China eases funding restrictions for project finance

Local governments will be able to use proceeds from special-purpose bonds as project capital, as the country tries to stimulate economic growth.

China has eased restrictions on funding sources from local and regional governments, in a bid to attract private capital to finance key infrastructure projects in the country.

The government announced last week that local and regional authorities will be able to use the proceeds of special-purpose bonds as project capital for infrastructure projects, financial media outlet Caixin reported.

“Compared to general bonds of local governments, special-purpose bonds typically attract more investors from non-policy […] financial institutions, such as brokerage firms and commercial banks,” Gloria Lu, an analyst at S&P Global Ratings, told Infrastructure Investor.

Previously, local governments were banned from using any borrowed money as project capital, in an effort to curb their growing indebtedness, Caixin said.

A report from S&P predicted that the effects of the change will be limited due to the strict set of conditions that projects must meet to be funded through the bonds. The assets financed need to be commercially viable, serve important national or regional development initiatives and be focused on the railway, highway, electricity or gas production sectors, the report said.

S&P estimated that between seven to 10 percent of the special-purpose bond issuance from the rest of 2019 will be used as project capital. The percentage amounts to investment ranging between 90 billion yuan ($12.9 billion; €11.5 billion) and 130 billion yuan, the ratings agency said.

“Together with bank funding, the additional capital would support our forecast of 8-10 percent infrastructure growth for 2019,” Lu said in the report.

According to Lu, the rules will guarantee that the proceeds from bonds are focused on projects able to repay the debt by themselves, thanks to stable cashflows, rather than through government funds.

Furthermore, the new policy might achieve “a leveraging effect”, attracting financial institutions to provide debt finance for these projects, she said.

Debt finance for major infrastructure projects can reach up to 80 percent of total funding “due to low equity requirements” in China. While financial institutions are needed to provide funding, they only do so based on their assessment of the project’s bankability, the S&P report said.

“Securing infrastructure funding is always a challenge since most projects have a low return profile, long maturity, and inherent construction and operating risks,” Lu said in the report.

“The same difficulty also applies to special-purpose bonds, given repayments can only come from cashflows from designated projects,” she added.

According to state-owned Xinhua news agency, the ‘One Belt, One Road’ initiative, the development of the Yangtze River Economic Belt, and the Greater Bay Area integration project are some of the projects governments and financial institutions are “encouraged” to support under the new regulation.

In its report, S&P said the measure is part of China’s efforts “to shore up the economy” due to the trade war with the US, and provides new funding avenues to local governments facing shrinking fiscal revenues and restrictions on the use of off-the-balance-sheet financing vehicles to fund infrastructure. However, it noted that it could also add to leverage risks.

“The stimulus […] is part of counter-cyclical measures to support the economy. If there were a resolution to the US-China trade dispute, China may weigh more on consumption and technology upgrades, et cetera,” Lu said.

Putting aside current market turbulences, Lu explained that China’s central government hopes to attract more private investors to its infrastructure market in the long term, as part of its efforts to reduce the debt burden of regional authorities.

“The central government is looking for PPPs to become a real risk-sharing mechanism, opening the door for private capital to invest based on the merits of the projects, rather than local governments taking on large financial undertakings that may potentially increase their future obligations and increase their ‘hidden debt’,” she said.