“The largest amount of funds was channeled to toll roads.”

Southern Weekend: In your research report, your team conducted a thorough investigation on the debt scale of urban development investment companies (UDICs), local state-owned enterprises (SOEs) and local government bonds. What is the situation?

ZHONG Ninghua: Let’s start with the debt of UDICs. After the 2008 financial crisis, a large number of UDICs were set up in various places to support infrastructure construction. The interest-bearing debt of UDICs rose from RMB 6.6 trillion yuan in 2009 to more than RMB 47 trillion yuan in 2020.

Our team’s analysis was based on all UDICs that have issued bonds. We found that the average debt ratio of UDICs is rising, while their profitability is declining. By the end of 2019, their average profit rate of total assets (net profit/total assets, ROA) was just 0.5%.

Southern Weekend: Why are UDICs barely profitable but able to borrow more and more money in the market?

ZHONG Ninghua: Behind the scene, it is that market investors expect the local governments to provide “implicit guarantees” for local UDICs. The local government is often the controlling shareholder or even the only shareholder of UDICs, but UDICs also undertake quasi-public welfare projects such as infrastructure construction, so investors widely expect that the local government will assume part of the rescue responsibility in the event of a default.

Recently, we have done a calculation in an academic paper that “implicit guarantees” are expected to reduce the cost of financing for UDICs by about 40% on average.

We have used two methods to test this expected strength, and the results are quite consistent. Moreover, the “implicit guarantee” of urban investment debt in the western region is expected to be the strongest, followed by the central region, and the eastern region is the weakest. In terms of time, the “implicit guarantee” of urban investment debt from 2010 to 2011 was expected to be weaker, while its expectation of “implicit guarantee” from 2012 to 2019 showed an overall upward trend.

Generally speaking, if an enterprise’s profit is bad but it can borrow more and more money, there must be another force helping it, and this force is getting stronger and stronger.

Southern Weekend: In addition to urban investment debt, how about the debt situation of local SOEs?

ZHONG Ninghua: From 2009 to 2019, the total debt of China’s local SOEs increased from less than RMB 20 trillion yuan to RMB 91 trillion yuan, with an average annual growth rate of 18.5%.

The overall profitability of local SOEs is also at a lower level. In 2019, the average return on assets (ROA) of local SOEs nationwide was 0.7%, and the average return on equity (total profit/total equity) was 1.7%, with large regional differences.

It should be added that views vary widely among academic circles, industry and different government departments, as to whether the debts of UDICs and local SOEs should be regarded as the implicit debt of local governments. We cannot give an authoritative statement, so the analysis of UDICs and local SOEs cannot be directly regarded as the analysis of local government implicit debt.

Southern Weekend: Local government bonds are not controversial local debt, how about the scale and investment orientation of these bonds?

ZHONG Ninghua: In 2014, China’s State Council issued Guofa [2014] No.43, and local governments at all levels began to independently issue local government bonds. From 2015 to 2020, the average annual growth rate of China’s local government bonds exceeded 20%. By the end of 2020, the balance of local government bonds had exceeded RMB 25 trillion yuan. Of this amount, the stock of general bonds was about RMB 12.6 trillion yuan, and the stock of special bonds was about RMB 12.9 trillion yuan. By region, the proportion of new local government bonds to GDP in the western region was significantly higher than that in the eastern and central regions.

In particular, the special local government bonds grew at an average rate of over 30% from 2015 to 2020. In 2020, 99.7% of the new special bonds was project revenue special bonds.

Our team spent a great deal of time and effort collecting and sorting out the data of the investment in special bonds, and found that about 18% of the special bonds for project revenue were invested in transportation infrastructure construction, and the average maturity was 14.5 years, while the average maturity of special bonds was 9.2 years. Among the special bonds for transportation, the largest amount of funds invested in toll roads, accounting for about 40%, followed by railways and urban public transportation.

In terms of investment orientation, the debts of UDICs and local SOEs are heavily skewed towards transportation infrastructure construction.

We manually sorted out and analyzed the investment orientation of the funds raised by urban investment bonds. From 2009 to 2019, on average, about 15% of the funds were invested in transportation infrastructure construction, 18% of the funds were used to replenish working capital, and 29% of the funds were used to return the old loan by getting the new loan.

Total assets and total liabilities of the SOEs in the transportation industry have accounted for 12% and 13% respectively in the national SOEs. Total assets have amounted to RMB 52.61 trillion yuan, total liabilities have amounted to RMB 25.69 trillion yuan and the average annual growth rate of debt has reached 15%. The transportation industry here includes transportation, storage and postal services.

“Average use efficiency per kilometer is declining.”

Southern Weekend: At present, how much has been invested in China’s transportation infrastructure construction?

Zhong Ninghua: In recent years, through statistical analysis in a broader range, the investment in China’s infrastructure construction has reached RMB 19 trillion yuan, accounting for nearly 1/5 of its GDP. Huge infrastructure investment has led to many mega-scale, and world-class projects in the past decade, such as the Qinghai-Tibet Railway, Hong Kong-Zhuhai-Macao Bridge, and Daxing International Airport, etc.

