendous bank loaning in the first part of the year has leaked into property markets as well. Anecdotally, it’s clear as you travel around China that a lot of new housing sits empty, waiting for appreciation – the investors have not even bothered to rent it out.

If there is a housing bubble, the question is how big it is, and whether it can be safely deflated once the immediate danger of recession is past. Central economic planners are watching this carefully, and while the official line is that the economy is still weak and that a moderately loose policy will be maintained through the end of the year, I guess that once it’s decided that it’s safe to pull back that more restrictive housing policies will be among the first out the door.

- Don Johnson

Guest contributor, Infrastructure, Investment, Property, Regional

The massive increase in fixed asset investment so far this year has come almost entirely from the government, with the private sector playing a smaller role. Investment in real estate, often taken as a proxy for private sector FAI, increased 6% in the year to end May, against an almost 40% increase in FAI as a whole. One key question is if and when the private sector will return to investment. An uptick in FDI from Hong Kong and Taiwan, much of which is domestic capital round-tripping back into the country, has been taken as a positive sign. But Caijing has two reasons why investment from the private sector might stay at depressed levels:

1. Weak demand: government might invest to support the economy and social stability, but the private sector is only going to invest on the expectation of a return on its investment. With no signs of return to life in major export markets, and a limit to demand in the domestic economy, the private sector sees limited profitable opportunities for investment

2. Massive bank lending to the state sector might actually be squeezing credit available to the private sector. The banks have been keen to lend to state owned firms where there is an implicit government guarantee of payback if the firm defaults. Going forward, these state-backed projects will continue to soak up a disproportionate amount of bank lending, and if some of them start to default, the banks will be even more constrained in their ability to lend to private sector projects.

Caijing also notes that on a provincial basis, the increase in FAI in April in Zhejiang and Fujian, where the private sector is relatively well developed, was less impressive than in more state-sector focussed provinces like Shandong.

Banking, Fiscal Policy, Industry, Infrastructure, Investment, Property, Regional

Amidst ongoing uncertainty about the outlook for China’s economy people are looking at various different indicators for clues as to how the recovery is taking shape.  I have touched on electricity generation as an indicator in previous posts.  Another option is to look at the number of passengers on the railways and the amount of freight being carried.  The assumption is that the more the economy is growing the more people will be travelling and the more goods will be being moved about.

In its latest edition Caijing looks at the numbers for the railways in the first four months of the year.  They find that for the first four months of the year, there was a 5.7% yoy decrease in the amount of freight transported on the railways.  That is a slight improvement on the 6.3% yoy decrease in the first 3 months of the year.

The train freight statistics seem to suggest the economy is not doing so well.  And it might be even worse than the figures suggest.  Last year there were horrendous snow storms in the first quarter which brought the train network to a halt.  Negative growth in train freight this year from a period when snow storms stopped the trains from running last year is not very encouraging.

China’s train network is inadequate to the needs of the economy (that’s one of the reasons the government is making a massive investment in the railways as part of its stimulus spending).  That means changes in rail freight don’t adequately reflect upturns in the economy (because once the railways are at full capacity they can’t deliver any more freight even if the economy is growing fast enough to generate additional demand).  But with downturns they might be a reasonable indicator.

Next week all of the key macro-economic statistics for May will be released which should give a better picture of how things are going in the second quarter.

Financial Crisis, GDP, Infrastructure

It’s tough times in the Chinese steel sector as an uptick in prices on the promise of higher demand from infrastructure spending fades away.  One of the places where these problems are most keenly felt is in Hebei, which in 2008 produced 116m tonnes of steel, 23% of China’s total production.

A review of the provincial governments plans suggests they aim to eliminate 10% of older and less efficient blast furnaces in the course of 2009 ,which will presumably reduce some of the environmental damage caused by the sector and ease problems associated with excess capacity.

At the same time they plan to encourage a move of production capacity toward coastal areas - presumably to make it easier to receive shipments of iron ore and to export finished products.

There are also plans to develop the equipment manufacturing sector and the ship building sector - which would extend the steel production value chain into higher added goods and allow the province to capture more of the benefits.

Another priority for the provincial government is reducing the price of imported iron ore.  Brazilian and Australian iron ore giants have gouged huge price increases out of Chinese steel producers in each of the last few years.  2009’s annual price negotiation is ongoing and it will be good news for steel producers in the province if they can extract a significant decrease in the price.  Some analysts where talking about a 40% reduction - though I have not been following this closely in the last few weeks.

A more reasonable price for iron ore, combined with prices for coking coal and oil which are already low, would relieve the steel producers from almost all of the cost pressures they were facing back in summer 2008.  The pick up in prices which will surely come when the new investment spending translates into new orders would then feed through into higher profits.

A few other bits of Hebei steel industry related information:

In December 2008 Hebei Steel Group and Ministry of Railways signed an agreement to co-operate on providing steel for the massive railway extension which is part of the government’s Rmb4trn economic stimulus plan.  Apparently the plans include the building of 40,000km of railway between now and 2020, at a cost of more than Rmb5trn - so quite a lot of steel.

Hebei steel group’s chairman Wang Yifang has announced that they plan to produce 41m tonnes of steel in 2009, up from 33m tonnes in 2008.  That’s a 24% increase compared to the 32% increase in 2008 - so at least for this one company the economic slowdown has slowed the pace of expansion rather than halting it entirely.  The strategic plan for the company also suggests they plan to have the capacity to produce 50m tonnes a year in place by 2010.

Of course, this announcement might also be part of a competitive strategy where they play chicken with other steel producers - seeing who will be first to blink at the lower prices brought on by excess capacity.  By announcing increases in production despite falling prices, Hebei Steel Group might be signalling that they can stand the pain of low prices for their output.

