The biggest lesson that US and European households and economies learned from the financial crisis of 2008 is the importance of making ends meet. China has a good record in this regard. Chinese consumers are known for saving money for their old age, healthcare and children’s education. It boasts the world’s highest saving rate. The outstanding local government debt stood at US$2.56 trillion at the end of 2017, well below the cap of US$2.92 trillion for the year, according to China’s Ministry of Finance.
Even if it adds to the US$2.2 trillion limit of central government debt, which is not likely to be touched or exceeded, government debt would total just 37 percent of the country’s GDP in 2017, much lower than the international red line which is 60 percent of an economy’s GDP. However, an important reason why local government debt lingered on the list of risks in China’s growth in recent years is the creative accounting that masked the build-up of local government debt. The latest example is the public-private partnership (PPP).
First adopted in the UK, PPPs have been used widely in other countries since the 1990s. They take the form of a long-term agreement between the government and private investors to deliver public services, and they involve the sharing of risks in funding, building and operating a public project. Private sector participation is expected to improve efficiency and reduce the costs of delivering public services. It is also an opportunity for private investors seeking stable returns, though they are often low and take a long time to realize.
China began to promote the model as a national policy at the end of 2014. At a forum in financial center Shanghai on November 1, 2017, Shi Yaobin, China’s Vice Finance Minister, declared that China had already become the world’s “biggest and most influential PPP market.” By the end of October 2017, 6,806 projects with a total investment of more than US$1.58 trillion had been launched.
China is also eyeing the international PPP market. On the sidelines of the forum, the China PPP Center under the Ministry of Finance signed an agreement with the United Nations Economic and Social Commission for Asia and the Pacific to help regional countries develop PPP projects, particularly in water, energy and transportation.
Chinese companies are working on PPP projects in countries along the route of China’s Belt and Road Initiative, such as Sri Lanka, Cambodia and Colombia, ranging from port development to power and rail projects. Chinese and US analysts, officials and companies are showing growing interest in making US infrastructure projects a new area of cooperation to buffer the negative impact of competition between the world’s top two economies.
However, through manipulation and sleight of hand, PPPs have been distorted into a borrowing platform for local governments. Private investment has been crowded out. To correct these distortions, the rules on PPP have been tightened since the November forum, with Chinese and international analysts regarding the move as a signal of a slowdown and restructuring of the PPP market in China.
Investment outside the public budget in China’s PPP projects is defined as “societal capital.” Most so far is not private. According to the National Development and Reform Commission (NDRC), private investment accounted for only 24 percent of the total investment in PPP projects in which the identity of the winning bidders had been disclosed between 2014 and the end of 2017. State-owned enterprises (SOEs) have dominated the market until now.
“The central government expected to promote a win-win PPP model to solve the local government debt problem, but in practice more than half of the partners in the PPP contracts are central SOEs,” said Zhang Guohua, director of the Comprehensive Transportation Research Institute at the China Academy of Urban Planning and Design. He added that this means local government debts were transferred to central SOEs, which would potentially be covered by the central government.
The dominance of central SOEs is also part of the conflict of interests among players. Wang Shouqing, chief expert at the Center for Public-Private Partnership at Beijing’s Tsinghua University, noted that while the central government is focused on local government debt reduction through PPPs, local officials care much more about building their own careers on the back of an improved local growth record. Large projects can boost local GDP growth quickly. In the meantime, local SOEs complain their piece of the pie has been sliced off by stronger central SOEs. Private enterprises are better at operating public projects which generate profits, such as toll roads. They are not happy about losing new business opportunities to central SOEs.
In addition, local governments promised to buy back the equity of their “societal capital” partners in their PPP projects, be it SOEs, private enterprises or financial institutions. In this way, the partners get their investment returns from the government, not from the project. The buyback contract has turned a joint stock partnership into a deal between the government as the debtor and “societal” partners as the creditor. The practice has simply increased local government debts, but they are hidden away.
Since early 2016, the increase in private fixed asset investment has stayed slower than the total investment increase. The launch of PPPs was also part of the central government’s efforts to boost private investment, which accounts for some two-thirds of the country’s total investment. The low participation of private investment in PPPs so far shows this target has been largely missed.
The barriers that hindered private investment have been identified by the government and the market. Private investors are concerned that newer local officials will refuse to implement contracts signed by their predecessors. Local officials regard PPP projects as something approved by the government to private companies, rather than a partnership on an equal footing. Meanwhile, local officials do not want to face questions about why they put State assets in the hands of private investors in the first place if anything goes wrong. On the side of private business, most are small- and medium-sized enterprises, which are not powerful enough to finance and operate large public projects which need huge investment and high levels of expertise. Public projects typically provide low returns which take a long time to realize, meaning they are not attractive enough for private investors, who also balk at signing contracts deliberately designed to have private enterprises take on disproportionate risks.
