Commentary on Political Economy

Friday 17 February 2023


China’s Old Playbook Is Back. That’s Bad News

A nod to projects fueled by debt, at the expense of industrial technology, may not end well. 

Building boom.

Building boom.

Photographer: Qilai Shen/Bloomberg

China’s economy was supposed to be in tatters in the aftermath of Covid Zero. Analysts were betting on a long-term and sustained downshift in growth. Multinational companies were mulling a move away. Now, as the stringent lockdowns pass into distant memory, forecasts are being revised up as industrial activity recovers. It’s worth wondering how Beijing has engineered such a swift turnaround.

Manufacturing and services rose for the first time in four months in January, while the International Monetary fund raised its forecast for the Chinese economy to expand 5.2% in 2023. Goldman Sachs Group Inc. now anticipates China’s gross domestic product to grow by a faster-than-expected 6.5% this year. Construction activity has roared back. That’s a quick reversal from the doom and gloom scenarios just months earlier as the country posted its slowest growth in years.

A look at China’s industrial complex — from engineering and construction companies to high-tech manufacturers and heavy-equipment makers — shows Beijing’s old playbook is rearing its head.

Industrial and infrastructure projects — from ethylene manufacturing to rail transit lines — are gathering steam. Those in the design stage with government backing ticked up sharply in the latter half of 2022. Shenzhen launched 266 manufacturing projects in January, while Chongqing has plans for over 1,100 major works.

Construction Boom

In recent months, there's been a sharp increase in government projects in the design and construction stages in China

Source: CICC Research

Engineering and construction companies will likely ride the boom. More labor is available now that Covid Zero is over and these firms can start work on a backlog of 71.6 trillion yuan ($10.4 trillion) of orders, according to S&P Global Ratings. In addition, prices of raw materials like cement are coming down from recent peaks. Large state-owned enterprises like China State Construction Engineering Corp. and Power Construction Corp of China Ltd. have taken market share from their privately owned counterparts as they execute big plans. The building activity is powering expectations for manufacturers of excavators, concrete pump trucks and mixers.

Credit Comeback

China's new credit shot up in January as Beijing looked to bolster the economy

Source: CEIC

Underpinning the frenzy of activity, is good, old credit: 4.9 trillion yuan of new loans were extended in January, of which, 3.5 trillion yuan were for the longer-term to state-backed enterprises for infrastructure projects. Bank loan growth rose to a 10-month peak. New total social financing to the economy was close to 6 trillion yuan — the second-highest reading in history.

This leverage-backed, infrastructure-dependent cycle mimics the beginning of many in the past that left the economy burdened with debt and the corporate sector with weak balance sheets. The question isn’t whether China can deliver on the thousands of projects being planned —  a 400,000-square-meter factory can be completed in 10 months with just over 300 workers. It’s what Beijing will do with these projects once they are finished and what the returns on these huge investments will look like. 

Consider China’s engineering and construction companies, known for their bad borrowing habits. In the five years to 2021, their total debt more than doubled while earnings only grew 80% 1 . Meanwhile, heavy-rail-equipment manufacturers are saddled with large losses from the pandemic that they’ll need to breakeven on before they push growth and take on more loans. 

Building Up

China's rated engineering and construction companies' debt has been rising faster than their profits

Source: S&P Global Ratings

Note: Adjusted debt and Ebitda; The aggregate numbers are the sum of all E&C companies (except Metallurgical Corp., China State Construction International, and CSCEC International Construction)

In recent years, Beijing has acknowledged the need for higher-value growth by spending and investing in industrial technology. It’s piled into electric vehicles, their infrastructure, energy storage, 5G base stations, solar panels, wind turbines and factory-automation equipment, foregoing a deep reliance on old-economy sectors like coal and primary, heavy industries. Success with batteries, EVs and the supply chain around them has made it possible to even export these. Last year, high-tech manufacturing grew over 22%. Investment in these areas is continuing. This week, the Tianjin Municipality signed off on 36 manufacturing projects related to energy, high-tech equipment and information technology, worth almost $10 billion.

So, while financing of new-age sectors is bumbling along, the recent turn to its old ways of infrastructure loaded up with debt risks distracting capital and policy away from higher-value growth from strategic areas. Earlier this month, China’s central asset regulator put out a notice urging state-owned enterprises to focus on major national projects, infrastructure and strengthening the industrial chain. Elsewhere, there are now drives to “revitalize” the traditional economy to, in theory, boost activity and jobs post-Covid.

Part of the broader problem is, credit isn’t as effective for growth, meaning each yuan isn’t doing nearly as much as it once did. Meanwhile, the world is climbing out from the Covid-19 shadow and demand for mainstream Chinese goods may weaken more. Global competitors are pouring money into industrial technology innovation in preparation for new-age economies, adding to the pressure on Beijing to move up the value chain. It’s no longer about keeping the economic expansion chugging along; it’s about the quality and effectiveness of growth.

If China continues to dig its heels into the build-and-they-will-come approach, then it stands to undo the recent industrial progress. The exuberance may push firms to spend excessively with limited prospects for returns. It also sets back the deleveraging measures over the past five years when firms like China Railway Construction Corp. used debt-to-equity swaps and other means to lower their debt burdens. The state-first policy will hamstring private enterprises and impede technological gains.


What’s more, Beijing no longer has subsidies and funds on tap as it once did. Fiscal revenue last year missed its target because of Covid and the cratering real estate market. Expenditure on healthcare, employment and social security is weighing on resources, too. Consumer-focused subsidies are taking precedence to lift sentiment and boost employment. Leftover funds from the past year are likely to run out quickly.

China’s industrial sector is poised to enter an upcycle that typically lasts 36 to 40 months. If Beijing decides to ride the wave with its old economy approach at the expense of high-tech manufacturing, then maybe previous forecasts from the IMF and Goldman Sachs were right all along.  

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