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CHENGDU/WUHAN (China): When China announced a four trillion yuan (RM1.97 trillion) package to ward off the 2008 global financial crisis, city planners across the country happily embarked on a frenzy of infrastructure projects, some of them of arguable need.
Chengdu, the capital of southwestern Sichuan province, answered the call for stimulus action with a bold plan for a railway hub modeled after Waterloo railway station in London.
Except London's Waterloo was not ambitious enough.
"I was shocked when I finally got to visit Waterloo. It was so small," said Chen Jun, a director at Chengdu Communications Investment Group, which built the new Chinese terminal. "I realised we would probably need a station a few times bigger to meet the demands of our city."
In a manner typical of many infrastructure projects in China, Chengdu more than doubled the size of its planned transport hub, borrowed three billion yuan from a state bank to finance it, then set out on a blistering construction timeline that saw the finishing touches put on the project two years later.
But instead of getting the accolades they expected for helping to stimulate the economy, Chengdu Communications and many of China's 10,000 local government financing vehicles (LGFV) have now come under a harsh spotlight for the grim side-effects of the construction binge.
China's local governments have piled up a mountain of bad debt, some of it to finance bridges to nowhere and other white elephant projects, which now threatens to constrict growth at a time when the global economy is sputtering. It is adding to other systemic risks in China, including a sharp downturn in the property market and a rapid rise in problematic loans.
Local governments had amassed 10.7 trillion yuan in debt at the end of 2010. The government expects 2.5 to three trillion yuan of that will turn sour, while Standard and Chartered reckons as much as eight trillion to nine trillion yuan will not be repaid — or about US$1.2 trillion to US$1.4 trillion (RM3.77 trillion to RM4.4 trillion).
In other words, the potential debt defaults could be even larger than the US$700 billion US bail-out programme during the 2008 crisis.
Reuters reported in mid-year the government was working on a relief plan for local governments, including allowing them to tap the municipal bond market for the first time as an alternative to bank loans, which are becoming harder to get.
The risks of default are rising. Nearly 85% of the local government finance vehicle loans in northeast Liaoning province, for instance, missed debt service payments in 2010, an audit report posted on the Liaoning Daily website said.
But in visits and interviews at city-run vehicles around China, officials appeared unworried. They say they were only following Beijing's directives to keep growth on track, and the central government would surely step in to bail them out.
Perhaps their complacency is justified. Beijing, which holds more than US$3 trillion in foreign exchange reserves, certainly has the resources to rescue them, and has done so in the past — it set up asset management companies to help China's top banks clean up mountains of bad loans in the late 1990s.
But China is also vulnerable to a global downturn, and would need every piece of its economy performing well to avoid a serious slump. The infrastructure boom insulated the economy from a collapse in exports in 2008. Beijing has less firepower now. Inflation is uncomfortably high, and dumping more money into the economy would only make things worse.
Barclays Capital has predicted a global recession would trigger a "hard landing" in China, with gross domestic product sinking well below the 8% mark seen as the minimum for assuring enough job creation to keep up with urban migration.
A severe economic slump would depress land sales, a vital source of funding for local governments, and make their debt load even more precarious.
In Chengdu, Chen leans back on a sofa in his office, smiles and readily concedes Chengdu will have big problems covering the bills for its version of the Waterloo train station.
"We're still unable to reflect on our accounts the problems that may arise from our investments into Chengdu's railroads," Chen said. "What happens next is that we may face some trouble repaying our loans when many of them come due."
Chengdu Communications had liabilities of 18.9 billion yuan at the end of 2010 against current assets valued at 11.7 billion yuan.
Chen is not unduly concerned. He thinks he has a solution, one local governments across China have also grasped: Real estate. Chen, the chairman of six other state companies in the city, intends to build huge residential and commercial projects around stations such as Waterloo — with borrowed money, of course.
The problem with that idea is that Beijing has been taking increasingly urgent steps to halt a speculative property boom and has told state banks to cut lending. Domestic investment — much of it in property and infrastructure development — accounted for 70% of China's gross domestic product last year, a far bigger share than in developed economies.
According to the McKinsey Global Institute, the proportion of China's total debt to gross domestic product was 159% at the end of 2008, before it began the massive stimulus programme that has racked up piles of local government debt.
Local governments have long had to tap other sources of income to supplement their meagre share of the country's taxes. Beijing controls the bulk of tax revenues to prevent local officials from spending wastefully, and as a way of redistributing wealth between poor and rich provinces.
So they raise money by selling or taxing property or borrowing money. They are barred from borrowing directly from banks as government entities, however, hence the proliferation of their financing vehicles.
Local officials have a strong interest in keeping property prices high, since it is a key source of revenue. China Real Estate Information Corp, a Shanghai-based property information and consulting firm, estimates 40% of local government revenue came from land sales last year. Land also is often used as collateral backing the loans to their financing vehicles.
So throughout China, a building boom financed with massive bank borrowing is being securitised by land prices that local governments fervently hope will stay high, even as Beijing tries to tamp them down.
"The underlying problem here is that local governments have a lot of expenditure mandates for infrastructure, for social services, and they don't have enough regular revenue to cover it," says economist Arthur Kroeber.
Wuhan, capital of central Hubei province, is known as one of China's "four ovens", cities where summertime temperatures can soar to 40°C. Its strategic location at the intersection of the Yangtze and Han rivers has made it a major transportation hub and in the past three years the city has been feverishly building bridges, railways and expressways.
Wuhan Urban Construction Investment and Development Co, the vehicle set up to finance much of this infrastructure, had taken out 68.5 billion yuan in bank loans as of September 2010, a sum far in excess of its operating cash flow of 148 million yuan.
Perhaps for that reason, city officials found a novel if unpopular way to pay for the three new bridges they have built across the Yangtze, adding to the seven already spanning the world's third-longest river after the Amazon and Nile.
Besides the usual bridge tolls, Wuhan requires residents with cars to cross them at least 18 days a month, at 16 yuan a round trip. — Reuters
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