CLEANING UP CHINA WITH A MOUNTAIN OF DEBT / THE WALL STREET JOURNAL

Cleaning Up China With a Mountain of Debt

China chooses a greener—and more indebted—future

By Nathaniel Taplin



China dreams of a greener future, and is borrowing heavily to get there.

An annual health check on China’s economy by the International Monetary Fund out Tuesday highlighted a worrisome trend: China’s real fiscal deficit, including borrowing by semi-official entities such as local government financing vehicles, known as LGFVs, hit 12.4% of GDP in 2016, more than a third higher than the equivalent figure in 2012.

China’s official budget deficit is only 3%-4% of GDP, but most investing is done at the local level through a constantly evolving set of off-balance sheet entities like LGFVs, public-private partnerships, and so-called industrial funds.

The role of these often highly leveraged institutions in supporting growth is rising. As manufacturing and property investment has slowed, infrastructure has been used to fill the gap. Infrastructure spending hit 27% of total investment in mid-2017, up from just 22% in mid-2011. Over the same period, which also saw the massive blowout in the IMF’s broader fiscal deficit measure, manufacturing and housing investment fell nearly 10 percentage points to just 44% of the total in July.

The Dongxing Lake Reservoir in Liaocheng, Shandong province. Infrastructure funding in China is increasingly heading into environmental protection and water management. Photo: SIPA Asia/Zuma Press


This infrastructure funding, which used to go mostly into new roads and the oversupplied electric-power sector, is increasingly heading into environmental protection and water management, which China desperately needs.

Although such projects may support growth in the long run by keeping the population healthy—they aren’t typically big moneymakers. A water-conservation and treatment project in the northern megacity of Tianjin evaluated by the Asian Development Bank in 2010 had an internal rate of return of only 5%-8%, according to the bank’s estimate. With average bank and shadow bank lending rates running at around 5% and 7% respectively, that doesn’t leave much room for error. A paper by four Oxford University professors in 2016 found that more than half of infrastructure projects in China over the previous five years were uneconomic.

China needs better water works and cleaner air to safeguard its citizens’ health and long-run economic potential. But as debt-funded infrastructure plays an increasingly important role in China’s postcrisis growth strategy, the future is looking greener—but not less risky.