To make a comparison, the former U.S. President Donald Trump, during his four years in office, tried to mobilize US$ 1.5 trillion to revitalize American infrastructure construction, but failed, and his proposals were opposed by both the House and the Senate. The new president, Joe Biden, has again proposed a US$ 2.6 trillion infrastructure construction plan, of which less than US$ 300 billion will be spent on transportation. In contrast, China spends more than US$ 2 trillion on infrastructure construction every year.

Why is it so hard for the U.S. to mobilize large-scale infrastructure construction? The main reason is that the scale of investment in infrastructure construction is extremely large, the return on investment is extremely low, and the investment cycle is extremely long. This has caused that the financial markets dominated by private capital are reluctant to participate in such investment.

The huge investment in China’s infrastructure construction is often overlooked. Actually, the road is much more expensive than the house. For example, 500 houses are built in a “ghost town”, assuming that the price of the house is calculated in RMB 20,000 yuan per square meter, the total value of the houses in the “ghost town” has approximately reached RMB 1 billion yuan. Although the situations in different regions vary, the debts left by the “ghost town” are in billions of RMB.

Then, from the analysis of the investment in road construction, the cost of the expressway per kilometer in Yunnan-Guizhou area is more than RMB 100 million yuan. If we build an expressway with a total length of several hundred kilometers, it will cost tens of billions of RMB. If a bridge or tunnel is built, it will cost more. The investment in road is not explicit, but it precipitates a huge amount of funds.

Southern Weekend: What kind of transportation facilities do the local government spend the most money on?

Zhong Ninghua: In the transportation infrastructure mainly consisting of railways, highways and waterways, railway construction is mainly funded by the State, and China Railway is mainly responsible for railway construction and operation, etc. Compared with toll roads, the investment in waterway infrastructure construction is small. In 2020, the fixed-asset investment in inland waterway, coastal areas and other construction totaled RMB 0.14 trillion yuan, while the fixed asset investment in national highway construction totaled RMB 2.25 trillion yuan. The latter was about 16 times as large as the former.

Expressways are likely to be a kind of transportation infrastructure invested by more local debts. As a result, more than half of all new expressways in the past decade have been built in western area, where all types of local government debts have grown fastest in the western area.

By the end of 2019, total investment in national toll road had reached nearly RMB 10 trillion yuan. Among them, the debt capital accounted for nearly 70%, and banks were the main creditors.

Southern Weekend: How about the profitability of expressways?

ZHONG Ninghua: National toll roads generally adopt the method of “borrowing money to build roads and collecting fees to repay loans”.

From 2013 to 2019, toll revenue on national toll roads grew at an average annual rate of 8.4%. However, toll road-related expenditure grew at an average annual rate of 16.5%. The gap between revenue and expenditure expanded rapidly from RMB 66.1 billion yuan to RMB 485 billion yuan in six years.

Since 2014, the toll fees of national toll roads have been insufficient to repay the principal and interest of its debts, and the gap between income and expenditure has been widening. In some areas, the toll fees of toll roads are even insufficient to repay the interest of its debts.

Only when there are more cars on the roads can the expressways receive enough tolls. From 2013 to 2019, the average daily lane traffic volume on national expressways increased by 4.6% annually, passenger turnover by 6.0%, and cargo turnover by 5.3%.

However, if the annual freight turnover is divided by the mileage of expressways to calculate the average annual freight density, it is found that the overall trend of this indicator has been downward since 2017, and the average annual passenger density has not increased significantly. That is to say, as the total mileage of expressways rises faster than the total passenger and freight turnover, the average use efficiency per kilometer on the national expressways is declining as a whole.

In our view, the use efficiency of the built expressways is reduced which means that some local debt risks have increased.

Southern Weekend: What kind of risk will be generated when the revenue of expressways exceeds its expenditure?

ZHONG Ninghua: In the region with low freight density, the default risk of the debt in transportation infrastructure projects is also relatively high.

We have respectively calculated the ratio of principal and interest repayment to its toll revenue in 2019 in eastern, central and western regions. It is found that the freight density in western China is low, the toll revenue is less, and the expenditure of principal and interest repayment on toll road-related debt on average has reached twice as much as that of the toll revenue.

We have also sorted out and analyzed the daily freight density data of major expressways in each province together with the Research Institute for Transportation Science of Chang’an University, and found that even within the same province, the density of freight varies greatly in different expressways and even between different sections of the same expressway.

Taking the Gansu section of Lianyungang-Horgos Expressway (G30) as an example, in 2019, the average daily freight density of “Qingshui-Jiayuguan” expressway section was the highest, 10 times higher than that of “Tianshui-Dingxi” expressway section. This means that the assessment of toll road-related debt risk should make a detailed analysis of different expressway sections.

“How can we achieve the balance between these two goals?”

Southern Weekend: Many people ask a question: should the contribution to the infrastructure construction be counted just as economic ledger?

