Roads to nowhere won’t lead China out of crisis

With the coronavirus shutting down large parts of China, plans for big infrastructure spending to stimulate the economy are rising. But what will be built, and for whom?  

The scale seems striking. Several provinces have cumulatively announced plans to build or restart around 25 trillion yuan ($3.6 trillion) of projects over the next few years. For 2020, that amounts to around 3.5 trillion yuan of expenditure. To finance this building spree, around 950 billion yuan of special bonds were issued in the first two months of the year, with close to 70% for infrastructure.Work has resumed on more than 500 major highway and waterway projects that had been halted with the outbreak, and local governments are pushing for more. There are also some encouraging indicators as the country begins to emerge from lockdown. Factory restarts and return-to-work numbers are getting better. Rail and freight data are edging up. Machine operating rates have been rising at a faster pace than workers are returning to their jobs, suggesting a rush to show construction activity and boost sentiment.  Whether all this building actually gets done is one issue. China has large swathes of land and rural areas outside the southern and eastern regions that could use infrastructure, but they have always needed an uplift. A more pressing question is what purpose is served besides deploying money on roads to nowhere. The economy remains hung-over from excesses of past stimuli. Will one more highway in the hinterland boost car sales? Can a maglev rail line ease pressures on crippled industrial and tech supply chains?

Much of the spending is intended to address an impending hit to growth from the virus and the latent effects of  the trade war with the U.S. It comes as the central and local governments race to meet targets under the current five-year plan while heading into a new one. But attempting to prop up growth numbers won’t return workers to the parts of the economy that need it most or get companies the parts they need.The headline numbers might not even be met. A 1% increase in infrastructure investment can lift nominal gross domestic product by 0.1 percentage points, according to HSBC Holdings Plc analysts. That means, they say, that such spending needs to grow by 10% to 12%, from 6% to 8% previously, to help reach the growth target of at least 5.7%.(1) Home-bound investors have cheered the prospect of infrastructure stimulus, China’s fallback in tough times. Stock prices of domestic construction machinery makers Sany Heavy Industry Co. and Jiangsu Hengli Hydraulic Co., which should benefit from a push to build, have far outpaced the benchmark Shanghai Stock Exchange Composite index over the last month, even as large parts of China were effectively shut.

The foundations of such hope-based bets are flimsy. Spending doesn’t directly translate to growth because it includes outlays on land acquisition, for instance. In addition, a look at machine-operating rates as of February shows that activity has increased most in the already built-up southern and coastal regions. Meanwhile, the companies that are back to work are mainly state-backed. The country needs factories to be up and running, not smoother roads.

Part of what’s driving these stocks to multi-year highs is that Beijing is pulling out all the stops. They’re off by a few percentage points in the latest rout, but heading up again.

Hundreds of billions of yuan are being funneled to local governments with pressured finances. The issuance of special bonds amounts to directly injecting cash into the construction sector. Approval for the new projects comes straight from the top, arguably ensuring better quality. Yet even if all this building takes off, where will the trucks and excavators come from if parts factories aren’t operating? Demand was already high pre-virus as old machines were being replaced, but growth was coming down from double-digits.

None of these measures address the problem at a hand: an economy with broken supply chains. Beijing’s reflex to build its way out of trouble is the wrong one for this crisis. President Xi Jinping says the government will back “new infrastructure” that includes 5G telecom networks and data centers. Those plans may yield results in a few years, but not in the next two quarters, when the hit to growth and manufacturing will likely be severe.

China has been through this before. If there’s one lesson from its state-sanctioned discretionary spending, it’s that public investment is no longer efficient in China and real return rates have dropped.  Each yuan does less for the economy as debt piles up and deepens China Inc.’s existing balance sheet problems. The benefits end up with the state sector, not the smaller and more fragile private side. China needs, as soon as possible, to alleviate the pain from the supply shock that is spilling over and worsening demand. Trucks and excavators can only do so much.  

To all this, add fiscal constraints. The virus has brought extra costs, with public expenditure totaling at least 90 billion yuan, according to HSBC’s analysts. But revenues are slowing, thanks to tax cuts and measures to boost demand.  

China’s road to nowhere will be a bumpy one. 

(1) In their base case scenario, the analysts assume that the virus outbreak will be better contained in March. They expect real GDP growth to slow to 4.1% from a year earlier in the first quarter, and 5.1% the second quarter, before recovering to 6.0% in the third quarter. They have cut their 2020 real GDP growth forecast to 5.3% from 5.8% previously.They also assume that China’s “around 6%” target indicates that growth should be no lower than 5.7% this year.