2 DEBT FOR GROWTH?

From Fiscal Allocation to Bank Loans

“Let’s say a local government needs a billion to build a road, but can only afford to pay a hundred million each year from its fiscal budget. Using the old method [of fiscal allocation], building a road would take ten years, and the road would stay under construction throughout the entire decade. Now we [the CDB] provide a one-billion loan to the local government. Road construction can start right away. The road facilitates economic activities, generates growth, increases fiscal revenue, and repays our loans,” former CDB deputy governor Liu Kegu, one of the earliest architects of the CDB’s lending mechanisms, said in an interview.¹ This simple story provides a fundamental rationale underlying the CDB’s lending—the employment of market instruments to enhance the government’s fiscal capacity. This market-oriented rationale has been driving the institutional evolution of China’s development finance.

As chapter 1 discussed, the birth of China’s policy banks, alongside other financial institutions, reflects the emergence of a banking system separating from an overarching state-dominated fiscal system. In fact, China’s fiscal system per se has undergone several rounds of financialization since the late 1970s; indeed, the state has created various financial vehicles and adopted a wide range of financial instruments to replace traditional fiscal spending in order to capitalize development in a more efficient and rapid manner (see table 2.1). The creation of policy banks therefore can also be perceived as an outcome of the financialization of China’s fiscal system.

In the era of central planning, the capitalization of all forms of industrial and infrastructure projects fell under the domain of “public expenditure”; that is, the Ministry of Finance (MOF) allocated fiscal revenue to projects designated by China’s central planning organ, the State Planning Commission (Guojia jihua weiyuanhui, SPC).² In this system, the state “spent” or “appropriated” funds rather than “lent” or “invested” them. With the onset of the Reform and Opening Up in the late 1970s, this centrally planned public-finance system began to transform, and the state’s role in development financing began to change.

TABLE 2.1     Various means of financing infrastructure and industrial projects

In 1979, the central government issued an official document that aimed to convert public spending into state lending in the domain of “basic construction” (jiben jianshe), that is, industries fundamental for economic development.³ Firms were mobilized to borrow from the newly established China Construction Bank, a state-owned specialized bank (discussed in chapter 1), and to invest in profit-generating projects of basic and strategic industries. This document was the start of a major institutional reform in China’s public-finance system, also dubbed “loan for appropriation” (bo-gai-dai). The undergirding rationale of this reform was to incentivize firms to make prudent investment decisions and pursue profitability, because loans owed to state banks needed to be repaid whereas funds appropriated by the government did not. In the two decades that followed, more and more industrial projects were financed with loans rather than budgetary revenues.⁴ The state refashioned its role in development financing, becoming a creditor instead of a grant provider for major industrial and infrastructure projects.

In addition to lending, the Chinese government employed equity investment to replace traditional public spending. In 1988, China established six national specialized investment companies (guojia zhuanye touzi gongsi, SICs), each of which focused on fixed-asset investment in one of six industries: forestry, agriculture, energy, transportation, raw materials, and mechatronics and textile machinery.⁵ The central government shuffled revenues as well as state-owned specialized bank loans to the SICs for the purpose of optimizing state investment. However, the SICs lacked incentives or expertise to perform their profit-generating mandate. Indeed, they were created in the early stage of China’s economic transition, when the role of “companies” in a market context was brand new to the managers overseeing the SICs. China’s Company Law, which aimed to “establish a modern enterprise system and standardize the organization and operation of companies,” was not passed until five years after the SICs were created.⁶

The institutional legacy and the mindset of the planned economy were evident in the early 1990s. Though they were supposed to be conducting profit-generating investment, many SICs simply followed the annual plans of the SPC and funneled designated amounts of capital raised through taxation or borrowed from state-owned specialized banks to industrial projects. The only difference between the SICs’ investments and traditional government spending was that, as equity investors, the SICs could collect dividends from the projects. As a result of imprudent investment, the SICs accumulated large volumes of nonperforming loans (NPLs). To resolve the problem, the government decided to restructure the SICs and the state assets they owned in the mid-1990s. It redirected the approximately 5,000 SIC projects to varying state agencies. The newly established CDB took possession of the loans owed to specialized banks, and equity shares were assigned to state-owned enterprises (SOEs) as well as the newly established State Development and Investment Corporation, which integrated the SICs.⁷