ZHONG Ninghua: We fully accept that infrastructure construction like expressways has strong externalities. Infrastructure construction is indeed a great achievement for China and the rest of the world is trying to solve this problem, but there is no solution. China has really built so many roads.

I want to illustrate the externalities of infrastructure construction by taking an example. Last year, I started to buy lemons on e-commerce platforms, but I found that the lemons were transported from Sichuan to Shanghai with a journey of more than 2,000 kilometers, and they cost only about RMB 20 yuan, including postage. In developed countries, their freight may cost more than RMB 50 yuan. The economic cycle between the East and the West of China is driven by its achievement in infrastructure construction. By relying on the infrastructure, the express delivery industry can get development and the Internet economy can be built accordingly.

Therefore, on the whole, the construction of expressways has significantly improved the accessibility of the relevant areas, made it more convenient for people to travel, and brought more economic and employment opportunities. Furthermore, the regions connected by expressways are more likely to participate in the great cycle of the national economy, thus providing basic conditions for the construction of a new development pattern which is based on the great domestic cycle and mutually promoted by both domestic and international cycles. There are also some expressways with strong strategic features, which is of great significance to the peace, stability and development of the whole country in the coming decades.

However, in the above analysis, we are almost entirely limited to financial indicators, balance of payments and other issues of the expressways, whether is it too one-sided? In fact, our analysis just highlights a contradiction, that is, these positive spillover effects cannot be effectively converted to the benefits of the project itself.

Although building a new road has many benefits, the UDICs, SOEs and local governments that have invested in operating the road are faced with the rigid requirements of “seeking balance” in all kinds of financing, and the financial pressure of principal and interest repayment.

Our question is, in the future, on the one hand, China will continue to be built into a country with strong transportation network. On the other hand, China will guard against and defuse debt-related risks, how can we achieve the balance between these two goals?

Southern Weekend: Do you have any suggestions on specific improvement methods?

ZHONG Ninghua: The revenues from infrastructure projects are multi-dimensional. The first is the evaluation of the project itself. As far as I know, in many projects, in order to achieve the requirement of “self-balancing”, the expected traffic volume (passenger capacity and cargo volume) is overestimated, and the actual level is far from the expected and planned level. This shows that the project establishment is not scientific. We suggest that when planning and demonstrating a new road, we should first check the use of all the surrounding roads, find out how many cars actually run, and then make a judgment.

The second dimension is to assess the extent to which new roads will boost the local economy and whether they are necessary to be built. People say that the infrastructure can drive the local economy, but in fact, many roads fail to drive the local industry development after being built. A road connecting two places can only drive the economic growth on the premise that there are industries, exchangeable goods, and movement of people between these two places. Given the cost of an expressway in ten billion of RMB, these issues need to be carefully examined before the road can be built.

Southern Weekend: Your team and you have been studying local government debts for nearly 10 years. What is your research context?

ZHONG Ninghua: We started to do relevant research in 2012. At that time, I already felt that the debt problem in China would be an important issue, I had data on China’s industrial enterprises above the designated size, including about 4 million samples. On this basis, we began to study the debt problem about Chinese enterprises.

Although China’s overall debt is rising fast, much of it is concentrated in a small number of enterprises. For example, in 2013, the debts of the top 2,000 enterprises accounted for nearly half of the 345,000 enterprises’ debts, especially the debts of some large listed SOEs were in trillions of RMB. This explains why, on one hand, China’s debt is rising, but on the other hand, financing is difficult and expensive for micro and small enterprises.

Therefore, China’s debt actually has a very strong structural problem. As we mentioned in 2016 that the deleveraging approach should be structural and targeted at large SOEs.

Subsequent policies are also introduced in this direction. In 2015, the State put forward the deleveraging requirement. In 2016, the State put forward the deleveraging of the enterprise sector as the focus, and in July 2017, the State further put forward the policy of the SOEs deleveraging as the top priority.

Later, we continue to focus our research on SOEs. SOEs are divided into central SOEs and local SOEs. We have found that after deleveraging, the rise in central SOEs’ debt slows, but local SOEs’ debt is still rising. At the beginning of 2018, the debt of local SOEs exceeded the total debt of central SOEs.

They borrowed so much money, what did they spend all that money on? On the macro level, infrastructure construction accounts for nearly 1/5 of GDP, it is our judgment that the biggest chunk of capital is invested in transportation infrastructure construction.

So what investment results have been achieved? We have worked with Prof. XIAO Runmou and Associate Prof. YAN Shengyu from Chang’an University, who have decades of experience in analyzing road-related data. We have found that the profitability of expressways is not good. Since 2014, the money collected by expressways has not been enough to repay the principal and interest, even the interest can not be paid enough. To put it simply, the risk of debt comes from the low efficiency of investment projects, which ultimately manifests itself in the form of default and failure to pay back the money.

Everyone has been talking about the risk of local government debt. What exactly is this risk? Where is it? Who will bear it? This is what I have been thinking about since 2016. In order to know where the risk of debt is, we must first know where the capital is invested. If you don’t know where your money is spent, you can’t tell if you can pay it back. Based on this idea, we conducted this study.