March 14, 2017
Is China Really
Overinvested?
A Report By The China Senior
Analyst Group
1
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Is China Overinvested? Provincial Data Suggest A Nuanced View
A widely held view of the Chinese economy is that it is overinvested. The logic is as follows. China's
manufacturing and export-led growth model requires that a large percentage of GDP be invested
rather than consumed. The official desire to make this model self-funded and not rely on foreign
savings (capital inflows) means that domestic savings must be sufficiently high or, equivalently,
consumption must be sufficiently contained. This, in turn requires a heavy role for the state, rather
than the market, in ensuring sufficiently high savings.
This state-led, investment-led, export-led model was successful for several decades. GDP growth
was high and inefficiencies relatively low. But as the economy has become more sophisticated in
recent years, (and global growth has slowed), the market has not been allowed to play a more
decisive role as envisaged under the 13th Five-Year Plan, the government's current economic
blueprint. The result has been a period of growth that was too fast, and investment too high. Debt
has risen sharply, credit quality has declined, and the sustainability of the trajectory of China's
growth path has come under question.
The conclusion that Chinese investment (and GDP growth) must consequently slow has been taken
as near gospel. But is that view unconditionally correct? S&P Global's China Senior Analyst Group
broadly agrees with this view, but argues for a more nuanced assessment. Drawing on provincial as
well as sectoral data, we conclude that while some parts of the Chinese economy are indeed
overinvested, many areas remain underdeveloped. In particular, the central and western provinces
face investment gaps in infrastructure, energy and, in some cases, property.
Under this line of thinking, investment needs to be rationalized and redeployed - not necessarily
reduced, at least not drastically. This objective, in turn, requires changes in policies that allow the
redeployed investment to be financed. Most importantly, the economy first needs to be put on a
more balanced and sustainable growth path. This requires action to reduce credit growth and the
creation of new impaired assets, and improve the allocation of capital by letting the market play a
more prominent role. Allowing for more defaults by unproductive companies, and accepting a more
realistic GDP growth target, would also put China on a more sustainable path. Implementing these
actions will allow for a redeployment of investment along the lines spelled out below. Not
implementing these actions in a timely manner will put longer-term growth at risk.
Provincial GDP Levels And Investment Requirements
China, with an estimated per capita income of about US$8,500 in 2015 (measured at market
exchange rates), currently qualifies as an upper middle income country under the World Bank's
categorization2. But to infer that this status accurately describes the economy would be a mistake.
There is, in fact, a sizable amount of dispersion in per capita income levels across China's 31
provinces, which have an average population larger than California, the most populous state in the
U.S. Looking across these 31 provinces, China has a top-to-bottom per capita GDP ratio of about
five-to-one (see chart 1). Tianjin was China's richest province in 2015 with a per capita GDP level of
about US$17,000, followed closely by neighboring Beijing and Shanghai provinces. If these were
countries, they would likely qualify as (relatively poor, admittedly) members of the OECD.
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At the other extreme, the southwestern provinces Guizhou and Yunnan, plus the western province
of Gansu, had per capita GDP levels near the World Bank's upper middle income country minimum
threshold of about US$4,000.
CHART 1
China - GDP Per Capita, By Province - Year 2015 (US$)
Per capita GDP
World Bank upper threshold
World Bank lower threshold
20000
18000
16000
14000
12000
10000
8000
6000
4000
2000
Gansu
Yunnan
Tibet
Guizhou
Shanxi
Anhui
Guangxi
Jiangxi
Henan
Sichuan
Heilongjiang
Hebei
Xinjiang
Hainan
Hunan
Qinghai
Ningxia
Shaanxi
Jilin
Hubei
Average
Chongqing
Liaoning
Shandong
Fujian
Guangdong
Inner Mongolia
Jiangsu
Zhejiang
Shanghai
Tianjin
Beijing
0
Source: National Bureau of Statistics. World Bank.
CHART 2
Provincial Per Capita GDP Relative To Mean
Standard deviation (left scale)
Maximum (right scale)
Minimum (right sale)
1.6
4
1.4
3.5
1.2
3
1
2.5
0.8
2
0.6
1.5
0.4
1
0.2
0.5
0
0
Source: CEIC. National Bureau of Statistics. S&P Global Ratings calculations.
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While this five-fold gap seems large--and it is--it has narrowed substantially since the late 1990s,
when it was about ten-fold (see chart 2). This shifting of income toward the central and western,
less-developed provinces is the result of deliberate policy actions to spread the benefits of China's
economic opening and modernization, which were originally heavily skewed toward the coast. To
give this per capita income gap some perspective, the comparable ratio between the richest and
poorest US states, Connecticut and Mississippi, is about two-to-one. It, too, has narrowed since
the 1960s.