The state’s failed attempt to use the profit-driven SICs to finance industrial projects revealed that China’s nascent market actors, state-owned banks and firms created from scratch or transitioned from government organs, were facing difficulties in truly pursuing commercial strategies. Extricating themselves from the restraints of the institutional legacies of the pre-reform planned economy proved a challenge. Despite the state’s strong intention to advance marketization, existing government ministries that used to play crucial roles in central planning, such as the MOF and the SPC, continued to exert power in the allocation of capital in the old way. The CDB was facing the same challenge. In its first four years, it functioned mostly like a fiscal arm of the state. The SPC restrained the bank’s authority in determining what projects to finance. Like the SICs, the CDB was mostly channeling capital to projects assigned by the central planning organ. The CDB’s lending to industrial and infrastructure projects also retained the financing mechanism of the SICs to a considerable extent. As such, it served as a financial vehicle of the MOF.

A dissection of the CDB’s loan composition in its first few years demonstrates the CDB’s “transitional” character. At the outset, the CDB received a license to issue two kinds of loans: subsidized “soft loans” (ruan daikuan) and unsubsidized “hard loans” (ying daikuan).⁸ Soft loans were a financial instrument for equity investment. They could be used to fund the capital base of projects, which usually accounted for 5 percent to 15 percent of a project’s total funding.⁹ Soft loans were funded by the CDB’s registered capital injected by the MOF, which essentially came from the central government’s fiscal revenue. Hard loans were funded by the CDB’s self-raised capital. Soft loans carried significantly lower interest than hard loans. In the mid-1990s, soft loan interest rates could be as low as 5 percent or less, whereas hard loan rates ranged from 8 percent to 15 percent, depending on the duration and type of project.¹⁰

The CDB practiced both equity investment and bank lending and offered two different kinds of loans to finance the same project because every project had to have a minimum amount of base-level funding in order to borrow from a bank. Soft loans lowered the fundraising costs for projects’ capital base and allowed project owners, either government or firms, to leverage the equity investment and borrow more from creditors, thereby jump-starting projects that were important for national economic development but lacked sufficient capital base. For example, the CDB offered a soft loan of roughly $400 million to the Ling Ao Nuclear Power Plant in Shenzhen, which was one of China’s largest energy projects in the latter half of the 1990s.¹¹

Compared to government spending and the SICs’ equity investment, the CDB’s soft-plus-hard lending was more market-based in two respects. On the capital-input side, CDB loans were funded primarily, though not entirely, by the bank’s self-raised capital rather than by fiscal revenue alone. On the capital-output side, CDB loans were mostly disbursed as bank lending, which needed to be repaid. Nevertheless, the bank was yet to be considered a “real bank” in its first few years because the MOF subsidized some of its funding sources and the SPC largely dictated its lending decisions.

Things began to change rapidly in the late 1990s. Against the backdrop of the Asian financial crisis, the Chinese government initiated a new round of reforms to advance the marketization of China’s financial sector, aiming to build full-fledged modern market institutions and transform the nascent state banks into real market actors.¹² In 1998, Chen Yuan, who formerly worked as a vice governor of China’s central bank, became the new governor of the CDB. Chen started a series of institutional restructurings to “marketize” the policy bank’s funding and lending mechanisms and established an International Advisory Council consisting of top bank officials from foreign financial institutions to learn from the experiences of the CDB’s overseas counterparts.¹³

