China’s Rising Pile of Infrastructure Debt

While China’s emergence as the world’s second biggest economy has led many developing countries to Beijing as the panacea for all economic issues, especially those related to infrastructure development, the country’s leaders are awakening to a new reality: underperformance and debt heading for a crisis.

A recent Oxford University titled “Does infrastructure investment lead to economic growth or economic fragility? Evidence from China” says overinvestment in economically unviable projects has left the country the most indebted of the 25 most emerging markets including India and Brazil and is now turning into a major issue to handle.

As Asia Sentinel has reported previously, China and the countries it is investing in are growing startling piles of debt out of governmental hubris in Bseijing. But some of the numerous projects are in danger of stopping and for most of the system profitability is believed to be problematical.

With current debt-to-GDP standing at 282 percent, exceeding that of many advanced Western economies including the US, and its per capita debt now above US$20,000, the study predicts an “infrastructure-led national financial and economic crisis” that could extend to many international markets, especially those deeply linked today with China’s economy and seeking to benefit from its ‘Silk Road’ projects.

Conventional wisdom dictates that infrastructure development precedes economic development. This is precisely the logic that countries like Pakistan, which are economically aligned with China, are currently following. However, China may prove the exception, dragging its economically aligned countries along with it.

The researchers suggest that over half of the infrastructure projects completed in China during the past three decades have performed poorly, while only 28 percent can be considered to be genuinely economically productive.

The reason, as the study suggests, for this is high “propensity to cost overruns and benefit shortfalls.” Interestingly, as the evidence suggests, debt-financed “infrastructure investments in China suffered average cost overruns of 30.6 percent” for the 95 projects studied, leading ultimately to serious shortfalls in the expected benefits and consequent loss of “economic value.” Hence, earnings have fallen far short of what given projects were expected to yield.

A case in point is of China’s YuanMo expressway. The study argues that “there was no plausible scenario in which—after suffering a 24 percent cost overrun, a 49 percent traffic shortfall, and a 53 percent toll-price shortfall—the YuanMo expressway could yield a positive return.” Hence the conclusion: cost overruns and revenue shortfalls from poor infrastructure investments caused a build-up of debt and increased the risk of economic fragility.

As the evidence suggests, “between 2000 and 2014 China’s total debt grew from US$2.1 trillion to US$28.2 trillion, in current prices—an increase of US$26.1 trillion, greater than the GDP of the US, Japan, and Germany combined. The growth in China’s absolute debt is neck and neck with the total capital investment, which between 2000 and 2014 was cumulatively US$29.1 trillion.”

These figures directly challenge the prevailing wisdom that investment in infrastructure leads to economic growth. In the case of China, the contrary has happened, and the reason for such an internally fragile situation is poor economic decisions based upon what the authors call “delusional optimism” rather than rational thinking and accurate estimates of cost and benefits, which then directly contribute to the pile of debt.

Needless to say, as the study has found, “China’s is the second-most indebted government in the world” after Japan. This has happened in conjunction with the fact that China is also the “world’s biggest spender on fixed assets in absolute terms.”

With most of the investments being debt-fueled since 2000, the question of the economic viability of these projects thus necessarily emerges and leads to an explanation of why, taking a cue from the study, “the most tangible consequences of poor investment decisions have been an accumulation of a destabilizing pile of debt in the economy; unprecedented monetary expansion—even larger than the quantitative easing programs of the US, the Euro area, the UK, and Japan combined—and subsequent economic fragility to financial crises.”

Most certainly, the “debt-fueled” investments in projects expected to yield high revenue and other benefits have become the bane of China’s economy. However, against conventional wisdom, China is continuing to follow the same economic logic in investments it is making overseas.

An interesting case in point can be the highly-valued China-Pakistan Economic Corridor (CPEC). Promising though it looks on the face of it, CPEC is one of the most highly debt-financed projects in the history of Pakistan and appears to be suffering from the same “delusional optimism” as the authors call it that China’s policy-makers are using, making the CEPC yet another case of debt-financed investment causing fragility rather than economic growth. Significantly, the Singapore Port Authority pulled out of an agreement to operate the Gwadar port at the eastern terminus of the project in 2012.

Saddled with loans as this project is, the economic logic working behind it is also the same as in China: infrastructural developments leads to economic growth. While more than US$51 billion has so far been put into it, an economic breakdown reveals that it is equally suffering from “cost overruns and benefit shortfalls.”

Contrary to the official narrative that China’s trade via Pakistan will reduce the distance and yield both strategic and economic benefits, Dr Farrukh Saleem, a Pakistani economist, told Asia Sentinel that contrary is the case.

For instance, great importance has been attached to the “corridor” portion of CPEC (which is roughly US$11 billion, or 25 percent of the total) and time and again Pakistan authorities have predicted the economic boom this corridor will yield in the near future. For China, however, the cost of transferring goods from Pakistan to its main population and industrial centers will end up much higher than what it has to defray currently, according to the analyst.

Consider this: the 887km National Highway-35, which is the Pakistani portion of the Karakoram Highway (KKH), will link the Gwadar port to Kashgar. However, the distance from Kashgar to China’s main population centers such as Guangzhou, with a population of nearly 45 million, is 5,554 km. Similarly, the largest mainland industrial center in China is Beijing and Beijing is 4,357 km from Kashgar.

Given the distance between Gwadar and China’s main population and industrial centers, transport of goods from and to Gwadar makes no economic sense. And given that China has more than 2,000 ports of which 130 are open to foreign ships and that China’s largest metropolitan areas and its industrial hubs are all only a few hundred kilometers from China’s ports, transport of goods via land route makes least viable economic sense.

Therefore, Farrukh argues, for instance if oil is transported from Gwadar to China’s population and industrial hubs, the cost would come out to be around US$70 per cubic meter as against the current cost of $10 per cubic meter. He further argues, “moving a barrel of oil from Ras al Tanura (in Saudi Arabia) to Shanghai in a two million barrel vessel moving at a speed of 23 km per hour at a ship rate of $80,000 per day will cost $0.90 a barrel, and moving a seaborne barrel of oil from Ras al Tanura to Gwadar and then overland to Chongqing will cost anywhere from a low of $7.15 to a high of $12.40 per barrel.” as

The cost of building the overland rail network connecting Pakistan and China has already jumped from US$3.56 billion to US$8 billion. Hence, the classic case of what the authors of the Oxford study have termed cost overruns and benefit shortfalls and overestimation of benefits and underestimation of costs.

How this high-cost transport of oil will impact China’s economy is not difficult to discern. Furthermore, this route will have the capacity to transport approximately only 175,000 barrels per day as against China’s need to import close to 8 million barrels per day at its peak efficiency. Given this capacity, 175,000 barrels a day means next to nothing for China’s economic needs. Hence the question: how viable and economically efficient this whole corridor will turn out to be for China in the long run?

While the ‘cost overrun and benefit shortfall’ will crucially impact Pakistan too, China does not stand to gain much of what it is being expected out of CPEC. Given the extremely poor performance of a great majority of such projects in China, the question that many economists and analysts in Pakistan and elsewhere are asking is: will CPEC be yet another addition to China’s already high proportion of non-performing loans and pile of debt?

While the case in hand, CPEC, does suggest that (over)investment in economically inviable infrastructural projects does not per se guarantee development, the said study has also brought forth many evidences that show the worrying side of China’s otherwise high-economic growth and the ultimate end it is headed to: financial and economic crisis. Hence the question for the countries seeking to jump on the China’s bandwagon: should they necessarily be basking in China’s ‘glory’?