Local Infrastructure Investment in China Requires Clear Policy Understanding
Since this year began, various macro policies in China have actively deployed investment initiatives. These macro policies hope to “stabilize growth” through bolstering infrastructure investment. Economic data released in April showed that the growth rates of domestic consumption, investment, imports, and exports declined significantly due to COVID-19, with consumption data showing a sharp decline.
Despite the similar drop in investment growth, there is still some growth maintained, contributing to the economy’s overall support. Many believe that infrastructure investment promotion is becoming the main component of incremental policies. Some localities also hope to use infrastructure investment as the starting point for local economic development.
They are looking forward to going full force; at a time when the central government is stepping up the promotion of infrastructure projects and expanding financial support for infrastructure investment. Some market institutions even predict a 10% increase in infrastructure investment this year. Meanwhile, a fresh round of large-scale infrastructure investment is turning into a policy and a market outlet.
Promoting a certain scale of infrastructure investment has always been a major tool of China’s fiscal policy in recent years. However, the form and content of this key tool for an active fiscal policy have changed dramatically.
Notably, there have been two changes taking place. One is the content of infrastructure investment has been adjusted, and the other is how infrastructure investment is carried out, particularly under strict control of local hidden debt.
As a result, ANBOUND researchers believe that under the policy requirements of “improving quality and increasing efficiency,” new infrastructure investment in China plays a more important role in adjusting and optimizing the economic structure.
For the new round of infrastructure investment policies, local governments will need to avoid forming a “policy illusion”, and establish rational expectations for the trend.
Infrastructure investment projects have recently been accelerating, with the growth rate increasing significantly compared to last year. However, traditional infrastructure investment’s effect on economic growth is below expectation. With this, its marginal revenue is gradually decreasing. On the other hand, some new infrastructure investments in new energy and digital economy have not yet produced market benefits. They are still in the stage of investing and market cultivation.
Thus, there is still a need to increase investment in science and technology as well as human capital. In addition, the COVIDS-19 pandemic has also affected the progress of existing infrastructure projects tremendously. As a result, the impact is slowing down the progress of overall projects.
Although infrastructure investment is currently regarded as one of the policies to address the pandemic’s impact, one cannot overlook how the pandemic itself affects infrastructure-related investment. Despite that infrastructure investment supported the economy during the pandemic, investment in infrastructure, real estate, and manufacturing has slowed down month on month, showing the COVID-19 outbreaks’ massive impact on infrastructure-related investment.
From January to April of 2022, fixed asset investment increased by 6.8% year-on-year, down 2.5 percentage points from January to March. Infrastructure investment (excluding electricity, heat, gas, and water production and supply) increased by 6.5% year-on-year from January to April. In the same period, real estate development investment decreased by 2.7%, down 3.4 percentage points from January to March. Meanwhile, manufacturing investment increased by 12.20% year-on-year, down 3.4 percentage points from January to March. Infrastructure investment slowed down significantly in April, from 8.8% in March to 2.95% in April.
In the absence of effective control of the COVID-19 outbreaks or the recurrence of the outbreaks, it is difficult for infrastructure investment to provide substantial support to the economy. At the same time, it is also affected by the mutual influence of manufacturing and real estate investment. Under diminishing business demand and chronically sluggish real estate market conditions, the efficiency of infrastructure investment is not exactly promising.
Judging from the source of funds, the new round of infrastructure investment is still mainly dependent on fiscal expenditure and revenue. It is especially prevalent in the first four months of expenditure this year, where the fiscal revenue growth rate has significantly decreased due to the pandemic. The situation has created a wide gap in the sources of supporting funds for local infrastructure support. It also limits its ability to expand further the scale of infrastructure investment.
Although the scale of local special bonds issued this year remains quite large, the early issuance of local special bonds has basically been completed. To speed up the progress of infrastructure investment, the Ministry of Finance requires that the new special bonds issuance be completed in the first half of this year.
However, after this event, the source of funds for infrastructure investment will face a window period. This is a period in which it will be determined whether the funds’ long-term sustainability still requires ongoing financial support. Both central and local governments will face significant hurdles to closing the funding gap if the economic downturn continues alongside the pressure of increasing fiscal revenue and expenditure.
The income of local government funds has fallen sharply at present, particularly during the real estate market downturn. Meanwhile, the income from local land transfers has also dropped dramatically, making it difficult for local financial resources to absorb the additional investment expenditure.
Local investment has become “willing but helpless” under the “red line” that strictly prohibits the increase of hidden debt. Although the government leads infrastructure investment, Li Xunlei of Zhongtai Securities recently stated that, over time, funds other than financial funds have accounted for a larger proportion (more than 70%). Such funds are mainly related to the investment and financing activities of platforms or project companies.
There has been a noticeable increase in the willingness and intensity of stable growth in infrastructure this year. This is based on the deployment of work in critical regions. However, the tone and red line of “tight control of hidden debts” have not changed at present.
Local government can only do their best and act according to their capabilities within the existing institutional constraints and financial resources. Li Xunlei mentioned that although infrastructure investment is a policy “grasp”, its role should not be overestimated.
In light of the various scenarios and trends in infrastructure investment, local governments still need to continue considering their profitability and sustainability. This evaluation also has to include “increasing quality and efficiency” and “urban rejuvenation”. In this case, to encourage industrial development and agglomeration, investment in the development of industrial parks will continue to be the driving force behind the current wave of infrastructure investment.
It is more necessary to consider the city’s carrying capacity for the new population, promote the city’s orderly renewal, and improve the city’s business and consumption environment. These considerations are made possible with the construction of housing for living, the transformation of shantytowns, and other real estate-related investment construction.
In terms of “new infrastructure,” it is necessary to adopt more market-oriented approaches under the current financial capacity. These approaches are vital to enhance and optimize investment returns and avoid the formation of new debt burdens.
Final analysis conclusion:
Local governments in China need to avoid the traditional linear mindset in the new round of infrastructure investment. Other than understanding the reality of local development and financial affordability, they also need to pay attention to the policy red line and changing situation, and treat it rationally from the perspective of systemic development.
Writer by Wei Hongxu
A researcher at ANBOUND, graduated from the School of Mathematics at Peking University and has a PhD in economics from the University of Birmingham, UK
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