China Worries About Growth as It Limits Wasteful Investment – Analysis by Reuters

By Ellen Zhang and Marius Zaharia

BEIJING/HONG KONG – China’s local governments are struggling to meet their debt issuance targets amid mounting scrutiny over potentially inefficient infrastructure investments. This has sparked discussions about reallocating these funds to stimulate economic growth, aiming to meet set targets.

For years, municipal investment has been a key strategy for stabilizing growth in the world’s second-largest economy. However, recent economic performance has underlined the need for additional government stimulus.

Not all municipal investments have proven fruitful; debt has been increasing at a pace that outstrips economic growth. Large expenditures on railways, roads, and bridges have often resulted in infrastructure that attracts minimal usage and incurs high maintenance costs.

In response to concerns about wasteful expenses, authorities have increased oversight on investment projects, particularly in the 12 provinces with the highest debt levels. As a result, local governments have only utilized 45.5% of their 3.9 trillion yuan special debt quota during the first seven months of the year, a noticeable drop from 65.7% during the same period in 2023 and 95% in 2022.

This unexpectedly low level of fiscal activity poses a risk to achieving the year’s target growth rate of around 5%, particularly given the challenges posed by weak consumer spending and a troubled property market.

“It has been challenging to identify projects that will yield profits in the short term,” said Jack Yuan, a senior analyst at a financial ratings agency. “Many provinces may struggle to meet their growth targets without increased state-led investments.”

In March, Chinese officials indicated that local special bonds would be earmarked for well-prepared projects in regions noted for high investment efficiency. Analysts like Yuan predict that debt issuance is likely to accelerate in the upcoming months as authorities focus on meeting growth objectives set during key political meetings in July.

However, this might necessitate new approvals from Beijing regarding the use of these funds, which are conventionally allocated for infrastructure projects such as transportation, water management, energy, and urban development. Potential new areas for funding could include purchasing vacant apartments for social housing or reacquiring undeveloped residential land. These initiatives could inject much-needed capital into the struggling property sector, enabling developers to resume or expedite stalled residential projects while boosting homebuyer confidence.

“The government must broaden the scope of these bonds,” explained Larry Hu, a chief economist, who views real estate as a viable option for such funding. “We should expect to see an increase in issuance, which would enhance fiscal support for the economy and help us meet the growth target.”

Reports revealed that the Ministry of Natural Resources has suggested that local governments consider using special bonds to buy back idle land. Additionally, municipalities might utilize these bonds to refinance higher-yielding debts issued by local government financing vehicles, alleviating funding pressures and minimizing negative repercussions on the broader economy as they work to reduce debt.

On the investment front, infrastructure spending grew by just 4.9% year-on-year from January to July, a decline from the 6.8% growth recorded during the same stretch in 2023.

A government source from Lanzhou, the capital of the heavily indebted Gansu province, noted that local authorities are scaling back expenditures on urban landscaping. While special bonds could traditionally be used to enhance green spaces, many projects merely involved replanting existing areas rather than creating new parks, generating only temporary jobs without long-term benefits.

“That was a waste,” the source remarked, speaking anonymously due to the sensitivity of the matter. “The previous approach was to spend the funds or risk having them taken away.”

A source within the Beijing municipal government observed that securing funding has become increasingly challenging. Previously, project applications sought maximum amounts; now there’s a pressing need to justify the necessity of each project, with a focus on cost considerations.

One policy advisor, who requested anonymity as well, indicated that heavy reliance on governmental investment has led to significant debt and corruption. They emphasized the need for local officials to identify income-generating projects that can cover debt interest.

“However, such projects are not always available,” the advisor concluded, underscoring the reasons behind the slow issuance of debt. “It may be more beneficial to provide financial support to low-income households to enhance consumption.”