The financial risks in urban construction
Recently, a piece of news report on Kunming’s subway project has been reprinted by many domestic and foreign media and hot debates have been triggered. There are media saying that the fiscal revenue of Kunming City is only 37.8 billion yuan, but it has invested nearly 300 billion yuan on the subway project.
For the common people of a region, owning fast public transit systems of course is a good thing. For the current Chinese large and medium-sized cities, traffic jams for urban roads are very common. Taking Kunming as an example, up to the end of May of 2013, the vehicle ownership amount broke through 1.8 million. Since 2009, the annual average increase of vehicles has been 160,000. Facing such a huge traffic flow, the ground transportation cannot bear such a big burden.
Under such a background, the subway has become the choice of more and more local governments. But the cost for the subway construction is not low, and there is an expert who estimates that if a subway is calculated with the length of 30 kilometers, the building cost may reach 15 billion yuan. And this is equivalent to the fiscal revenue of a medium-sized city -- in 2012, there are only about 30 cities with the fiscal revenue more than 30 billion yuan. How can the local government collect such big amount of funds?
The local government financing platforms have played a very important role. As a highly underdeveloped country for the financial market, China seriously lacks the “safe assets” that can be used as mortgage and can loose finance restriction. The projects with land as mortgage on financing platforms and asset-backed securitization (ABS) with the projects as mortgage actually have created safe assets as far as possible which can not only provide funds for local governments to promote urbanization and economic growth, but also have provided enough good assets for enterprises and investors.
The reason why Kunming City can gain so many funds is also in this way. According to the reports of the local financing platforms of the statistics issued by China Banking Regulatory Commission in June, there are altogether 48 financing platform companies, including Kunming Rail Transit Co., Ltd. whose major business is rail transit. The local government gives the rail transit company the development right of land along the lines of rails, and the company will use the appreciation as the construction funds. In the early stage of project development, one effective way is to use land mortgage to gain funds from banks, and this is also the pattern of “land + bank” that is common across in China.
Viewing from the operation experience of subways all over the world, the subway itself is almost difficult to gain profits, but the opening up of subways can let the business districts along the subways benefit from it: through rail transit aggregation, the commercial, business, living and entertainment facilities form a new city center, stimulating the regional development. Up to now, in the whole world, only Hongkong subway is profitable -- the profits of Hongkong subway are not from the subway itself, but from the properties along the line of the subway. The reason why so many mainland cities let rail companies own the properties along the lines of subways, the secret also lies in that as long as there is good operation for real estate projects around subways, then there is no problem for the funds that are needed for subway construction and operation.
If such a way of financing is operated properly, then serious problems can be solved in a skilled way; but if the progress is not smooth, heavy debt burdens will be put on relevant platform companies, and huge amounts of bad and non-performing loans will be accumulated in banks. Therefore the key of the problem lies in the real estate projects along the lines of subways -- if the real estate can’t appreciate in value, the funds for subway construction and operation will be unsustainable. So, will the subway construction really bring real estate appreciation, and even the appreciation can compensate for the subway construction expenses? At least viewing at present, the situation is not so simple.
Viewing from the existing experience, the subway construction will drive the rise of land prices, but the rise is not unconditional, but has to be restricted by a series of factors: the population size of an existing city, the annual growth of external population, the disposable income of local residents, and the monetary policies of the central bank etc. So as long as one condition is lacking, then the game that the land generates cash flow is unable to continue. Then, does Kunming possess such conditions? It’s not optimistic.
According to the data of the sixth population census, though the proportion of the population of Kunming occupying that of Yunnan Province has risen from 13.48% of the fifth population census to 13.99%, the increase is still very slow. In the recent ten years, the permanent resident population only has increased nearly 650,000 persons and has reached 7.263 million, but the relevant growth speed of real estate is far higher than that. According to the statistics of the Statistics Bureau of Kunming, in 2000, the completed total amount of real estate investments of Kunming was 6.39113 billion yuan, and the commercial residential building areas of newly starting building construction is 2.118 million square meters; the same data in 2012 was 91.907 billion yuan and 58.85 million square meters respectively.
For the reason why Kunming Municipal Government constantly increased land supply in 2012, one very important reason is for the financing of urban infrastructure construction. According to The Short Term Construction Planning for Urban Rail Transit of Kunming City (2013-2019), the total investment on the rail transit construction project of Kunming City is 63.491 billion yuan, including that the percentage of capital fund is 40%, and nearly 25.396 billion yuan is to be solved by the fiscal fund of Kunming City, but the funds except the capital fund is to be solved by the ways of financing by bank loans etc. For Kunming Municipal Government with the annual fiscal revenue of only 37.8 billion yuan, it has great difficulty to provide so much capital fund, so land sale becomes a very realistic choice. But the puzzle also lies in here, suppose there is excessive land being put in the market each year, then the prices of the land-transferring fee will be influenced; if there is too little land, then the land-transferring fee gained is insufficient to maintain the starting construction of the early stage.
Of course, Kunming Municipal Government may also get financing from the financial market by ways of entrustment etc., and actually they have already done that, but the biggest problem for entrustment is its short maturity, usually less than three years, but the construction is time-consuming, and then the problem of the so-called maturity mismatch will occur. But no matter the financing is got from the financing market or the land-transferring fees are directly gained, finally all the hopes are put on the real estate market, and the risks of such practice have rarely been assessed by people: in case of the depression of the real estate market, either rail transit companies, banks or trust companies will encounter great calamity.
If it is an enterprise, facing such a great risk, maybe it will not choose to start a subway project. Why is Kunming local government so radical? Taking a broad view on the whole country, Kunming local government is not the only one where such a problem exists. In my view, there are two factors for the reason for doing so.
Firstly, the short term of local officials and the long period of subway construction are unmatched. The current period investment has driven the increase of GDP, and may become the achievements in local leaders’ official careers for promotion; but the future officials have to be responsible for these debts. Under such a motivation system, any local officials all have the impulse for increasing investments.
Secondly, the local residents do not need to directly shoulder the responsibility for local debts. Though the final debts of these subway investments have to be undertaken by the local common people -- no matter the debts are directly repaid by the finance, or are indirectly paid by local residents by way of high housing prices. But under the current fiscal system, the residents do not feel that they need to take on local debts. On the contrary, what they see is that the opening up of the subway can bring convenience for their trips and bring assets appreciation. For the financial burdens of the city several years later, they will not care about it. Thereupon, for the building of subways, local officials and residents make a rare consensus.
Viewing from this angle, building subways is a conspiracy between local government and residents.
Of course it is a good thing with no traffic jams, but it needs to pay considerable costs for enjoying convenient and fast traffic. In this sense, it is not that the more subways the better, and speed is not the only standard for measuring whether the traffic is good or bad. The key is to let the construction cost for infrastructure match with the local fiscal capacity. For example, everyone wants to live in a big house, but if you really are allowed to live in a big villa, can you afford its water, electricity and property fees?
Originally published on China Times | 2013-8-21
