China Infrastructure Report Q4 2009

Official statistics show that China had a very strong second quarter, with growth hitting 7.9%. The Country Risk team noted in July 2009 that ‘upon recovering from the current global downturn, we expect China to return to its previous strong growth path, albeit at a more sustainable level of around 7-8%. This move towards a more balanced growth path will be led by a structural shift away from fixed asset investment and net exports, and towards private consumption’. The structural shift away from fixed capital investment is central to our outlook, and indeed is a key factor behind our long-term forecasts.

The impact of the stimulus plan has been impressive. Activity has picked up, though with urban fixed asset investment rising by 35.3% in June 2009 compared with the previous year. Our earlier caution regarding its desired effects has been replaced by a bullish forecast of 14.5% industry value real growth for this year. This is based primarily on our forecasts that fixed asset investments will peak this year on the back of the stimulus plan. In tandem, the demand for raw materials (steel and cement) will also rise, though huge stockpiles will mean that there is plenty of domestic supply to sustain the initial phases of the infrastructure plan, thus demand for building material imports is expected to rise in Q409.

Though our forecasts for the short term (2009-2010) have been revised upwards, our long-term forecasts remain unchanged. We maintain our view that the sector will reach maturity in 2011 following a decade of relentless spending on infrastructure, and this slowdown will be symptomatic of the anticipated structural shift in economic activity.

On the corporate side, the strong results of China Railway Group (that have been bolstered by new government contracts), as well as the existence of several ongoing infrastructure projects, are clear signs of sustained activity in China’s infrastructure sector. Two major infrastructure-related initial public offerings (IPOs) are pending. The biggest one will be the IPO in late July of China State Construction and Engineering, which is expected to be the largest ever in China and possibly globally. The second biggest will be the listing of a new company that will control railway assets in Shanghai and Beijing. The timing of the IPOs highlights that companies operating in the infrastructure field in China are in a strong position to capitalise on their gains from the stimulus plan, which guarantees that they will see sustained business while other sectors struggle. The proceeds from IPOs will assist with the financing of infrastructure projects. Last but not least, Bank of China International (BOC) and Singapore's Temasek are reportedly in negotiations to establish a fund to invest in infrastructure in China. Reuters cites unnamed sources that say the talks between Temasek and BOC International, the investment banking arm of the Bank of China, are still in the early stages, but the idea is for a joint venture agreement to establish a fund of between US$1bn and US$2bn. These funds would be invested in Chinese infrastructure projects, particularly targeting projects supported by the Chinese stimulus plan.

According to the Beijing Municipal Development and Reform Commission, as cited by China Knowledge, Beijing alone is planning to spend US$160bn in infrastructure projects in 2009. Infrastructure projects will represent 35% of the municipality's fixed asset investment in 2009, a 4% rise from 2008.

This is quite a surprising announcement given the significant investments in the city that were already made in preparation for the Olympic Games. The pledge does highlight the government’s commitment to infrastructure spending, but we also believe it raises questions as to whether or not funds are being allocated where they can maximise productive capacities.

According to BMI’s Infrastructure Business Environment and Project Finance Ratings, China’s infrastructure business environment and investment risks are relatively low. For the business environment, the country’s score increased this quarter as a result of higher industry forecasts, and China now achieves an overall score of 71.4 out of 100, up from the previous 69, coming in at second place in the Asia Pacific region.

The Project Finance ratings offer a more mixed picture. The overall score is 60.4, suggesting a moderate level of potential risks throughout a project’s lifecycle in the country. However, according to our tables, the market does present higher risks in the Design and Construction phase when compared with other markets in the region. When compared with other regional markets in the Commissioning and Operating phases, meanwhile, the risk environment in China is more appealing than in other regional markets. This could mean there is greater chance for revenue generation to become disturbed in the longer term.