(Profile picture from ceb.com)
Investments has always been the pillar of the Chinese economy despite efforts to re-balance towards more consumption. In fact, recent economic figures in 1Q 2016 show a mild rebound in fixed asset investments, growing by 10.7% in the first quarter instead of 10.2% in the first two months. Infrastructure investments have also picked up, expanding 19.6% YoY or 4.6% faster than the first two months. That said, fixed asset investments are typically linked with the “old growth model”, which could lead to excessive capacity in the industrial sector. China is in dire need to upgrade the old investment model into a new one.
From a funding perspective, one of the key caveats for the investment-driven growth model is that some local governments or SOEs have taken up too much debt, which could potentially lead to systemic financial risk going forward. There have been some notable changes since Minister Lou Jiwei became the Minister of Finance, who has been a keen promoter of the wide adoption of public-private-partnership model in major infrastructure projects. The MOF also started a new website www.cpppc.org, which disclosed PPP projects by province with substantial details and is updated on a bi-monthly basis. Lou also encouraged more private sector participation in the infrastructure sector during the World Bank’s Global Infrastructure Forum on April 16th, further showing his keen support of this model.
(Lou during the Global Infrastructure Forum with fellow participants, source: Xinhua)
A Short History of PPP in China
PPP is never a new terminology in China. It is believed that the first BOT (build-operate transfer) project in China was a power station in Guangxi Province back in 1995. In 2002, the old Ministry of Construction enacted the “Measures for the Administration on the Franchising of Municipal Public Utilities”, which led to another wave of BOT/BT investments. That said, BT(build-transfer) was the dominant form back then, which neither changed the the financing part (100% government-backed after transfer), nor facilitating a healthy partnership between the public and private sector (private sector being only the contractor of the government). That said, there have been some model PPP projects that were fully appreciated by both parties, one of which being the No.4 line of Beijing Metro, built, participated and invested by the HK MTR. MTR introduced a bunch of new concepts to the Beijing Metro, including overall design, interchange at the same level, modern ticket machines, helpdesk, etc. MTR’s China/International Revenue has been stable in 2015 at 12.6 billion HKD, with an operating profit of 586 million HKD. This model project has been one of the key sources of confidence for PPP model to be implemented at a healthy, constructive and commercial environment.
(No.4 metroline in Beijing, source: CNS)
Lou was not only inspired by the Beijing Metro line model. During his tenure as the head of China Investment Corporation (CIC), the company invested 10% of stake in London Heathrow Airport as well as a minority stake in UK utility group Thames Water. Experts in this industry told us that it was during these acquisitions that Lou became convinced that China should also adopt the same business model to revitalize and reshape its infrastructure investment framework, where typically efficiency is in lack of.
More than 8 trillion RMB PPP investments on the pipeline
In November 2014, the MOF published a notice on PPP operational guidelines (Chinese: http://jrs.mof.gov.cn/zhengwuxinxi/zhengcefabu/201412/t20141204_1162965.html ). Following these guidelines, MOF also announced consecutive list of PPP model projects (Chinese: http://jrs.mof.gov.cn/ppp/gzdtppp/201510/P020151012357758728335.pdf), which covers transportation, municipal engineering, healthcare, environmental protection and multiple industries. NDRC also published relevant guidelines to encourage PPP schemes. The top-down support from MOF and NDRC is unprecedented, especially compared to the PPP boom in the early 2000s, when guidance is only initiated by a single ministry that had limited influence.
Meanwhile, MOF has made strenuous efforts to make disclosure more transparent and regular – the establishment of the cpppc.org website and its regular update gives us an overview of the current PPP investment landscape domestically – as of January 31st, 6997 projects were disclosed (MOF announced a second batch by early April, extending the number to 7704 projects, but without a statistical overview) , implying an investment amount of 8.1 trillion RMB. Guizhou, Shandong and Sichuan led in total projects and investment amount in terms of provinces. Industry wise, municipal engineering ranks the top in terms of number of projects, whereas transportation is the sector with highest implied investment amount.
(PPP investments by industry in terms of projects)
(PPP investments by industry in terms of volume, RMB mm)
In terms of funding options, 42.3% of the total investment will be paid by users, whereas 35.8% will be using viability gap funding – which means it is partially funded by users, with the remainder fulfilled by the government. Government-only projects were as less as 21.25 of total investment, or less than 1.8 trillion RMB out of the 8.1 trillion RMB total.
Although there are enough reasons to be optimistic about the ongoing PPP schemes across China, less than 10% of the projects have been down to the execution phase, which means a lot of the investments listed here might still be exploratory and might not come down to the finish line.
Potential risks might evolve when projects materialize
From the perspective of the central government, it makes a lot of sense to promote the PPP scheme, as it reduces the debt burden to the project company level instead of local governments; meanwhile, if right incentives are offered, private savings/investments will be more than willing to invest in some projects, as they “guarantee” yields due to most of them being utility-related projects. Local governments, however, may have a different perspective, as they are the ones who are handling all the potential risks and managing private enterprises’ expectations.
The primary risk is the potential risk of underpayment by the local governments – water utility projects in China has suffered from the inability by the local governments to raise water tariffs – a much needed but highly controversial move; local governments may also be overstretched in terms of capability to manage PPP projects, leading to potential loss of investors; meanwhile, legal risks might evolve as franchising laws in China are underdeveloped or lack of enough cases to bring about a comprehensive reform. The “trial and error” approach seems to be the only way forward here; there is also “key-man” risk, as local government officials tend to have a lot of power in deciding the fate of certain investment projects, which may change dramatically after he/she moved to another official post. All of these requires a better regulatory and financial framework, with cooperation from both local governments and private enterprises to put it together.
Private enterprises shine in environmental protection sector
SOEs have normally taken the lead in PPP investments in transportation and municipal engineering sectors, due to its sheer size and capital-intensive nature. However, environmental protection industry might be one of the anomalies. Take Beijing Origin Water (300070-CH) as an example – it is one of the leaders of membrane bio-reactor water treatment technology in China. The company has seen its revenue growing by more than 5 times in 5 years’ time, thanks to its deep involvement with a number of local governments on water treatment projects. By the end of 2015, Origin Water has established more than 40 PPP project companies with various local governments, with a total processing capacity of 15 million tons and covering 60 million population. One of the company’s project company with Yunnan government, Yunnan Water Investment (6839-HK) is one of the first PPP project companies to get listed on the Hong Kong Stock Exchange. The project company has seen its revenue growing by 41.6% YoY to 1.6 bilion RMB in 2015, and net profit growing by 68.9% to 317 million.
(Water Treatment Plant, source: Origin Water Company Website)
Despite the robust growth in the past years, the company is also well aware of the risk in the PPP model – in its annual report’s risk section it wrote “PPP is not a simple joint venture, it’s more like a ‘marriage’. And if one cannot reach the ‘win-win’ situation, it will lead to substantial risk in the PPP model, from which Origin Water has taken lessons. ” PPP model will certainly arrange marriages for thousands of projects and companies, but cannot evade from the risk of divorce going forward.