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New models to finance urbanization
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An essential ingredient in China’s growth and development over the past 30 years has been its ongoing process of urbanization, a transformation of unprecedented scale.
China is changing from a predominantly rural society to a predominantly urban one; the urbanization process is still ongoing, and is expected to continue until about 2030. During this period, about 15 million people per year will join the ranks of China’s urban population.
Embedded within such a transformation is the question of funding. China plans to spend some 40 trillion yuan (US$6.6 trillion) over the next two decades on its urbanization push — equivalent to its annual GDP in 2012.
As China moves toward its urbanization goals of 1 billion people living in cities, what are the options for funding this transformation in an efficient and sustainable manner?
Given China’s economic model and history of centralized planning, one might expect that a significant funding element would come from central government support to local government budgets.
In reality, however, China’s central government has provided only limited financial support to local governments, leaving the job mostly to local government officials and city leadership.
These leaders are responsible for managing the ongoing urbanization process in their city, identifying sources of capital, and utilizing funds needed to pay for ongoing urbanization projects such as housing, schools, roads and transportation links, hospitals, utilities and social and leisure infrastructure.
Local governments also face additional costs to maintain the expanded social services for a larger urban population.
While the central and local authorities do have a number of choices about how to pay for urbanization, it appears that the trend of development through land sales may have peaked.
If funding for China’s urbanization is to be put on a more solid and sustainable footing, local governments need more (and more flexible) funding options and funding models.
In recent years, this topic has been hotly debated with a number of solutions identified, two of which are local government bonds and public-private partnership arrangements.
Bond issuance
Funding by means of local government bond issuance is enabling some local governments to access capital markets to fund urbanization.
Previously, local governments were prohibited from issuing bonds directly: all government bonds were issued by the Ministry of Finance of China. Then, in October 2011, a pilot program gave authority to four local governments to issue bonds directly. Included in the pilot program were governments from Shanghai, Shenzhen, and the provinces of Zhejiang and Guangdong.
In July 2013, the central government further announced its plans to expand this trial program, to allow greater local government access to the bond market. In addition to the four localities above, governments from two more major coastal provinces, Jiangsu and Shandong, now have the authority to sell bonds directly.
These moves also could be viewed as a gradual transition to a new model, where local governments have more autonomy to decide on which funding methodology fits the need of the project, thus mitigating certain market risk factors.
Another alternative for funding, delivering and operating urbanization projects is the use of public-private partnerships.
This is a model utilized extensively in some overseas jurisdictions. PPPs can offer collaboration between the public and private sectors for the purpose of providing public services that have been traditionally provided only by the public sector.
Public-private partnerships are not unknown in China. In fact, the Chinese government has been applying a public-private partnership scheme known as build-operate-transfer on a large scale since the 1990s.
Under the build-operate-transfer model, the government grants a private company the right to build a project, and allows the private company to operate the project for a profit over an agreed-upon period. After the period expires, the private entity transfers the project to the government.
Public-private partnership arrangements represent a small fraction of local infrastructure projects, and such schemes are not without risk for public and private interests. For example, China’s legal and regulatory policies are developing and subject to change. This can create business uncertainty for investors. As has been the case overseas, letting and managing such contracts is complex and requires specialist skills in government, as well as private sector participants.
China’s urbanization is a long-term phenomenon — a process only partially completed. What is changing now is that local governments may be increasingly motivated to seek out new ways to finance their physical expansion.
The influx of new urban residents is a steady and relentless force, making ever more urgent the need for pragmatic policy solutions.
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