Analysis – As it curbs wasteful investment, China worries about growth, by Reuters

By Ellen Zhang and Marius Zaharia

BEIJING/HONG KONG (Reuters) – China’s local governments have fallen behind on their plans to issue debt as scrutiny intensifies on potentially wasteful infrastructure investment, fueling talk that such funds could be used in other areas to drive growth back towards the target.

Municipal investment has for years been one of the most effective tools for stabilizing growth in the world’s second-largest economy, whose poor performance in recent months calls for a new injection of government stimulus.

But not all of that investment has been productive, as evidenced by the fact that debt has grown faster than growth over the past decade. Large sums have been spent on railways, roads and bridges which attract little traffic and are expensive to maintain.

To control wasteful spending, authorities have tightened controls on investment projects, particularly in China’s 12 most indebted provinces.

As a result, in the first seven months of this year, local governments issued only 45.5% of their share of 3.9 trillion yuan ($546 billion) in special debt, compared with 65.7% in the same period last year. 2023 and 95% in 2022.

The weaker-than-expected fiscal stimulus risks pulling economic growth from its target of around 5 percent this year, which is threatened by sluggish household consumption and a severe downturn in the housing sector.

“It’s been difficult to find projects that are profitable in the short term,” said Jack Yuan, senior analyst at Moody’s (NYSE: ) Ratings. “Many provinces will struggle to meet their growth targets in the absence of greater state-led investment.”

Chinese officials said in March that local special bonds would finance projects with “sufficient preparation” in regions with high investment efficiency.

Yuan and other analysts expect debt issuance to pick up in the coming months as authorities prioritize hitting the growth target as promised at key policy meetings in July.

But that may require Beijing to green-light new ways for cities and provinces to spend the funds, which are typically used for transportation, water, energy, urban development and other infrastructure.

Analysts say new areas could include buying empty apartments for social housing or buying back undeveloped residential land. Such moves would inject cash into the crisis-hit housing sector, giving developers a lifeline to resume or speed up construction on delayed residential projects and improving homebuyer confidence.

“The government needs to expand the scope of these bonds,” said Larry Hu, chief China economist at Macquarie, who sees real estate as a potential new destination for such funds.

“We will see emissions pick up, fiscal support for the economy will increase and then we may still be able to hit the growth target.”

China’s Economic Observer newspaper reported in June that the Ministry of Natural Resources proposed that local governments use special bonds to buy back unused land.

Alternatively, municipal bonds could be used to swap higher-yielding debt issued by local government financing vehicles to ease their funding pressure and reduce spillovers to the real economy as debt is reduced, Moody’s Yuan said.

WASTE

Infrastructure investment rose 4.9 percent year-on-year in January-July, slower than the 6.8 percent rise in the same period of 2023.

A government source in Lanzhou, the capital of indebted Gansu province, said local authorities were spending less on urban development.

While special bonds can be spent on expanding green space, in many cases that has meant replanting perfectly good park turf or roadside flowers and vegetation rather than creating new green space, the source said.

This generates temporary jobs. But it does not improve living standards in the long run, nor does it provide any profit while forcing the government to repay the debt. Such expenses have not occurred this year, the source said.

“It was a waste,” the source said, asking not to be named because they were not authorized to speak to the media. “The principle was to spend the money or it would be taken.”

A Beijing municipal government source said that “in the past, it was easier to apply for funds. When someone applies for projects, ask for as much as possible.”

Now “we have to figure out why the project needs to be done. They say that every project is a cost.”

A political adviser, who also requested anonymity because of the sensitivity of the subject, said relying on government investment to fuel growth has led to debt and corruption. Local officials must find projects that produce enough revenue to repay the interest on the debt, the councilor said.

“But such projects do not exist every year,” the adviser said, explaining the slow issuance of debt. “It is better to give the money to low-income groups to stimulate consumption.”

(Graphic by Kripa Jayaram; Editing by Shri Navaratnam)