How does China pay for her infrastructure? – Funding the world’s most ambitious megaproject

China’s regulatory regime remains a major deterrent to investors, as it affords the government considerable latitude and discretion relating to sectoral investment strategies. Specifically, such discretion includes the selection or restriction of foreign investment which would compromise the national interest or compete with state-owned or domestic enterprises.

In 2012, the Chinese government announced major reforms to foreign investment laws. The Twelfth Five Year Plan on Foreign Capital Utilization (the “12th Foreign Capital Five Year Plan”) provided a blueprint for a series of market entry reforms designed to improve transparency and efficiency in the infrastructure investment market, and to incentivise and increase private investment opportunities. China’s 13th Five Year Plan, adopted in March 2016, increased the focus on new infrastructure investment as well as upgrading existing stocks of assets, both within China and beyond, over the next five years.

The signature foreign policy initiative, variously known as the New Silk Road, One Belt One Road or the Belt and Road Initiative (BRI), was launched in 2013. The plan is for a transcontinental development plan to improve existing trade routes and create new links across over 60 Eurasian countries. This will be achieved by channelling large scale state-led investment into infrastructure throughout the region. More specifically, BRI is composed of two elements: the Silk Road Economic Belt (One Belt) and the 21st Century Maritime Silk Road (One Road).

The Silk Road Economic Belt covers six main ‘economic corridors’, and includes infrastructure projects for roads, railways, natural gas and oil pipelines and energy. The 21st Century Maritime Silk Road is a development initiative that emphasises linking the Asia-Pacific economic region by building a network of port cities and upgrading existing maritime infrastructure.

The Chinese government anticipates that the Silk Road network of highways, railways, pipelines, ports, telecommunication links and logistics hubs will potentially benefit more than 70% of the world’s population. This level of ambition certainly represents a ‘step-change’ in the scale of international infrastructure investment collaboration, as well as in the complexity and multifaceted nature of the scheme itself. It is estimated that, by 2020, countries along the route will need approximately US$2.38 trillion worth of investment in transport infrastructure alone, and about US$2.95 trillion investment in total. This single project is more than twice the size of the current Chinese domestic infrastructure market.

In response to this funding need, the Asian Infrastructure Investment Bank (AIIB) was established in 2016 with an initial capital reserve of US$100 billion. The Chinese government provided US$15 billion, with the remaining funds derived from the other AIIB member states. Between its inception, and early 2020, the AIIB had granted US$12.24 billion loans across sixty-four projects. The China-backed Silk Road Development Fund, set up in 2014 with an initial capital injection of US$100 billion, distributed circa US$6 billion of funds across fifteen projects in its first three years of operation. Between 2015 and 2020, US$160 billion worth of projects were planned or commenced. It is expected that the New Development Bank (NDB) and the SCO Development Bank, amongst other organisations, will play a significant role in financing these development initiatives.

The AIIB has committed investments of US$7.85 billion in loans across a number of infrastructure sectors in 21 different economies. Pertinently, this equates to less than a quarter of the expected amount, as the AIIB was expected to lend US$10 billion-US$15 billion a year in its first five or six years of operation. Further to this, there remains limited data detailing how much of the approved lending has actually been distributed.

Perhaps of even greater surprise is that so far only one AIIB loan has focused on China, a US$250 million investment in an air quality improvement project in Beijing. Interview evidence would suggest that, moving forward, economic circumstances will dictate that more of the AIIB funds will be focussed on the Chinese Infrastructure market. Whilst there are undoubtedly concerted efforts to attract greater levels of private investment to support such initiatives, the current governmental approach to the financing of infrastructure investment also presents some concerns. Although it is relatively normal that large scale infrastructure projects are financed by central government and smaller projects by local government, the fiscal structure of the Chinese Budget Law means that local governments are prohibited from engaging in borrowing from banks or running budget deficits. They therefore do not always have capacity to finance investment. This concern is exacerbated by figures from the Chinese National Bureau of Statistics suggesting that provincial governments have been the backbone of infrastructure financing activity in terms of decision making and financing – contributing to approximately 90% of the total infrastructure investment volume.  

Interviewees detailed that in order to circumvent legal restrictions, it is common practice for local officials to set up what is known as Local Government Financing Vehicles (LGFVs) to finance infrastructure projects. These vehicles are off-balance-sheet municipal financing agents, hosted in a corporate setting de facto, but treated in statute as state-owned enterprises.

To fund infrastructure projects with LGFVs, local governments provide capital primarily by means of budget allocations or transfer of land use rights and/or rights to existing state assets such as bridges and roads. Alternatively, funds could be derived from bonds issued by the central government on behalf of the local government. The LGFV then multiplies its capital base by issuing equity or bonds to private sector investors, and/or by non-recourse borrowing from banks, with land and other assets transferred by the local government as collateral.

As of 2015, there are 7,170 LGFVs in China, whose investments in local infrastructure projects account for roughly 2.4% of the country’s total GDP. Standard & Poors (S&P) estimate that local governments’ off-balance-sheet borrowings may be as high as US$4.4 trillion – constituting a potentially catastrophic debt mountain. A number of international investors contributing to this investigation highlighted that LGFVs have come under considerable scrutiny within the international investment community. Investors called into question the sustainability of China’s provincial government debt whilst many inferred that the infrastructure procured via LGVFs will not generate sufficient financial returns to service such debt. China’s local governments are not permitted to guarantee the debts of third parties; as such, lenders to LGFVs have little assurance that they will be repaid. S&P suggested in 2018 that many LGFVs in Xinjiang region are very weak financially. This has prompted a lack of investor confidence and reflects the gradual weakening of the financing vehicles’ roles and links with their local-government parents.