China Infrastructure Report Q2 2009

China's Five-Year Plans The Chinese economy has been administered and regulated through a series of five-year plans since 1953.

Modelled after the Soviet-style command economy, the idea was that they would become a vehicle for economic development - centrally-planned and controlled by the Chinese Communist Party (CCP). The CCP is responsible for setting growth targets, launching reforms and mapping strategies for economic development. Each five-year plan contains detailed economic development guidelines for all of China's regions. Interestingly, as China is moving away from the rigid structures of a centrally planned economy, the latest (eleventh) Five-Year Plan, was officially re-named Eleventh Five-Year Guidelines.

During the Tenth Five-Year Plan (2001-2005), the focus was on achieving high growth levels through more efficient industrial output, research and development (R&D) and increased employment. That was the period when the rise of the Chinese economy transformed not only China itself, but the entire East Asian region and beyond.

The Eleventh Five-Year Plan (2006-2010) is instead oriented towards 'softer' development goals, emphasising social development, eco-friendly policies, prudent resource management, political civilisation, cultural development and building a new socialist countryside. There is therefore a shift from the more industrial-based and driven economy, towards one where the achievements of the past shall be sustained and cultivated. According to the Chinese government website, 'in the industrial sector the fiveyear main task is not expansion in scale, but structural upgrading to turn China's big industry into a powerhouse'. What this means for the infrastructure sector is that we now see investments diverted into the central and western regions of the country and not just the heavily industrialised east. Road networks, railways, power grids and water irrigation systems are now at the forefront, in an effort to integrate even the most remote regions with the rest of the country, as rising incomes have produced a new middle class, more urbanised than ever before.

At present China appears committed to improving the business environment, under the terms of China's WTO accession. China's energy supply has witnessed rapid increase over the past five years, due to increased government investment in energy infrastructure projects. China's coal output in 2005 surged to 2.1bn tonnes. China generated 2.5trn kilowatt-hours (kWh) of electricity in 2005, 80% more than in 2000 and will increase power generating capacity by 40% by the end of 2010 to reach a total of 1,000 megawatts (MW).

Improved infrastructure in the transport sector has also helped boost China's transport capacity. From the period 2000-2005, an additional 6,000km of rail tracks were in operation. The total length of China's roads also expanded to 1.95mn km by the end of 2005, of which 40,000km is comprised of expressways.

In addition, the length of gas and oil pipelines totalled 38,000km.

China is revisiting an older tactic for boosting domestic demand: building up its transport network. Zheng Xinli, the vice-chairman of the Policy Research Office, was quoted by Reuters as saying 'last time when we tried to boost domestic demand we built up our highway system. This time we will probably build up our railway network.' Crucially, Chinese officials stipulate that the main difference is that the government has enough money in its coffers to pay for the projects, as opposed to issuing long-term infrastructure bonds as it did for the highways. This has very interesting implications for the infrastructure sector, especially for the large state-owned infrastructure and civil engineering players, which are looking forward to major contracts in the coming two years.

Regarding the regulatory and competitive landscape, China's construction industry remains quite protected. State-owned companies drive the construction sector in China. There are about 9,000 stateowned construction corporations, compared with just 400 foreign-owned firms doing business in the country. Foreign construction companies are allowed to form joint ventures and are eligible to bid for works that are entirely foreign-funded or for projects that local companies are unable to undertake.

However, the government does not allow foreign enterprises to undertake design, construction or consulting alone.

While the construction and engineering sector is dominated by a handful of major state-owned enterprises, their contribution to total construction output is being eroded by the recent influx of foreign contractors, encouraged by ongoing economic reforms. It is estimated that about US$50bn-worth of construction projects are open to foreign participation every year, mainly in transport and water infrastructure. Key locations for construction spending are Beijing, Shanghai and the western provinces.

PPP's for infrastructure development in China varies from sector to sector. Certain sectors are considered of strategic importance and have traditionally been closed off to the private sector, and more specifically private overseas investors. One example is the power grid infrastructure, where the two players allowed in the sector are the state-owned China State Grid Corporation and China's Southern Power Grid. The infrastructure sector remains under the heavy control of the Ministries and National Development and Reform Commission (NDRC) and therefore participation form private sector remains limited. That being said, the infrastructure needs of China are reaching a point where projects are becoming increasingly complex and demand for larger scale projects is rising. For this reason the efficiency and experience of the private sector are sought. The power grid again offers a good example. Overuse and underinvestment have left the Chinese electricity grid in dire need of upgrades in large parts of the country. However, the domestic companies' planned projects took too long to get implemented, thus the NDRC passed legislation in late 2007 allowing foreign companies to apply for projects to upgrade the gridlines.

However, the NDRC will limit foreign players' involvement to construction and operation of power grids, while the mainland domestic companies will retain the controlling interest, as power is a matter of national 'economic security'.

The crucial test for the Chinese government will be to eliminate the physical and financial dangers from the industry. The action it takes over the coming years to curb corruption and improve working conditions will be crucial to the success of its ambitious infrastructure building plans and, ultimately, the country's economic development.

In addition, based on the findings of a survey conducted by international law firm Norton Rose, investors are mostly concerned about legal and regulatory risks, environmental (including change in regulations), and political risks when investing in China.

Therefore, for overseas investors looking to participate in PPPs the investment climate remains unwelcoming. Red tape and regulatory obstacles can be tedious, while companies need to find domestic partners to develop joint ventures. Overall however, we believe that companies in the infrastructure sector in particular are somewhat better placed to get a foothold in the country. Infrastructure projects have a significantly longer lifespan than other sectors and some build, operate and transfer (BOT) projects have taken place in China since the mid-1990s. Therefore, foreign investors can take a longer time to integrate into the market and establish a long-term presence, in anticipation of the Chinese market opening up more in the future.

In BMI's new Project Finance Ratings, China achieves a modest (below average) score of 57.6, ranking at 9th place out of 14 countries in the Asia Pacific region, while it ranks 28th out of 62 countries in the global rankings. According to our findings, the greatest amount of risk lays in the commissioning and operating phases of a project, which points to long-term risks present in China. We consider demand risk to potentially rise as GDP growth will see a steady decline over the coming years, according to BMI forecasts. In addition, heavy state ownership in the utilities and transport sectors raises the risks that the government will be able to dictate prices in the market (and even arbitrarily intervene to change them) thus raising the long-term risks to the projects returns on investments.

The wind power sector is one area where foreign private companies can establish a strong presence.

Indeed, the main motive is to use the technology and knowledge spill-over to develop a strong domestic renewables market, both in equipment and in power generation. Nevertheless, a niche has been created for foreign players in China's heavily state-controlled power sector, and it is witnessing robust growth.