Behind the spectacular growth of China’s cities lies a potential fiscal crisis. It is unlikely that municipal governments can count on revenues from land leasing as a major, lasting source of finance. Many are under pressure to find alternative sources to finance urban development and infrastructure. This presentation will discuss a confluence of factors underlying the crisis, and explore the alternatives.

1. Financing China’s
Urbanization
Weiping Wu
Professor and Chair
Urban and Environmental Policy & Planning
Tufts University
weiping.wu@tufts.edu

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

3. 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

4. Urbanization and regions

5. 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

6. Local fiscal context
 Mismatch between local revenues and
expenditures (source: Lu and Sun 2013)

7. 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)

8. Quick comparison
Industrialized
countries
Other developing
countries
China
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 state
banks
Grants & subsidies
(e.g. DOT, FTA)
Borrowing Local taxes
User fees Others Others

9. Urban infrastructure financing
1990 1993 1996 2002 2005 2009 Total Sans borrowing 2009 (%)
Budgetary allocation
Central budgetary allocation 1.09 2.70 1.04 7.60 6.22 10.66 1.15 1.71 1.58
Local budgetary allocation 1.98 5.95 8.63 39.27 79.59 166.04 14.68 21.96 24.67
Local taxes
Maintenance and construction tax 6.51 9.8 15.78 31.60 55.13 77.19 10.17 15.21 11.47
Public utility surcharge 2.26 3.3 5.56 4.99 5.55 9.80 1.02 1.53 1.46
Fees and user charges
Water resource fee 0.28 0.48 0.61 1.24 2.50 2.48 0.46 0.69 0.37
Infrastructure connection fee 8.66 14.29 32.56 2.64 3.94 4.84
User charges 8.94 14.55 25.89 2.68 4.01 3.85
Land transfer fee 28.30 59.45 263.60 10.96 16.40 39.17
Borrowing
Domestic loans 0.88 4.46 9.57 87.39 166.99 30.80
Foreign capital 0.25 1.38 5.59 6.11 9.27 1.71
Bonds 0.29 3.43 0.63
Stock 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 4.10
Other sources 5.21 25.47 26.05 30.47 30.59 57.08 5.64 8.44 8.48
Total 21.04 58.13 84.78 315.62 542.25 672.94 100.00 100.00 100.00
2005 (%)

10. “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

11. Key instrument – LGFVs
Treated as municipal SOEs
(Source: Ueda and Gomi 2013)

12. 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

13. Dilemmas
 Negative relationship between land supply
and fiscal gap (source: Lu and Sun 2013)

14. 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

15. Alternative financing for China
 Municipal bonds
 Local property taxes
 Private participation (PPI)
 Institutional investors
◦ Pension funds
◦ Insurance companies
◦ Private equity
◦ Sovereign wealth funds

16. 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

17. Sectoral distribution of PPI
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Brazil Chile China India Russia South
Africa
Turkey
Energy Telecom Transport Water and Sewerage
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Brazil Chile China India Russia South
Africa
Turkey
Energy Telecom Transport Water and Sewerage
Project count
Investment
Source: PPI Database
http://ppi.worldbank.org/explore/ppi_exploreCountry.aspx?countryID=50

18. 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

19. Expected returns estimates
Source Expected returns
Mercer Investment
Consulting (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%

20. 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

21. 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

22. 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

23. 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