In mid-November 2017, a sweeping check-up on PPP projects was launched, along with a raft of new rules designed to crack down on tricks that may bring more local government debt. The government is also looking to boost the private investment component.
The Ministry of Finance clarified which types of existing contracts have to be terminated, and which new contracts will be prohibited. They include projects which have not passed the value-for-money assessment, a tool justifying the PPP-based supply of public services, or the stress test for local budgets. Contracts in which local governments offer guarantees for bank loans or commitments on fixed returns to “social capital holders” are forbidden. “Ineligible projects” like these are required to be eliminated by the end of March 2018. “Discriminatory conditions hampering equal participation of social capital” must also be removed.
Central SOEs are reined in from further sprees in the PPP market. They cannot bid for PPP projects which would increase their debt-to-assets ratio. Heavily indebted central SOEs will be barred from the PPP market. These rules, along with others on risk controls of PPP projects, were announced by the Assets Supervision and Administration Commission of the State Council a week after the Finance Ministry’s move.
The next action was taken by the NDRC, focusing on how to encourage more private investment in PPPs. It came up with measures to facilitate financing and operating of PPP projects. Private enterprises are compensated for their losses in PPP projects if the local government does not honor its legal commitments. This guarantee must be written in PPP contracts, according to the new NDRC policy.
During this period, China’s financial regulators and associations announced a tightening of the rules on asset management products sold by banks, trusts, securities and insurance companies to retail and institutional investors who are seeking higher returns than from regular savings accounts. The rules do not particularly target PPP financing. However, these products have long been used by PPP stakeholders to fund their stakes in the projects via complicated financial wizardry. Analysts believe the rules blocking the methods by which debts are disguised will have a big impact on PPP projects.
International ratings agency Fitch Ratings predicted the new rules would cool down PPP activity and infrastructure growth, but lead to “a shift toward private-sector investment in PPPs” in 2018, according to its report on January 15. This view is widely shared by Chinese and international analysts.
There are other barriers yet to be removed. Wang Shouqing found that many local officials had little idea about how to operate PPP projects. They are not ready to go through the standard process, which they complain is complicated. Gao Jianjun, former secretary of the Party municipal committee in Ruzhou City, Henan Province in Central China, told NewsChina that they normally rely on consultancies to help them with the process. However, intermediary service providers themselves have not developed enough expertise, experience or discipline. The result is that local governments did not realize their consultants were not as expert as they claimed to be until their applications were refused by others at higher levels, Wang said.
PPPs are increasingly attractive in other markets around the world. Finance ministers of Asia-Pacific Economic Cooperation members agreed at a meeting in October 2014 to promote the PPP model in the region for infrastructure investment. “The world’s capitals, as well as the international organizations and fora that give voice to global public goods, trends and needs, have raised to a deafening crescendo on the need for more investment in infrastructure,” wrote Jordan Schwartz, World Bank Director for Infrastructure, PPPs and Guarantees, in his blog for the World Bank on December 19, 2017.
China hopes to play a big role. Chinese leaders have called for PPP-based cooperation at multilateral meetings. Chinese analysts have proposed to use PPP in Chinese initiatives, mainly the Asian Infrastructure Investment Bank (AIIB) and the Belt and Road Initiative.
“The PPP model will become a major way of international cooperation for Belt and Road countries in providing public products and services, including infrastructure,” said the China PPP Center in its foreword to its Belt and Road case studies database. So far, it has included 10 case studies of Chinese investment in developing countries around the world. Chinese companies, particularly central SOEs with rich experience in infrastructure both at home and abroad, have already made strides in overseas markets. According to World Bank data on private investment in infrastructure, the largest project in the Latin-American and Caribbean region by value is the Belo Monte Transmissora de Energia in Brazil, an ultra-high-voltage transmission line sponsored by the State Grid Corporation of China. There is also great potential for Chinese companies’ participation in US infrastructure renovation plans on a PPP basis, although there has been little movement so far.
While Chinese companies are well-equipped with capital and experience, there are political challenges in overseas markets. At the roundtable on PPP viability along the Belt and Road at the Shanghai Forum, Cheng Zhangbin, a senior economist with the AIIB, warned that in the PPP model, political problems may arise if the public knows that a company is taking profits from a public service or the government supports a loss-making company in a public service. He also suggested that smaller countries start with small PPP projects to build up capacity gradually. Fu Junyuan, executive director and chief finance officer of China Communications Construction Company Ltd., stressed that decisions on where and whether where a PPP project is a good choice must be based on consideration of the long lifecycle and low returns for infrastructure operations, as well as fragile business and political conditions in host countries. He added that partners from other countries should be invited to participate in overseas projects.
Chinese companies and analysts still firmly believe that the time is ripe to promote PPPs at home and abroad. The key is to get it right.
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