What does that mean for investment levels? While there can be little argument that the allocative
efficiency of lending has declined in recent years (and by implication the investment thereby
financed), China still faces enormous long-term investment needs in order to bring the income
levels of the poorer provinces closer to the richer ones. Again, allocation matters along with
efficiency.
Property: A Local, Not A National Story
China's property market has received considerable media attention in recent years, for good
reasons. Real estate is a key component of the Chinese growth story. Estimates of the sector's
contribution to GDP range from 15% on a narrow basis to more than 25% when including ancillary
activities. And with widespread stories of overbuilding and of the existence of "ghost towns" and
their implications for non-performing bank loans, the concern is understandable.
CHART 3
China’s Property Diamond
Source: Citibank. S&P Global Ratings
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However, like the U.S., China's property markets are local, not national. The key markets are
roughly defined by a diamond containing Beijing, Shanghai, Shenzhen, Chengdu and Wuhan as its
focal points (see chart 3). (We will see this diamond again later in this report.) These markets,
which reflect China's urbanization pattern to date, are in relatively high-demand and expanding;
and the risk of a crash is therefore relatively low in our view. Indeed, the core cities, particularly the
ones on the coast, have seen price growth far outstripping the rest of the country.
So where is the problem and how big is it? The overinvested, riskier parts of the property market
tend to be relatively small, low value, and located in less-developed parts of the country. The
economic prospects of these regions tend to be weak and hence do not draw any inward migration
to support real estate growth. The local governments in these areas may need to bail out some
small-sized developers of ghost towns and their bank creditors, but we see these risks as largely
contained and non-systemic.
Recently, developers have become savvier in focusing on these key metropolitan areas instead,
where there is population growth and housing-upgrade demand. Indeed, this groundwork can be
laid since China's urbanization is said to have another two decades or so to run. The percentage of
the population living in urban areas recently exceeded 50%, is rising by about 1 percentage point
per year, and is expected to eventually settle in the 70%-75% range.
China's Surprisingly High Logistics Costs Suggest Much Work Remains
To Be Done
A key constraint to convergence within the provinces is the contrasting state of infrastructure. We
can illuminate the scope of this challenge through logistics data. What is the cost of getting goods
from point A to point B in China relative to other economies? (The logistics data below for China
reflect a breakdown of roughly one-half for transportation, one-third for inventory and the rest for
management costs; these shares have been stable over time.)
Given the perception of too much infrastructure in China, the answer is surprising. China spends
about twice the share of GDP on logistics as the U.S. and Europe, and even more than India as
shown in chart 4. The most recent data show that China spends 18%-20% of its GDP on logistics as
compared with 9% in the U.S. Europe spends just 8% of its GDP on logistics and Japan spends
11%. Even India spends a relatively low 13% of its GDP on logistics, although that probably reflects
a low level of manufacturing penetration rather than efficiency.
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CHART 4
Logistics Costs
(%)
Total costs in logistics -- China (right scale)
Cost of GDP -- China (left scale)
Cost of GDP -- US (left scale)
Cost of GDP -- Japan (left scale)
(RMB trillian)
30
12
25
10
20
8
15
6
10
4
5
2
0
0
Source: China National Reform Commission.
What's going on? The short answer is that China's logistics spending and build-out has to date
been concentrated in the eastern and coastal provinces. That is our diamond noted earlier. The
larger and more geographically challenging western and central provinces lag behind. It should be
noted that these statistics span all delivery methods for goods transport: roads, pipeline,
waterways, etc.
China Has Energy Infrastructure Needs As Well
China also has substantial infrastructure investment needs in the energy sector. These include
diversifying the composition of energy creation as well as addressing pollution concerns. The
government's main objective in this area is to reduce the country's reliance on coal, which supplies
nearly two-thirds of China's energy needs. Coal-fired power is largely to blame for the country's
crisis-level smog and pollution problems, which have led to pressure on the government to move to
cleaner alternatives This two-thirds share is far above the contribution of coal in other major
countries (see chart 5).
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CHART 5
Primary Energy Sources
Coal
(%)
Oil
Natural gas
Nuclear
Renewables and waste
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
China
Korea
Japan
Germany
United States
France
Source: International Energy Agency.
