Analysis: China subway boom spotlights investment risks

In the Chinese city of Nanchang, where the local government is building a new subway network, the modern train station rising out of the red earth sits in an empty part of town. The crowds that Nanchang envisions will someday use its metro are nowhere in sight.

Nanchang's population of three million -- relatively small by China's standards -- and the municipality's finances raise questions about the subway's viability and makes the city a case study of the risks China takes when it relies on investment to power growth.

"In the future, when we need to sustain growth, we need to come up with even bigger investment projects," said Zhang Zhiwei, a Nomura economist. "This is not sustainable."

As the world's second-biggest economy limps to its weakest full-year expansion in 13 years, Beijing has leaned once again on a tried-and-tested model of ramping up investment, this time in subways, bridges and other infrastructure, to aid growth.

To do this, the government has accelerated approvals for investments that were already planned, in the hope that this will be a more measured way of supporting the economy than the 4 trillion yuan ($640.87 billion) stimulus program unleashed during the global financial crisis, which sparked widespread construction spending by local administrations and a hangover of debt.

In just six months this year, Beijing has approved the building or expansion of metro lines in 23 Chinese cities. Nanchang, in eastern China, is one of the smallest cities building a subway system.

Nanchang's government says the network will meet the needs of a growing population, which it expects to increase 15 percent by 2015, that will put it on the map as a "big city".

But critics see it as an extravagance that underlines China's need to consume more and invest less.

The city plans to build two subway lines over 51 km by 2015 at a cost of 27.4 billion yuan - 10 percent of its 2011 GDP and 67 percent of 2011 fiscal revenues.

More investment will follow in three additional lines stretching 117 km by 2020.

"This is not something that if you want today, you can have tomorrow," said Wang Chaohua, a deputy general manager at the Nanchang Railway Transit Group. "A subway line will burnish Nanchang's branding as a big city."

The International Monetary Fund, most private economists and even the central Chinese government, agree the country needs to move away from investment-led growth.

Economists say investment this year will account for half of China's GDP, little changed from its 49 percent contribution in 2011. More developed economies rely on consumption for 60 percent to 75 percent of their economic activity.

The risk in relying on investment for growth is that it can create waste, such as roads to nowhere, build up bad debt, strain state coffers and stifle domestic consumption.

IMF researchers estimated in November that China over-invests at a cost of 4 percent of GDP a year -- or the equivalent of $303 billion -- and said it needs to reduce investment by 10 percentage points of GDP to keep its economy stable.

In the town of Lehua in west Nanchang, some locals have come to a similar conclusion as the IMF, at least in the city's case, where investment accounted for 74 percent of its GDP in 2011.

On a recent weekday afternoon when there was more poultry on the streets than people, a local grocer doubted the new subway will draw enough commuters to make the investment worthwhile.

"There are few people here. It has been this empty for 10 years," said Wan, declining to give her full name. "The economy just can't develop."

DEEP DEBT

Critics of China's infrastructure spending cite the 10.7 trillion yuan in local government debt accumulated after the 2008/09 financial crisis as evidence of potential risks. Up to a third of that could be non-performing debt, analysts say.

In Nanchang, the government had a budget surplus of 11.2 billion yuan in 2011, thanks to transfers from Beijing and revenues from land sales. But analysts say that figure is misleading.

Like many of its peers, Nanchang's government uses shell companies -- or financing vehicles -- to borrow on its behalf to fund off-budget expenses and pump-prime the local economy.

Public records show Nanchang's government has at least two such financing vehicles, which are both deeply in debt.

The Nanchang Municipal Public Investment Holding Co. Ltd had total debt of 13.5 billion yuan in 2011, nearly 28 times its operating cash flows.

The second, Nanchang City Construction Investment Development Co. Ltd., had negative cash flows of 155.6 million yuan last year and total debt of 10.6 billion yuan.

Such debt means loan defaults could spike if the economy stalls, says Fitch Ratings, which has a negative outlook on China's AA minus sovereign local currency rating.

That said, while metro lines are costly and tend to provide low returns at best, not all Chinese subway plans are unwise.

Supporters of the investment growth model note there is room for more investment despite the splurge of the past five years.

In China, investment in capital goods per person is only 6 to 7 percent that of the United States, a 2011 study by GaveKal-Dragonomics, a macroeconomic consulting firm shows. Infrastructure spending is a big component of overall capital investment.

Extending subway lines to sparsely populated areas that may be future high-density neighborhoods allows cities to plan their urban environment before it is too late, said Gerald Ollivier, a transport specialist at the World Bank.

Doing so now can save costs as subway lines become more costly to build as economies grow, he said, stressing that each subway project needs to be reviewed on its own merit.

That would certainly fit with Beijing and Shenzhen, which were ranked by IBM's Global Commuter Pain Survey as the second- and third-most congested places in the world last year, trailing only Mexico City.

The trick, argues Zhao Jian, a professor at Beijing's Jiaotong University, is for China to allow no more than 20 of its biggest cities to build subways to minimize any losses. Such a ranking would exclude Nanchang.

Whatever the economics, costs do not necessarily concern a lot of Chinese. Chen Lianying, a 58-year-old cleaner at the subway station construction site in west Nanchang, says her home is just a 20-minute walk away so she returns for lunch every day.

"Of course it's good to build a subway line. It's time we people enjoy life," she said. ($1 = 6.2415 Chinese yuan)

(Additional reporting by Lucy Hornby; Reporting by Koh Gui Qing; Editing by Bill Powell and Neil Fullick)