Climbing China’s Debt Mountain

By Michael King 

President Xi Jinping secured another five years leading China and further cemented his already substantial powerbase when he was appointed general secretary of the Communist Party at a week-long congress in October.

Ahead of what was in effect a rubber-stamping ceremony for the current leader, who The Economist recently hailed as the world’s most powerful man, Xi also received a boost from the International Monetary Fund, or IMF, which raised its growth forecast for the world’s second-largest economy. The IMF now expects China’s economy to expand by 6.8 percent this year, up from its previous estimate of 6.7 percent. It also raised its 2018 GDP growth forecast from 6.4 percent to 6.5 percent.

The IMF’s upwardly revised forecasts bode well for the region’s project industry. The upgrades were predicated on the belief that Xi’s government would continue the policy of investment-fueled growth – designed to double real GDP over 2010-2020 – which has generated a large chunk of the demand from Asia enjoyed by carriers and forwarders this decade.

However, there was a sting in the IMF’s tail, one of direct relevance to anyone in freight. The fund warned of a serious and rising risk to China’s economy due to its spiraling debt, and called on government to accelerate “recent encouraging efforts to curb the expansion of credit” or face a “heightened probability of a sharp slowdown” in GDP growth.

“A growth slowdown in China would have adverse repercussions for other economies through weaker trade, commodity prices and confidence,” added the IMF.

On Borrowed Time

Economists are in broad agreement that China’s economic chickens will, at some point soon, come home to roost. As exports fell after the global financial crisis in 2008, China stimulated its economy with high levels of infrastructure investment, which saw local governments and state-owned enterprises, or SOEs, borrow at unprecedented levels as they flung huge sums at major capital projects. According to one estimate, from 2011 to 2013 China used more cement than the U.S. did in the entire 20th century.

China’s investment-led growth during the last decade benefited the rest of Asia and, indeed, the world. But the pace of credit growth was alarming, as China’s debt load as a percentage of GDP expanded on average more than 10 percent per year since the global financial crisis. By 2016, the IMF found that the ratio had ballooned to 234 percent of GDP. Earlier this year, ratings agencies Standard and Poor’s and Moody’s both cut their sovereign rating on China, citing rapidly accumulating debt.

So what happens next? China’s economic priorities are difficult to decipher with any certainty – more insight from Xi’s administration is expected in the coming months once his second term policies become clearer. But, based on previous pronouncements and initiatives, it seems likely he will take steps to stabilize debt and refocus investment priorities, moves that will have direct repercussions for the project industry.

Indeed, investment levels already appear in decline. Japanese financial company Nomura estimates that real investment growth has slowed significantly since the second quarter of 2016, falling into negative territory in the third quarter of 2017 for the first time since comparative data became available in 2004.

“China is making progress in shifting from an investment-driven growth model to one more reliant on consumption,” said Chief China Economist Yang Zhao. “However, the weak investment momentum does highlight downside risks to economic growth. We maintain our view of an economic slowdown in coming quarters.”

Managing The Debt Problem

Reducing China’s debt problem will eventually involve tackling its hugely indebted SOEs, a challenge intelligence provider Stratfor believes has been on Beijing’s to-do list for some time. But forcing them to take a more commercially focused approach has, for the most part, taken a back seat to the SOEs’ chief objective of serving the government’s investment-driven growth strategy and keeping employment levels up.

“Though these goals have routinely led to inefficiency and corporate bloat, the companies’ central role in Beijing’s economic and political policies has guaranteed them unfettered access to funding and government aid,” said a recent Stratfor report. It concluded that SOE debts were “a house of cards” and a growing threat to China’s economy.

Beijing’s efforts to address the issue have thus far focused on allowing some “zombie companies” to go bankrupt, but the overriding political aim has been to retain and strengthen government control of the country’s most critical sectors, rather than root out and address the sources of SOE inefficiency.

Zhixing Zhang, senior east Asia analyst at Stratfor, told Breakbulk that President Xi’s government was well aware of its debt risk, and in recent months had slowed down credit expansion to deleverage structural financial risk, while also balancing this against the need to maintain social stability and employment. “In the long term, we expect the Chinese government will continue to rebalance, or reduce, its reliance on investment in capital projects, but also use targeted credit expansion,” she said.

This could see more focus on development of western provinces, as well as further investment overseas as part of President Xi’s One Belt and One Road, or OBOR, initiative, which comprises the land-based Silk Road Economic Belt and the ocean-going Maritime Silk Road. Zhang also said that SOEs could gradually take a more profit-driven approach to investments at home and abroad.

Few Signs of Slowdown

Yet, although it seems certain that at some future point China’s economy will need to cut debt by weaning itself off capital investments as a means of stimulating growth, the project industry is seeing few signs of a slowdown, with any notable reining in of domestic investment more than offset by China’s global ambitions – and its willingness to spend heavily to support them.

Li Jiang, head of industrial projects, China and global bulk chartering at DHL Global Forwarding, said that although domestic projects commissioned by Chinese SOEs had dropped off in line with supply-side reforms by central government, overseas project investment was increasing in accordance with President Xi’s “Go Global Policy,” a blueprint he believes will guide SOE and government investments in future.