The national goal is to lower coal's share of primary energy consumption to 58% from 64% over the
five-year period 2016-2020. Over the same period, the government wants to raise the share of
natural gas in the total energy mix to 10% from 6%, and that of nuclear and renewable energy to
15% from 11%. This profound change in the energy matrix will require investment in gas pipelines
and the electricity grid. It will also help to bridge the income gap by providing new sources of
employment. Importantly, this movement toward cleaner fuels also has a western province flavor
since five provinces-- four of which are in the west --produce 85% of China's natural gas.
Finally, there is a geopolitical security element to energy investment. In order to mitigate supply
disruption risks, China is moving to diversify its sources as well as its delivery systems. New
projects with Russia and Central Asia countries, as well as Qatar, to deliver oil and/or gas will
increase the sources of supply. And the new pipelines and ports to service these sources, including
a pipeline from southwestern Yunnan province across Myanmar to the Andaman Sea, bypassing
the vulnerable Straits of Malacca, will diversify the energy supply chain.
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Driving The Geographic Investment Shift--A: Intra-Governmental
Transfers
Given the key role of the provincial public sector in financing Chinese investment, the condition of
the finances at this level of government is critical. Unfortunately, we find relatively weak public
sector accounts in the poorer provinces, which present a formidable challenge to driving continued
investment in these regions. We will focus on debt levels and revenue structures to illustrate our
point.
Provincial debt data are shown in chart 6. As with per capita income, there is a large dispersion
across provinces. The key point here is the negative relationship between per capita income and
the provincial debt-to-GDP ratios. The general pattern is that the poorer provinces have much
higher ratios. And therefore much less fiscal space to finance investment.
CHART 6
Debt-To-Provincial Government Operation Revenue
Total debt stock (type I, II, III)
Narrow debt stock (type I)
350%
300%
250%
200%
150%
100%
50%
0%
Source: Local government fiscal and economic reports. S&P Global Ratings.
Turning to the revenue structure across provinces, we see a similar pattern. We have broken down
provincial revenue between recurring (own) revenue, land sales (proceeds from issuing long-term
leases to property developers), and transfers from the central government. Again we see that the
richer the province, the more sustainable the revenue composition. Beijing and Shanghai have the
lowest dependency on central government transfers at 2% and 5% of total revenue, respectively,
while Tianjin, the richest province has the highest share of own recurring income at 70% of total
revenue. In contrast, the poorer provinces get over one-half of their revenue in the form of central
government transfers and have relatively small shares for land sales (see chart 7).
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CHART 7
Provincial Government's Revenue Composition
Transfer from central (left scale)
Land sale (left scale)
Own recurring income (left scale)
GDP per capita (right scale)
100%
20000
90%
18000
80%
16000
70%
14000
60%
12000
50%
10000
40%
8000
30%
6000
20%
4000
10%
2000
0
Beijing
Shanghai
Tianjin
Jiangsu
Zhejiang
Guangdong
Fujian
Shandong
Hubei
Chongqing
Hainan
Shanxi
Jiangxi
Hebei
Liaoning
Shaanxi
Henan
Sichuan
Henan
Guangxi
Jilin
Inner Mongolia
Guizhou
Ningxia
Yunnan
Xinjiang
Gansu
Heilongjiang
Qinghai
0%
Source: Local government fiscal and economic reports. S&P Global Ratings.
The challenge is to ensure that local governments have the fiscal resources to continue to fund
their respective infrastructure build-outs. The debt swaps by creditor banks in the past few years
have, in effect, thrown a lifeline to provincial governments by lengthening maturities and lowering
debt service. However, the large state banks that provided the swaps do not have infinite space for
balance sheet expansion so this is not a sustainable solution. That leaves the central government
to save the day in the form of continued transfers. Here, there is a question of political will since,
given the rising stock of central government debt, these transfers will need to increasingly be
financed out of revenue, rather than through debt, which means that the richer provinces will have
to directly contribute to the budget in order to help fund the poorer ones.
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Driving The Geographic Investment Shift--B: FDI
This geographic reallocation of financing investment can also be seen through the lens of foreign
direct investments (FDI). China maintains a sizable "foreign invested" sector. This was originally
focused on export-oriented assets and based largely in the coastal provinces. However, with the
rise of China's middle class, the shift of relative incomes and purchasing power inward, and the
growing comfort of foreign investors with the China, FDI has followed (see chart 8).
CHART 8
Inward FDI By Region
North-East
North Coast
Eastern Coast
South Coast
Middle Yellow River
Middle Yangtze River
South-West
Big Northwest
45
40
35
30
25
20
15
10
5
0
1995
2000
2005
2010
2015
Source: CEIC.
