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Markets & Geopolitics

Case study: How does China pay for her infrastructure? – How growth in the renewables market is breaking down international investment barriers

Many obstacles remain for international investors seeking to enter the Chinese infrastructure market. However, a cooling in US-China trade hostilities, and exciting growth in the renewables sector could provide overdue opportunities.

Professor Martin Haran, Built Environment Research Institute, Ulster University
28 July 2021

Despite recent progress towards broader economic reform, there remain considerable barriers to private investment in Chinese infrastructure. This includes both the lack of market transparency and the lack of market price mechanisms – which increases the risk of poor investment decisions.

Pertinently, as recently as 2018, China was ranked 87th out of a total of 180 countries the Transparency International (TI) Corruption Index. Interview evidence suggests that the international investment community still have reservations about entering the market. Indeed, a number of institutional investors suggested that the Chinese government’s plans to advance its economic ambitions are often at loggerheads with its protectionist economic policies. The vast majority of infrastructure development projects are state-led, state-funded and state-operated. Consequently, restrictions on international investment funds and the sectors of infrastructure that they are permitted to invest in, mean that capital is not channelled into projects that could otherwise effectively address underlying shortage problems.

Further to this, broad sectors of the Chinese economy remain firmly off-limits to international investors. The release of the National Development and Reform Commission and the Ministry of Commerce Foreign Investment Industries Guidance ‘Catalogue’ was designed to roll back these strictures. Several infrastructure industries previously classified as ‘restricted’ or ‘prohibited’ have become less restricted or even ‘encouraged’. This includes economic infrastructure such as transportation, electricity supply, water and clean energy. Industries such as healthcare remain restricted, as do ‘sectors of vital national interests’, including telecommunications. Even for those industries where international investment is ‘encouraged’ or ‘permitted’, local and sectoral rules and regulations impose an extra layer of administrative control. The effect, intentional or otherwise, is often to create an effective barrier to investment.

In addition, interviews with institutional investors highlighted the propensity for new regulations or policies to come into force without prior market consultation, serving to heighten risk for investors considering entry to the Chinese market. Such regulatory risks are, in the opinion of investors contributing to this investigation, compounded by legislation and policies pertaining to real estate ownership. More often than not, the ownership of land or other real properties is a prerequisite to the successful initiation, development and operation of an infrastructure project. This, combined with restrictions prohibiting foreigners from directly owning real estate assets, leaves few options available to the foreign investor except a joint venture with Chinese partners. The lack of freedom to invest independently is a barrier to attracting international capital, while the shares of joint ventures with local Chinese partners are in practice not readily saleable or transferrable. This has not only served to hamper investors’ confidence in long-term investment prospects, but more importantly has detracted from the government’s credibility as a facilitator of inward international investment.  

The lack of freedom to invest independently is a barrier to attracting international capital, while the shares of joint ventures with local Chinese partners are in practice not readily saleable or transferrable.

In 2019, China and the United States concluded a bilateral trade agreement, the US-China Phase One Agreement. It was a direct result of trade disputes between the two countries over a variety of matters. These included, but were not limited to, economic openness, level playing field rules, and compliance with World Trade Organization guidance on state protectionism. The first phase of the trade deal mainly focusses on agricultural and manufactured products, reduction of tariffs on goods and intellectual property rights. Investors are generally cautious about the development of the trade relations and expect the next phase of negotiation to cover more fundamental trade issues such as barriers for foreign investors engaging in telecommunications and infrastructure. The results of the negotiations could have a lasting and significant impact upon the way in which international investors conduct business in China going forward. Nevertheless, uncertainties surrounding political and social developments in both countries could have wide ranging and significant implications.

There was a sizable and consistent increase in both the number and average deal value of completed deals within the Chinese market in the period 2014-2019. Exploration of the Preqin unlisted funds database highlights that the number of infrastructure transactions completed peaked in 2014, with a total of 100 deals completed. The average size of Chinese infrastructure transactions has fluctuated since 2008, but the 2019 figures show the greatest increase in value since 2012. In 2019, average deal value stood at US$330 million – a marked increase from the US$133 million and US$60 million recorded in 2017 and 2018 respectively. Given the scale of infrastructure investment need, it is perhaps surprising that unlisted funds have not assumed greater exposure to the Chinese market, but concerns over legislative and governance frameworks continue to serve as a barrier for many international investors.

The average size of Chinese infrastructure transactions has fluctuated since 2008, but the 2019 figures show the greatest increase in value since 2012. In 2019, average deal value stood at US$330 million – a marked increase from the US$133 million and US$60 million recorded in 2017 and 2018 respectively.

In 2007, the market was heavily dominated by energy, utilities and waste management transactions (71%) and transport infrastructure transactions (10%). Energy, utilities and waste management transactions increased in 2008 to comprise 75% of market transactions, however 2009 witnessed a sizeable decrease in energy, utilities and waste management transactions (to 28% of market volume) with renewables monopolising the market (constituting 72%). Renewables have been the prominent sector for completed deals since 2013. In 2019, renewable energy, alongside utilities and waste management transactions, accounted for circa 83% of deal flow by volume.

This emergence is undoubtedly due to the newly formed economic plans adopted by the Chinese government within the 13th Five Year Plan. In terms of investment, sectoral analysis indicates that renewables (53%), water supply and sanitation (24%) and electricity (11%) comprise the highhest proportion of allocated funding (Figure 5.4). The concentration in investment within these three sub-sectors depicts the primary infrastructure needs within China and the progress that has been made in bringing forward these particular forms of infrastructure in recent years.

This three-part series was excerpted from the WBEF report Bridging the Gap: Private investment in future infrastructure provision

Download the full report here