Financing China’s Urbanization

Weiping WuProfessor and ChairUrban and Environmental Policy & PlanningTufts University

weiping.wu@tufts.edu

Outline

China’s urbanization at a glance Context: financing urbanization Land-infrastructure-leverage in China Private participation in infrastructure Prospects for China

China’s urbanization at a glance~1980 ~2010 % change

Urbanization level (%) 19.4 51.0 162.9

Number of cities 193 657 240.4

Eastern region 69 344 398.6

Central region 84 218 159.5

Western region 40 95 137.5

Cities by population size

Super large (> 2 million) - 42

Extra large (1-2 million) 13 82 530.8

Large (0.5 -1 million) 27 110 307.4

Small & medium (< 0.5 million) 153 423 176.5

Agriculture’s share in employment (%) 64 39 -39.1

Ratio of urban-rural per capita income 2.6 3.2 23.1

Urbanization and regions

Local fiscal context

Fiscal decentralization◦ mismatch between expenditures and revenues

between levels of government ◦ fiscal gap for local governments◦ Local governments have neither adequate tax

resources nor authority to borrow externally◦ revenue-rich regions keep more (as result of

1994 tax reform)◦ sharp rise in interregional disparities in fiscal

spending

Local fiscal context

Mismatch between local revenues and expenditures (source: Lu and Sun 2013)

Infrastructure financing

Public investment (e.g. property tax as source)

Municipal bonds Bank loans Private participation (PPI) Other official sources ◦ Multilateral institutions (e.g. World Bank)◦ Development/INFRA banks (e.g. BNDES)

Quick comparisonIndustrialized

countriesOther developing

countriesChina

Borrowing from capital markets(municipal bonds)

Local taxes(e.g. property tax)

Land lease / transfer fees

Local taxes(e.g. property tax)

Grants – internal and external

Borrowing –mostly from statebanks

Grants & subsidies(e.g. DOT, FTA)

Borrowing Local taxes

User fees Others Others

Urban infrastructure financing

1990 1993 1996 2002 2005 2009 Total Sans borrowing 2009 (%)

Budgetary allocationCentral budgetary allocation 1.09 2.70 1.04 7.60 6.22 10.66 1.15 1.71 1.58Local budgetary allocation 1.98 5.95 8.63 39.27 79.59 166.04 14.68 21.96 24.67

Local taxesMaintenance and construction tax 6.51 9.8 15.78 31.60 55.13 77.19 10.17 15.21 11.47Public utility surcharge 2.26 3.3 5.56 4.99 5.55 9.80 1.02 1.53 1.46

Fees and user chargesWater resource fee 0.28 0.48 0.61 1.24 2.50 2.48 0.46 0.69 0.37Infrastructure connection fee 8.66 14.29 32.56 2.64 3.94 4.84User charges 8.94 14.55 25.89 2.68 4.01 3.85Land transfer fee 28.30 59.45 263.60 10.96 16.40 39.17

BorrowingDomestic loans 0.88 4.46 9.57 87.39 166.99 30.80Foreign capital 0.25 1.38 5.59 6.11 9.27 1.71Bonds 0.29 3.43 0.63Stock financing 0.68 0.10 0.02

Self-raised funds 2.58 4.59 11.95 60.08 94.60 27.62 17.45 26.10 4.10Other sources 5.21 25.47 26.05 30.47 30.59 57.08 5.64 8.44 8.48Total 21.04 58.13 84.78 315.62 542.25 672.94 100.00 100.00 100.00

2005 (%)

“Land-infrastructure-leverage”

Common source of financing◦ borrowing through local government financing

vehicles (LGFVs)◦ backed by future land lease revenues◦ Residential and commercial uses generates

more revenues

Driving forces◦ Exhibiting achievement in economic growth◦ Maximizing fiscal profit

Key instrument – LGFVs Treated as municipal SOEs

(Source: Ueda and Gomi 2013)

Dilemmas Urban land constitutes:◦ Principal source of LGFVs’ capital◦ Future extra-budgetary revenue◦ Collateral for LGFV borrowing

Unsustainable source of financing◦ Decline in land value (from real estate

irregularities) could reduce investment◦ End of land capitalization process (circa 2021)◦ Major source of inefficiencies, distorted

incentives, and loss of state assets

Dilemmas

Negative relationship between land supply and fiscal gap (source: Lu and Sun 2013)

Example: Beijing Capital Group

Formed thru merger of 17 state firms Scope: infrastructure, real estate, financial

services Invest in and outside of Beijing Infra projects largely thru BOTs Acquire land development rights for

residential real estate

Alternative financing for China

Municipal bonds Local property taxes Private participation (PPI) Institutional investors◦ Pension funds ◦ Insurance companies◦ Private equity◦ Sovereign wealth funds

PPI: emerging markets ($million)

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Brazil Chile China India Russia South Africa Turkey

Sectoral distribution of PPI

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Brazil Chile China India Russia SouthAfrica

Turkey

Energy Telecom Transport Water and Sewerage0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Brazil Chile China India Russia SouthAfrica

Turkey

Energy Telecom Transport Water and Sewerage

Project count

Investment

Source: PPI Database http://ppi.worldbank.org/explore/ppi_exploreCountry.aspx?countryID=50

Risk premiums for equity Regulatory risk◦ “Regulatory environment is first-order issue:

with transparent, published rules, and independent of politics”◦ “Chinese infrastructure space is ‘a black box’

due to unpredictable regulations” Currency risk◦ Higher than expected by domestic investors

Demand risk General business risk

Expected returns estimates

Source Expected returns

Mercer InvestmentConsulting (2005)

9-12%

JP Morgan Asset Management Average: 10-15%Toll roads: 2-8%PPP: 9-14%Airports: 15-18%

Inderst (2009) survey of European pension funds

9.5%

Dutch fund APG 10%

Return comparison (2010-14)

Index Daily return %(annualized geometric)

Own 14-Firm China INFRA Index(Weighted by share of market cap)

13.38

Hang Seng Index 1.58

S&P Global INFRA Index 6.79

Unlisted INFRA Returns (Preqin) 10.0

INDXX(All firms in China INFRA space)

-1.60

Assessment of China INFRA

High

• Water and waste water• Wind, solar, small hydro, and other renewable• Parking• Ports

Medium

• Toll roads• District heating• Solid waste • Airports

Low or uncertain

• Shale gas• Nonrenewable energy• Telecom• Transit and urban transport

Moving forward

Challenges◦ Current financing unsustainable◦ Mounting local government debts◦ Encroachment of agricultural land

Potential sources of financing◦ Municipal bonds (piloting in 10 localities)◦ Regional infrastructure banks

Moving forward (contd.)

Macro environment for investors◦ Capital markets◦ Sovereign and local credit ratings◦ Foreign exchange constraints

Private sector development◦ Domestic institutional investors◦ Independent service providers