Rail & Infrastructure

Peter pays Paul

Are public-private partnerships the way to drive the Chinese economy?

sany-w

Getting a lift: excavator sales are on the rise again

Spring is in the air, but countries herald its arrival in very different ways. The British are still listening out for the first sound of the cuckoo, while the Americans have already celebrated Groundhog Day (though this year Punxsutawney Phil decided the US would continue to endure a long winter).

The Chinese, meanwhile, take heed from wild ducks. As the Song Dynasty poet Su Shi put it, “When the river becomes warm in spring, the ducks are the first to know.” (This thousand year-old verse has even been used in the financial world to describe insiders who have access to market-moving information.)

In purer economic terms, CBN also says spring has arrived. And the green shoots are to be found on a steel creature rather than a bird: a mechanical excavator. Rising sales of these normally presage the first stages of a new economic cycle, with crane sales and finally concrete machinery peaking later on.

And excavator sales have been rocketing. After a five-year downturn, they began to climb in the middle of last year. The last four months of 2016 saw year-on-year rises of more than 70% each month. This tailed off slightly in January, but that month has always been a slow one. Sales picked up strongly again in February.

According to Caixin Weekly, Sany Heavy Industry, a leading excavator maker, sold 3,600 excavators in February, or three times as many as it did in February 2016. Its state-backed rival XCMG also sold 1,405, or six times as many as 2016.

Sany Heavy’s deputy manager Yang Shaoyong tells CBN that supply is getting very tight and “some customers from Jiangsu [one of China’s largest provinces in GDP terms] are even coming to the workshops themselves to urge delivery”.

March is normally the peak month for sales and expectations are for an even stronger month than February proved to be. Many financial analysts now have buy recommendations on companies in the machinery and construction sectors, even though both have outperformed benchmark indices since the middle of last year.

Over the past 12 months, for example, the Hang Seng China Enterprises Index has risen almost 25%. But wheel loader manufacturer Longking has risen 90% over the same period and Sany Heavy is up 33%.

“The whole mood of the industry has got a lot stronger,” David Phillips of Off-Highway Research told the Financial Times, referring to sales of construction machinery. “Business confidence is back. Things aren’t back to where they were before 2011, but there is a much more optimistic note.”

Analysts say rising sales are not so much the result of a new housing boom, but the government’s public private partnership (PPP) initiative, which began in earnest at the beginning of 2015. This is being driven by the government’s desire to maintain economic growth. By enticing private firms to co-invest in public projects (such as roads or hospitals), the business model also helps transfer risk away from debt-laden local governments to the private sector.

After two years, the investment push appears to have achieved far more success with the former objective than the latter. At the end of 2016, PPP projects amounted to Rmb19.5 trillion ($2.82 trillion), equivalent to one third of fixed asset investment, or 27% of GDP.

In a report published last Friday, rating agency Moody’s concludes that China has done a good job getting projects to the implementation stage, with the ratio rising from 5% in January 2016 to 17% by the end of the year.

Ministry of Finance (MoF) data also shows that some of the poorest provinces have benefited the most. The biggest projects by investment amount, or Rmb1.6 trillion, are in Guizhou, the third poorest province by GDP per capita. Yunnan, the second poorest province, ranks third on Rmb1.03 trillion.

Moody’s says most of the projects (57%) are in transport and municipal engineering, which covers sewage and water treatment projects. Liu Junpeng, southern Jiangsu sales director for XCMG, backs this up. He tells Economic Observer that 50% of his sales are for the kind of small excavators typically used for municipal engineering and rural infrastructure projects.

But the majority of these projects are missing one of the ‘P’s’. Moody’s estimates that genuine private sector investment amounts to less than 30%.

This is partly because China defines PPP as social capital, which embraces state-owned companies as well as private capital. But as rating agency Fitch has also noted, this means the state is not really transferring debt to the private sector, when projects involve SOEs, even if they are listed (it remains the equivalent of moving money ‘from Peter to Paul’, though the fiscal cosmetics improve in the near term).

Why is the private sector so reluctant to participate? Xu Junjian, a senior member of the China People’s Political Consultative Conference, tells newspaper CBN that private sector companies are put off by an unappealing mix of low returns, a lack of exit mechanisms and overbearing local governments, which want to retain control of the projects even though they typically own about 30% of the equity.

From a risk perspective, local governments and their private sector partners share the burden of interest rate risk, exacerbated by the fact that most PPP projects are structured around floating rate loans. The two partners also share market risk, or the possibility that the underlying assumptions governing a project’s usage (traffic flows, population density etc) are wrong.

Finally, analysts point out that private sector companies are at risk of not being paid back by often cash-strapped local governments. However, the central government is moving to address these concerns. Where repayment risk is concerned, it issued new guidelines last September requiring local governments to include their financial commitments to PPP projects in their medium-term financing budgets.

To further increase transparency, the MoF set up a national PPP infrastructure information platform late last year and the National Development and Reform Commission (NDRC) followed suit in February this year. The MoF handles PPP projects covering social housing, education and the elderly while the NDRC is responsible for transportation, energy, the environment and municipal engineering.

Central government is also restricting local governments from utilising more than 10% of their annual budgets on PPP projects. This has to include any demolition work attached to the project and construction subsidies, as well as the initial equity investment. Analysts note that this means provinces like Guizhou and Yunnan are likely to hit their limits pretty soon.

More importantly, the government is also trying to broaden funding options for the private sector so returns can be enhanced through a lower cost of funding. CICC estimates returns to be about 5% to 6% in the regions surrounding Shanghai and 6% to 7% in western cities such as Chengdu and Chongqing. However, there are big differences by sector, with power projects now generating returns of 10% to 11% compared to 8% to 9% a few years ago, while transport-related returns have dropped from 21% to the mid single digits.

CICC also thinks that infrastructure projects will amount to about 60% of all new bank lending in 2016: a fact, which makes the banks extremely happy because they earn higher rates on PPP loans than many other forms of lending.

Other new financing channels are likely to come from the insurance and wealth management sectors including a Rmb300 billion insurance-backed PPP fund.

Finally, the government is trying to provide exit mechanisms so private sector investors are not locked into projects averaging 15 to 30 years. For example, in December, the NDRC and CSRC issued guidance allowing PPP projects to issue asset-backed securities. In February, provinces were asked to recommend one to three projects for asset-backed financing and the first deal has already happened: an Rmb840 million transaction in the sewage and water sector.

Meanwhile CICC says the government ought to stop prioritising projects just because they are shovel-ready, and focus more on their long-term quality. Other analysts say the government could boost private sector involvement and reduce the need for subsidies if it let private investors share land sale and development gains with local governments.

Moody’s is still optimistic. “Continuous government efforts to improve the PPP framework will encourage more private sector involvement,” it concludes.


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