On May 24th, 2017 Moody´s downgraded China´s credit rating to A1 from Aa3. Moody´s cited China´s financial strenght will continue to erode going forward as economy-wide debt keeps rising (256% of GDP at the end of 2016). Economy-wide debt includes government, households and non-financial corporates.
Furthermore, Moody´s mentioned high leverage levels at State Owned Enterprises (SOE) and under-developed financial sector as key risk factors for the Chinese economy. In this case, both SOE and financial institutions have been directly involved in infrastructure development. Along these lines, a recent study provides clear evidence showing inefficient project development as a major driver of China´s weakening debt profile.
Evidence suggests inefficient infrastructure investment destroyed economic value in China
According to Atif Ansar, Bent Flyvbjerg, Alexander Budzier, and Daniel Lunn (2016) "Does Infrastructure Investment Lead to Economic Growth or Economic Fragility? Evidence from China", experience from Chinese projects rejects the orthodox theory that heavy investment in infrastructure causes economic growth. The authors analized the economic impact of 95 road (74) and rail (21) infrastructure projects developed by China from 1984 to 2008. The total worth of these projects is estimated around US$65 billion (2015 prices).
Main findings of this interesing research:
- China builds faster than rich economies, however... Projects took approximately 4.3 years to end construction while developed countries took nearly 7 years. According to authors, lesser focus on cost, quality, environmental impact and public consultation could explain this difference.
- Cost Overruns. 75% of projects reported cost overruns with actual infrastructure costs being on average 30.6% higher than estimated.
- Inneficient allocation of resources. 64.7% of projects (traffic analysis of 156 projects) reported significant lower traffic than estimated. Some cases with actual traffic less than 20% of original projections. Whereas, 35.3% of projects showed a traffic surplus of more than 60%, resulting in congestions problems. The combination of these results indicate an inefficient allocation of financial resources.
- Benefit Cost Ratio (BCR) below 1.0. 55% of projects reported an ex post BCR < 1 due to a combination of cost overruns and inadequate demand projections. Thus more than half of projects destroyed economic value.
- Debt problem directly liked to inefficient infrastructure development. The authors estimate that cost overruns accounts for approximately 1/3 of China´s debt.
The experience of China shows that "more is not always better". In addition, it is a clear evidence that the global infrastructure challenge is not only a matter of funding and financing but also about adequate planning and preparation in order to optimize value for money.