Moody's: Benefits of PPP infrastructure funding in China will take time to materialize

Moody's Investors Service says that the use of public-private partnerships (PPPs) in infrastructure funding could reduce the reliance by Chinese regional and local governments (RLGs) on public sector leverage, a credit positive.

But the large-scale participation of state-owned enterprises (SOEs) in such contracts could hinder the intended transfer of public infrastructure liabilities to the private sector.

"PPPs can be credit positive for Chinese RLGs, reducing public sector leverage and exposure to local government financing vehicle (LGFV) debt, provided any additional financial commitments are limited and transparently recorded," says Nicholas Zhu, a Moody's Vice President and Senior Analyst.

"But in contrast to most other countries, private participation in Chinese PPP projects can include SOEs," adds Zhu. "High participation by such entities in PPPs means that infrastructure-related debt is simply reshuffled from RLG balance sheets to SOE balance sheets, without reducing the public sector's overall leverage."

Moody's conclusions were contained in its just-released report "Sub-Sovereign: Benefits of PPP Infrastructure Funding in China Will Take Time to Materialize".

Moody's says that Chinese PPPs are characterized by high public-sector involvement, raising uncertainty over whether global best practices for such partnerships -- as seen in for example Australia, Canada and the UK -- will apply consistently in China.

In addition, not all Chinese RLGs will have the required level of sophistication and resource management to execute PPPs successfully.

As part of broader fiscal reforms announced in October 2014, China wants RLGs to reduce their dependence on borrowing through LGFVs, and rely instead on RLG bond issuance, or in the case of local infrastructure projects, on PPPs.

Various ministries have issued policy guidelines promoting PPPs, leading to a large number of PPP proposals. In November 2014, the Ministry of Finance (MOF) announced a demonstration of 30 PPPs in 15 provinces at a total cost of RMB180 billion.

The MOF limits RLG equity participation in PPP project companies to below 50%, a cap intended to encourage greater participation of non-government capital. But Moody's identifies several obstacles to genuine private-sector participation.

First, the large size of the investment required in many infrastructure projects, and their generally low profitability, make it difficult for most Chinese private-sector companies to participate. Most of these companies are small- and medium-sized enterprises at nascent stages of development, and the average capital for private-sector manufacturers, for example, totaled just RMB41.8 million in 2013.

A further obstacle to greater private-sector participation in PPPs is a lack of clarity in the legal framework governing the contractual relationship between RLGs and project companies