In 1995, over 40% of FDI into China went to the southern coastal provinces. This was because these
provinces opened up first, and were physically and financially linked to Hong Kong, China's
gateway to the rest of the world. Ten years later, however, the share of FDI going to southern
coastal provinces had halved, and the eastern coastal provinces around Shanghai surged ahead
with a 35% share. As of 2015, the northern coastal region around Beijing and Tianjin had pulled
even with the Shanghai region, with both the middle (interior) Yangtze and Yellow River regions
gaining as well. Sichuan province in particular has been very successful in attracting GDP in recent
years, and as of 2015 boasted that around 300 of the Fortune 500 companies are operating there.
While FDI remains a small part of China's total investment--it is was 2.9% of fixed asset
investment (FAI) in 2015 and has never exceeded 15% of FAI--it is important to remember that this
is mostly not about the money. China has long had sufficient savings to finance its investment and
growth. Embedded in FDI is international know-how--technology and operational best practices-that are very important in helping the recipient firms improve productivity and move up the value
and per capita income ladder.
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Driving The Geographic Investment Shift--C: The AIIB And One Belt,
One Road
Our final, and newest driver of the provincial investment shift will be project-funding provided by
the Asia Infrastructure Investment Bank (AIIB) and under the One Belt, One Road (OBOR) initiative.
The AIIB is a China-led multilateral entity with 52 signatories3. It will be focused mainly on
financing infrastructure projects across all of Asia and beyond (including in conjunction with other
multilateral banks). Related to the AIIB is Beijing's OBOR initiative, which is aimed at restoring the
historical land and maritime trade routes to major markets in Asia, the Middle East, Africa and
Europe.
CHART 9
One Belt, One Road Projects
Source: Mercator Institute for China Studies.
Given the development-bank nature of these investments, they will be skewed toward regions in
China that need funding to undertake their infrastructure projects.. The far west province of
Xinjiang and relatively undeveloped coastal province of Fujian have already seen investment to
develop them as land and sea economic corridors. We can expect to see further investment in
relatively poor western and southwestern provinces – like Yunnan - to support trade and economic
integration with neighboring Asian countries which will themselves see larger scale OBOR
investment.
The AIIB and OBOR constitute yet another channel to address the internal investment reallocation
issue in China (this time connected to larger investment projects involving neighboring countries).
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The twist for this channel will be the amount of foreign as well as private sector funding. The scale
and success of these initiatives, including the ultimate amounts of financial support involved,
remain unclear as of this writing. The constraints are both on implementation as well as the
willingness of the market to provide the financing. What is clear is that this is yet another
important strategy to closing China's internal investment gap.
China Is Not Simply Overinvested: Geographic Allocation Matters
Overinvestment and the implied issues of efficiency and sustainability are a central part of today's
China macroeconomic story. At one level, those concerns are valid. But by focusing on the macro
level at the expense of provincial and sectoral data, they paint a potentially misleading picture.
China's investment challenge, and ultimately its long-term challenge of achieving first-world
economy status, is more subtle. This is to redeploy investment toward the less-developed areas of
the country, with a view to building out their infrastructure quality across a number of metrics and
thereby driving a continued national convergence in productivity and per capita income.
Achieving this complex goal will require progress on a number of related fronts. Structural reform
in the existing state-owned enterprises will need to be accelerated and deepened in order to free
up resources and relieve pressure on public sector balance sheets. The creation of public finance
space will help to maintain transfers to the relatively poor provincial governments, which continue
to rely on such transfers to fund their infrastructure needs, given weak revenue generating
capacity (which will need to be addressed) and land sales. In the cross-border public sector, new
institutions such as the AIIB and OBOR will support the build-out of a range of infrastructure
projects in the central and western regions. And in the cross-border corporate space, continued
FDI into these regions--and the accompanying transfer of knowledge-- will be required to further
reduce costs, boost productivity, and drive the convergence of income across provinces.
1
The S&P Global China Senior Analyst Group is sponsored by the APAC Leadership Council. Its members are, in alphabetical
order: Terry Chan (Ratings), Vincent Conti (Ratings), Paul Gruenwald (Ratings), Christopher Lee (Ratings), Sebastian Lewis
(Platts), Chunchun Li (Corporate), HongMei Li (Platts), Qiang Liao (Ratings), Xin Liu (Ratings), Priscilla Luk (Indices), Yen Ling
Song (Platts), KimEng Tan (Ratings), Clemens Thym (MI), Ryan Tsang (Ratings), Zhuwei Wang (Platts), and Christopher Yip
(Ratings).
2
https://openknowledge.worldbank.org/bitstream/handle/10986/16045/WPS6594.pdf?sequence=1&isAllowed=y.
3
https://www.aiib.org/en/about-aiib/governance/members-of-bank/index.html)
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