Public-private partnerships (PPPs) are currently in vogue in China as a way to increase private investment in the economy and boost infrastructure spending. However, the growth of PPPs is raising concerns about local government debt, the central government’s commitment to genuine economic reform, and its ability to deliver sustainable growth.
In simple terms, PPPs involve private firms investing together with governments in projects and building and operating public facilities, with popular areas of focus including housing, road networks, rail lines, water utilities, and sewage systems.
Eager to reduce government spending, China’s government is pushing PPPs as a way to increase participation from the private sector in the economy and attract the technological expertise that established, experienced companies can bring to public services.Enjoying this article? Click here to subscribe for full access. Just $5 a month.
At the end of 2016, China had RMB 19.5 trillion ($2.8 trillion) of PPP infrastructure projects in the pipeline, according to research by Bank of America Merrill Lynch, up 62.5 percent compared with the RMB 12 trillion ($1.7 trillion) in projects registered in July 2016.
The ramp-up in the PPP pipeline is feeding an infrastructure investment boom in China, with year-to-date investment in infrastructure at the end of February growing 27.3 percent year-on-year (YOY) compared with 15 percent YOY growth in the same period in 2016. Investment in water utilities grew 35.8 percent YOY and road network investment was up 21.6 percent YOY.
But while PPP projects are expanding, it is state-owned companies, rather than private firms, that are driving the expansion.
Of the RMB 2.35 trillion yuan ($342 billion) worth of PPP projects tracked by Bank of America Merrill Lynch in China during 2016, 74 percent went to state-owned enterprises.
At the same time as state-owned companies are getting involved in PPPs, foreign corporate investment is slowing, with the most recent data on fixed asset investment in China for January and February 2017 showed that foreign-sourced investment declined 9.7 percent YOY.
Private firms don’t have much confidence in operating with local governments on PPPs, according to surveys by China Confidential. More than half of the firms surveyed said that they were concerned about local governments not honoring agreements and were worried about a lack of enforcement of investors’ rights.
As well as concerns about working with local governments, HSBC researchers believe that few private companies are committing to PPPs because the projects don’t look profitable enough. HSBC estimates that average returns on capital of 6 percent to 8 percent for PPPs aren’t attractive when equity investments offer returns of around 10 percent.
By contrast, state-owned companies are less worried about low returns. That’s because state-sponsored firms can borrow at rates as low as 2 percent to 3 percent from government-controlled PPP funds run by central and local authorities and policy banks such as China Development Bank and the Ex-Im Bank.
This dominance of state-led, rather than private investment, will do little to convince outside observers that the Chinese government’s rhetoric of increasing the role of the private sector – one of the main goals of China’s reform drive – is actually happening. At the same time, the increase in PPPs also links to a major area of concern for the economy, namely the increasing build-up of debt at the local level.
Local governments, particularly those in poorer regions, such as Guizhou and Yunnan, are rapidly building a pipeline of PPP projects, and while there may be economic benefits, Bloomberg notes that local governments are swiftly racking up contractual obligations to pay for the projects or fill the cash-flow gap for user-pay ventures. This may put unmanageable burdens on local-level finances, which the IMF estimated at RMB 28.2 trillion ($4.2 trillion), or 41 percent of GDP, at the end of 2015.
As debt burdens rise, governments at the local and central level may have less room to spur economic growth, particularly at a time when the authorities are dampening growth in the real estate sector, which is a major contributor to China’s economy.
That said, the Chinese government appears to be aware of the problem. Shi Yaobin, China’s vice minister of finance, recently remarked upon the misuse of PPP funding and acknowledged that they may increase local governments’ debt risk. China’s National Development and Reform Council, China’s second largest policymaking body behind the State Council, has put new regulations to govern PPP projects into its 2017 work plan, opening the possibility of new modes of governance that may reassure investors.
But new regulations will take time to not only be approved but implemented across China. As such, with PPP investment picking up – UBS Economist Wang Tao forecasts RMB 4 trillion ($580 billion) being enacted in 2017 – the economy may get a boost, but at the expense of raising local level debt piles even further and raising concerns about the government’s ability to deliver sustainable, long-term growth.