Shougang steel are shifting their production from Beijing to Hebei - reflecting a broader trend as heavy polluting companies move away from the capital (and also Tianjin) into neighbouring Hebei.  Shougang aim to be producing 9.7m tonnes of steel in Hebei in 2009.

Competition, Industry, Infrastructure, Regional

February witnessed a Southern Hemisphere charm offensive from China.  Hu Jintao paid a trip to Saudi Arabia, Mali, Senegal, Tanzania, and Mauritius, saying in one address that ‘every time I come to Africa I feel like I am coming home’.  Xi Jinping visited Mexico, Jamaica, Columbia, Brazil and Venezuela。  Hui Liangyu meanwhile visited Ecuador, Barbados and the Bahamas.  For those unfamiliar with Hui Liangyu you can see a picture of him here.

Africa is an important source for China’s raw materials and Beijing has had some success at doing deals with ruling elites - generally involving some form of infrastructure for minerals swap.  It is also hoped that Africa’s middle income countries, like South Africa, will increasingly be a market for China’s middle technology products.

Between 2006 and 2008 the Chinese government invested $400m in Africa, catalysing investment of $2bn from Chinese companies.  On trade, total trade of $10bn in 2000 has risen to $106.8bn in 2008 (though there are concerns that China’s competitiveness is wiping out Africa’s nascent manufacturing industry).

Latin America is also an important source for China’s raw materials - oil from Venezuela and Ecuador and soy beans and iron ore from Brazil.  It is also already an important market for China’s goods, and joint ventures in Mexico and elsewhere have allowed Chinese firms to sell into the US market through NAFTA.

There was an attempt to set out an overarching strategy for engagement with the region in a paper published by the Chinese government in late 2008 which you can read in Chinese here.

What to make of this latest series of visits?  A review of articles in Caijing and Southern Weekend sheds a little light on the situation.

On Africa, Caijing notes that Hu Jintao has been to Africa six times as President.  Many have accused China of being interested only in Africa’s mineral wealth.  On this trip, however, Hu did not visit any resource rich countries.  What is more, China is only the third largest market for Africa’s oil exports, accounting for 12.5%, behind the US (31.8%) and EU (31.5%).

Instead, an expert from the Chinese Academy of Social Sciences argues, Hu’s trip was carefully designed to indicate the China has a holistic interest in Africa.  The trip included an island, an inland country, a country China had only just established relations with, and a country with whom they had enjoyed good relations for many years.

With debt forgiveness and infrastructure investment an important part of China’s relations with Africa, the Hu Jintao trip, coming at a time when Western countries might be backing away from their development work, is also intended to indicate that China is a reliable development partner. Apparently Hu used the visit to assure African countries that China would, on their behalf, urge developed countries not to forget their obligations.

The Southern Weekend article notes that Chinese leaders are also aiming to expand investment and market opportunities for Chinese firms - lining up behind the ‘defend eight’ policy (defend 8% GDP growth).

Demand from the US and the EU has already shrunk, the author notes, but the fear is that governments in the Washington and across Europe will be unable to withstand protectionist pressures.  China needs to build consensus for free trade, and keep national markets open, to ensure demand for its products and keep its export engine ticking over.

You can see the Southern Weekend article here.  The Caijing article has mysteriously disappeared from their website.

China - Africa relations, China - Latin America relations, Energy, Infrastructure

In the course of updating the EIU’s city guide to Tianjin I came across a few interesting facts and figures, many of them related to the port and airport.

On the port, it seems like there are serious plans to increase the capacity to import raw materials - especially iron ore and crude oil.  CNOOCs plans to manufacture deep sea mining equipment in the area also underlines the role of Tianjin in meeting China’s future energy needs.

On the airplanes, assembly of the Airbus A320 appears to have catalysed the region’s aviation industry with plans to develop an indigenous helicopter.  Meanwhile the local government has bought itself a share in an airline, hoping to make Tianjin a nexus point for flying businessmen.

Tianjin port signed an agreement with China Marine Bunker (a subsidiary of PetroChina) who will invest Rmb220m in the development of fresh water and oil docks at the port.  In another port development, Cosco (Hong Kong) are investing Rmb300m in a special dock to handle iron ore, aiming for handling capacity of 23m tonnes a year.  Sinpoec, meanwhile are teaming up with the port to develop a dock for the handling of crude oil, with plans for an annual handling capacity of 20m tonnes that would make it the biggest in China.

Staying with oil, CNOOC plan to locate their core production facility in Tianjin, with total investment of Rmb22bn.  CNOOC will locate management and research functions, and the manufacture of deep sea mining equipment in the facility.

On airplanes: Tianjin is the location for the assembly of the Airbus A320, apparently plans are on schedule, and the first plans will be ready for testing in May of this year.  In other aircraft related news, Aviation Industry Corporation of China and the Tianjin government agreed a joint investment in the Binhai New area to build helicopters - with plans to start with parts in 2009 and build complete helicopters by 2011.

Finally on the aircraft front, Tianjin government joined others in making a major investment in one of China’s crisis wracked airline companies - with a Rmb500m investment in Hainan airlines.  Unlike previous beneficiaries of government generosity Southern Air and Eastern Air, Hainan Air is a private company.  The government apparently wants them to make Tianjin the nexus of all their routes - making it easier for businesses to fly to the city.

If anyone is interested in seeing Tianjin’s 2008 economic report and plans for 2009 they can see it, in Chinese, here.

Energy, Industry, Infrastructure, Regional