The $505 Billion Puzzle Behind China's Stock Rally

(Bloomberg Opinion) -- The $8.3 billion bill that Congress has passed to combat the coronavirus may seem like a lot, but to China, it’s pennies. Beijing has spent its way out of distress before, and may just reach for a trillion-dollar fiscal stimulus again. 

Investors understandably got excited after media reports that seven out of 31 provincial-level governments have pledged to spend a combined 24.5 trillion yuan — with 3.5 trillion yuan ($505 billion) slated for this year — on infrastructure projects. The final amount will certainly be much higher, as other municipals join the fray. 

Hope for a big-ticket fiscal package isn’t unfounded. After the collapse of Lehman Brothers Holdings Inc., China spent 4 trillion yuan building roads, bridges and railways, successfully pulling itself out of a slump. And there are tantalizing signs that China will deliver: To grease local governments’ access to financing, Beijing has allowed its underlings to issue special-purpose bonds early, to the tune of over 1.8 trillion yuan.

This optimism, coupled with monetary easing, has helped China’s stock market stage a V-shaped rebound. Infrastructure stocks tracked by the CSI 300 Index are up 12% from a low in early February.

But don’t get carried away. These flashy headline figures come from fawning local-government officials, eager to deliver growth targets to Beijing. What gets done is a different matter.

Some projects are clearly just blueprints awaiting a final nod. For instance, Yunnan province, the most aggressive of the bunch, is planning a high-speed railway linking its capital Kunming to the resort town of Lijiang. Beijing may balk at the cost, estimated at 100 billion yuan, or about 5% of the province’s gross domestic product, says Nomura Securities Co. 

Then there’s the fact that Yunnan’s books are in poor order. Over the years, it has had to save some of its local-government financing vehicles from the brink of bankruptcy. In early 2018, it injected 2 billion yuan of capital into a vehicle that defaulted on two trust loans. Last year, two others saw their offshore dollar bonds tumble: One entity is embroiled in a legal battle with a now-defunct energy trader, and the other had its chairman placed under investigation. Both bleed cash.

Speaking of finances, how will local governments pay for these billion-dollar projects? Last year, their general revenue rose by only 3.2%, the lowest in a decade, and well below their full-year target of 4.9%, according to Moody’s Investors Service. A big tax cut in 2019 and an economic slowdown has emptied municipals’ wallets.

China’s infrastructure investment has also been stalling, rising just 3.1% last year. For building projects to re-accelerate, local governments will need the help of banking regulators.

For now, municipals are relying on the bond market, avidly issuing special-purpose bonds that get gobbled up by obliging state-owned banks. That’s not enough. China’s annual infrastructure spending is about 17 trillion yuan, far exceeding the roughly 3 trillion yuan of bonds local governments can issue.

A lot of this comes back to Beijing’s crackdown on shadow banking, which began in late 2017. For the past five years, China has been relying on public-private partnerships to build roads and railways. Yet private money essentially fled after new rules forbade wealth management products, typically short-term, to invest in longer-term projects, a.k.a. infrastructure.

In other words, talk of fiscal stimulus is meaningless unless China's banking regulator relents.

It’s entirely possible that China is going to launch another massive fiscal package and any bet on infrastructure will pay off handsomely. But keep a close eye on sources of information. If the Ministry of Finance officially raises its fiscal deficit above 3% — an international gold standard, which Beijing has been careful not to cross — three cheers. Or if the People’s Bank of China reopens lending facilities to its policy banks, enabling projects like the shantytown redevelopment of 2015, even better. Boastful municipal officials, however, don’t make a terribly convincing case.

To contact the editor responsible for this story: Rachel Rosenthal at rrosenthal21@bloomberg.net

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

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