“To achieve state objectives, I built markets and used market means instead of using fiscal or administrative means,” Chen Yuan told a chief editor from Caijing, a leading business newspaper in China, in response to questions about what he had done since his appointment.¹⁴ Chen and the new CDB administration largely expedited China’s state-led financialization. One of the first things the bank did under the new administration was to resolve large volumes of NPLs it had inherited from the six SICs and the four specialized banks. Starting in 1999, the CDB joined a state-led campaign of zhai zhuan gu (transforming debts into equities), where the government mobilized creditors (namely, policy banks and commercial banks) to perform debt-equity swaps with four state-owned asset management companies created for the purpose. By acquiring the NPLs, these companies became the new equity holders of defaulting industrial projects run by SOEs. The CDB also performed debt-equity swaps with some of the NPLs, including those owed by the China National Petroleum Corporation (CNPC), an SOE and one of the country’s largest oil conglomerates. The bank turned the CNPC-owed debts into equities and stopped collecting interests from the conglomerate, significantly improving the capital position of the SOE and thereby enabling it to list one of its most promising subsidiaries—PetroChina—on the stock exchanges of New York and Shanghai. After the subsidiary gained profits from the stock exchange market, the CDB reversed the swap and began to collect interest.¹⁵ Essentially, the bank was employing a common practice in private debt refinancing to resolve the NPLs owned by SOEs.

While unloading the bad loans, the CDB also underwent restructuring in order to lend prudently. One major institutional change was the creation of a multilayered system within the bank for project selection, which included project appraisal, project review, and project approval (figure 2.1). In 1999, taking suggestions given by the Boston Consulting Group, the CDB formed three new bureaus: the Bureau of Market and Industry Analysis, the Bureau of Financial Analysis, and the Bureau of Loan Review (later renamed Appraisal Management Bureau). Each was responsible for conducting a new round of project review from their perspectives.¹⁶ Together, they were dubbed the “firewall.” After their reviews, a project would be handed over to the Lending Committee for approval. According to a CDB’s regulatory document published in 2000, the Lending Committee consisted of seven members: three vice governors of the bank and four top officials from four related project-review bureaus. A project needed to obtain a two-thirds majority from the Lending Committee in order to proceed and would be rejected if two of the firewall bureaus or the committee chair, a vice governor, vetoed the project.¹⁷ In 2002, the bank added another layer of approval: an independent committee consisting of over a hundred experts inside and outside the bank. In meetings of this committee, a randomly selected group of committee members would be asked to vote anonymously on projects. A project would be rejected if more than 30 percent of the experts voted against it.¹⁸

After being approved by all of these bank entities, the loan request would be passed to the governor of the bank for final approval. At the final step, the governor “had the power to veto a project, but did not have the power to revive a project that had already been rejected by other entities of the bank,” said Chen Yuan in his autobiography. The multilayered project-selection system decentralized the power of the governor and justified the CDB’s decision to turn down financially nonviable projects designated by government organs. Chen recalled that the bank had “declined projects recommended by the State Planning Commission, as well as those recommended by government organs of various levels.”¹⁹

The CDB’s Lending Mechanism: A Hybrid Practice

The creation of the internal project-selection system did not resolve all the problems facing the CDB in the late 1990s. While the bank gained autonomy from the control of government ministries, it also lost its access to the state’s costless fiscal revenue. It had to find a different way to fulfill its mandate to finance large volumes of infrastructure and industrial projects, many of which were nonviable according to a commercial standard and would have been capitalized by budgetary funding in the prior decades. To understand the peculiarity of the CDB’s lending mechanism, it is first necessary to examine the regular means through which public projects are financed. As a discussion on the most common financial mechanisms will show below, the CDB’s lending mechanism, like its funding mechanism, demonstrates a unique state-market relation.