“The demand for project forwarding services is booming in China at the moment, mainly driven by SOEs’ leading projects under China’s Belt and Road initiative,” he said.

“We foresee an upward trend in demand for conventional power plants, onshore and offshore wind farms, chemical plants for ammonia and urea, and railways, especially Chinese high-speed trains.”

James Che, head of energy and project solutions for Greater China at Panalpina, also highlighted the impact of China’s global outreach efforts, which he said were opening up “considerable” business opportunities.

“The country has become the world’s biggest manufacturing powerhouse and the most successful exporting country of integrated engineering, procurement and construction solutions,” he added. “All of this has created a strong demand for logistics covering all kinds of cargo types and trade lanes.”

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Panalpina entered the China projects market in 1999 and now also offers consulting services to help customers with EPC bidding and project logistics management. According to Che, in more recent years capital projects demand has been strongest for infrastructure (ports, roads, bridges, tunnels, railways), public service and government projects (metro and high-speed trains) and energy (nuclear, wind, solar, coal-fired). Overseas shipments from China that Panalpina’s energy and project solutions division has either controlled or supported recently also include mining and minerals shipments to Latin America and Africa, and petrochemical shipments to the Middle East.

“Although China is in a long-term structural adjustment phase towards lower GDP growth, it maintains world-leading growth levels, and China is still the single largest contributor to global economic growth,” he explained. “In recent years, the Chinese government has pushed ahead with the reform and restructuring of SOEs as well as reforms on the supply side.”

But while SOEs remain the executors of China’s desire to make its presence felt more keenly on a global scale, their collective modus operandi is expected to evolve. “We expect to see explosive growth in the coming five to 10 years in infrastructure, energy and manufacturing sectors,” Che said. “However, domestic and overseas investments will become more rational and prudent due to tighter risk control and stricter industry guidance by the government.

Favoring Home-Grown

Yet while China’s support of OBOR and other global initiatives designed to meet its geopolitical aims are helping support project demand, there are suggestions that if the Chinese government is going to foot the bill, then Chinese companies will be favored when contracts are dished out.

Shanghai-based Christophe Grammare, head of the China region at AAL, said demand for shipments linked to OBOR had “exploded” in the last two years, as Chinese businesses invested heavily abroad, particularly in Southeast Asia. But he doubted whether many of these projects were being pursued for profit, an approach that has ramifications all along the supply chain.

Explaining his point, he told Breakbulk that if a project that should cost US$10 billion was instead given a nominal paper value of just US$2 billion, then the rates available to shipping companies were also, by necessity, far below realistic valuations. “These projects are, in my view, being built at below-market cost if you compare them with similar Japanese or European projects,” he said.

“So, what we’re seeing with a lot of Belt and Road initiatives is that all the cargo is being carried by Chinese carriers and operators at rates which I would expect other carriers cannot compete. We have a lot of large forwarders we visit and they offer us freight, but not at rate levels we operate at. I doubt anyone can operate at this kind of rate level. But Chinese carriers are, so the losses being generated are being covered by someone up the ladder.”

In short, Grammare believes that Chinese supply chain providers are essentially being subsidized to support government policy overseas. “China is very efficient,” he said. “When they decide something, they usually have the means to do it. So, what we’re witnessing is the execution of that policy, which can also basically be understood as: it’s Chinese money, it’s Chinese investment, we’ll use Chinese operators so the money stays in the loop.”

Henry Woo, director and head of APAC region at Hansa Heavy Lift, also reported increased recent competition from Chinese carriers. “What has taken us by surprise on several occasions is how aggressive Chinese carriers are in setting their rates,” he said. “It can make one question the philosophy of the Chinese carriers’ organization and how can they possibly sustain themselves in the long run.”

Growth Of Chinese Carriers

The ascendancy of Chinese carriers has become evident at the port of Shanghai, where Luojing terminal is the main breakbulk gateway terminal.

“From the statistics I’ve seen, 50 percent of the trade now from Luojing is driven by the Belt and Road initiative, and there is also a fair amount of intra-Asia traffic which is relatively new and which as a foreign carrier we are not entitled to carry,” Grammare said. “Volumes at the port are rising, but if we look at the share of cargo from the port, less and less of that cargo is available on what I would call the open market cargo that international carriers can access.”

The upshot is that AAL’s own volumes have remained steady, but the carrier’s share of cargo handled at Luojing has fallen as Chinese carriers have secured larger shares.

Woo, however, maintains that the encroachment of Chinese carriers into the market will only be possible up to a certain point, at least in the short term. He argues that as China’s manufacturers move up the technology tree and take on more complex projects, they will need ever more sophisticated supply chain solutions. “We are seeing Chinese yards and fabricators maturing, particularly for the oil and gas and mining industries,” he said. “It would take some years for other developing countries to meet China’s competitiveness and production levels.

“So, in the short to mid-term, Chinese companies will still require the expertise of foreign companies to support deliveries of finished products – particularly if Chinese companies are advancing to more sophisticated, bigger, and heavier fabrications.”

All eyes will be firmly fixed on that latest policy pronouncements of President Xi in the months ahead.

Michael King is a multi-award winning journalist as well as a shipping and logistics consultant.

Photo illustration: Catherine Dorrough; source images via Shutterstock

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