SINGAPORE (Jan 14): China’s massive infrastructure spending, for years a favourite economic stimulus tool, has reached new scale and magnitude. As a result, the actual impact will not be as strong as before, says Vincent Chan, Credit Suisse’s head of China equity strategy.

In 2008, China spent RMB5 trillion on infrastructure; a decade on, it spent RMB25 trillion ($5 trillion). “When you’ve increased five times in 10 years, it becomes very difficult for you to really grow strongly,” reasons Chan, in an interview with The Edge Singapore.

In addition, changes in government policies and practices have dampened the enthusiasm of local officials in carrying out their work. Local governments have taken on a lot more debt, and the central government is wary. To curb the excesses, local officials are now personally liable if projects fail and loan defaults occur. Previously, if the same local officials were posted elsewhere, it would not be their problem anymore but their successors’. If and when a rebound from infrastructure spending happens, it will be more “subdued” compared with previous cycles, says Chan.

China’s policymakers have been known to employ infrastructure spending as a policy tool. To curb excessive debt, Beijing had wanted to cut railway investments last year to RMB732 billion from RMB801 billion in 2017.

However, as the trade war with US persists, with no signs of a quick resolution, Beijing changed gear, spending some RMB802.8 billion instead in 2018. For now, the momentum is set to continue. This year, China plans to add another 3,200km of rail to the total of 29,000km as at end-2018.

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However, Chan wants to put the investment on high-speed rail in context: Of the some RMB25 trillion spent, railway investment accounts for less than RMB1 trillion. “Usually, the high-speed railway projects will get the attention, because each of their project sizes may be quite big. However, in the bigger scheme, they are nowhere compared with the other projects added together,” he says. Other significant infrastructure expenditure includes that for power plants, the range of municipal facilities such as schools, environmental engineering, sewage and land levelling. The bigger proportion of infrastructure spending has gone into expanding the massive network of inter-city highways and intra-city roads, especially in the provinces further inland from the more prosperous coastal areas, and new urban zones that have been planned and are being developed, says Chan.

Between 2011 and 2017, infrastructure investment for China as a whole was around 20% of its GDP. However, Chan warns that infrastructure investment has reached “absurdly high” levels in some regions. Granted, Tibet, is coming from a low base. Yet, the proportion of infrastructure spending to the province’s entire GDP hit more than 80% between 2011 and 2017. The combined proportion for two other provinces, Yunnan and Guizhou, is more than 40%. On the other extreme, Shenzhen, one of the most developed cities, spent just 5% of its GDP on infrastructure.

Now, for all its purported financial muscle, there are questions whether China can keep up the infrastructure spending, as the deficits incurred from running these roads have widened significantly. For example, in 2010, the Chinese government’s revenue and cost for highways were just RMB350 billion. Last year, revenue increased to some RMB450 billion, but the cost, which includes principal payment of debt, has ballooned to RMB900 billion. “How can you expect the government to be very aggressive in pushing for infrastructure? There’s a natural constraint,” says Chan.

According to Credit Suisse, China’s stock market, following the sharp fall last year, is seen to stabilise this year. However, upside will be capped by weak earnings growth of just 5%, as over-hang from the trade war persists. In short, China’s market is seen to trade at a fair valuation, but on weak fundamentals (see chart). Besides infrastructure spending, China has been trying to encourage consumers to spend more, so that they can help pick up the slack in export-driven growth that has characterised China’s economy in the past. When Apple slashed its revenue forecast recently, softer sales in China was seen as one of the causes.

Chan disagrees. “The recent rounds of Apple products can no longer generate the kind of enthusiasm [they used to]. People can’t differentiate between the iPhone 7 and iPhone X,” he says. Furthermore, domestic Chinese competitors such as Xiaomi and Huawei have gained significant market share, with offerings that are cheaper yet have comparable specifications.

Chan acknowledges that consumer confidence in China is indeed down, but says it is better gauged via indicators such as car sales, and household appliance sales — which are in turn linked to the primary market of residential properties.

Chan points out that while the sale of physical goods is down, that should not fully translate into a pessimistic view of weaker consumer confidence. For one, the Chinese are spending more on digital services and apps. “Consumption attention seems to have shifted towards the virtual world rather than real products,” he says. One notable outlier, however, is internet giant Tencent Holdings. Some digital games published by this company continue to suffer from bans, as regulators try to curb gaming addiction among the young.

Will the consumer sector continue to be soft? The bigger cause is not quite the trade war and rhetoric started by US President Donald Trump. “Right now, a very important issue is that you don’t really have any ‘killer’ products that will generate very strong interest among Chinese households,” says Chan.

That does not mean the trade war will not be an issue. Since last year, bilateral ties between China and US have entered a new era. “You can use the word ‘Cold War’ and I will not disagree,” says Chan. Unfortunately for China, with US$500 billion ($676 billion) worth of exports to the US versus US$150 billion the other way round, it is quite likely that it will have to make some concessions.

Chan is optimistic that warmongering nationalistic hardliners will not gain full control of the agenda. “At some point, the Chinese government and society will have to face the question: How much would you risk of the last 40 years’ economic development?

The cost for China to really break away from the current global order is too high. In the 1970s, China could easily start a war with Vietnam without much notice. Today, it is difficult,” says Chan.

China’s infrastructure stimulus impact to be subdued, says Credit Suisse’s Chan 

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