The most common way of financing public projects is fiscal spending (figure 2.2). The financing process is entirely state-led and free of market participation: a government raises capital through taxation, appropriates revenue to projects that serve public objectives (for example, parks and roads), and does not expect any financial return from the projects. Public projects can also be financed in a market-oriented way with the possibility of generating profits—that is, through project finance (figure 2.3). John Finnerty defines project finance as “the raising of funds on a limited-recourse or nonrecourse basis to finance an economically separable capital investment project in which the providers of the funds look primarily to the cash flow from the project as the source of funds to service their loans and provide the return of and a return on their equity invested in the project.”²⁰

In project finance, a loan to a public project is an investment. Investors (for example, a bank) finance a project with an expectation that it will generate cash flow, which serves as repayment for loans and return on investments. The sponsor of a project (which could be a government entity) is not liable for the loss of the project. A special purpose vehicle (SPV), a legal entity established by the sponsor for the purpose of raising funds, carries the liability. The SPV is the borrower in a legal sense. It is created to specifically enable the functioning of project finance and dissolves after the project is completed. If a project defaults, the investors cannot take their money back from the project sponsor (this is called nonrecourse). They can only take assets associated with the SPV. Because of this, lending under project finance carries risk. Therefore, only projects with high levels of profitability are attractive to investors and can be capitalized through such a market-based means.

Both fiscal spending and project finance have shortcomings. A problem with fiscal spending is low economic effectiveness—tax revenue is spent without any immediate financial return. Theoretically, fiscal expenditure on infrastructure and industrial development may invigorate economic growth and consequently increase gross domestic product (GDP) and tax revenue, but this may take a long time and is not assured. Governments facing fiscal shortages thus may not have sufficient budgetary funding to finance public projects. A problem with project finance is that it cannot cover all projects. The need for strong profits to mitigate risk leaves projects with positive social effect but limited profitability unfinanced.

There are several ways to resolve this social-versus-commercial dilemma. The first way is to raise more taxes and finance more public projects, but this may trigger grievances from taxpayers and is therefore cautiously practiced. Another solution is issuing government bonds. Government bonds include sovereign bonds issued by the central or federal government and subnational government bonds issued by state, provincial, or municipal governments. Issuing government bonds is essentially government borrowing from the market (figure 2.4). An alternative way is to create public financial agencies (figure 2.5). These agencies usually have access to various means of lower-cost funding.²¹ As such, they can afford to finance projects that serve public objectives but do not promise sufficient profits to attract commercial investors.

While all of the mechanisms discussed above have been practiced in China at different time periods, the main financing mechanism that facilitated the country’s rapid industrial and infrastructure development over the past two decades was creating public financial agencies to fund public projects, and China’s main such agency was the CDB. The policy bank financed public projects using a mechanism resembling project finance but with a variation (figure 2.6). Unlike standard project finance, which channels capital through an SPV, the CDB financed projects by lending to local government financial vehicles (difang zhengfu rongzi pingtai), which are legal entities created by Chinese local governments to raise capital. Most Chinese provinces and cities have one or more local government financial vehicles (LGFVs), typically called “[province/city name] Provincial/Municipal Construction Investment Company.”

The difference between an SPV and an LGFV is that the former is project-specific and dissolves after a project ends, whereas the latter is more like a company backed up by the local government that established it. An LGFV undertakes more than one project and does not dissolve after the completion of a project. The differences imply two sources of creditworthiness. When lending to an SPV, a bank looks into the creditworthiness of the project, and the SPV only serves an instrumental role. But when lending to an LGFV, the bank appraises the creditworthiness of the LGFV as well as that of the project. As the next section will describe, some LGFVs are financially independent “companies” that are sustained without the fiscal support of the local government, whereas others rely heavily on the local government that owns them. When lending to the latter kind of LGFVs, what the bank essentially appraises is the fiscal capacity of the local government. That is to say, the CDB’s lending mechanism is both market-based and state-supported. It is market-based in that lending decisions are based on financial appraisal of the creditworthiness of the borrowers/projects, and it is state-supported since such creditworthiness is backed up by local governments’ fiscal capacity.

Nurturing a Nationwide Market of Infrastructure Finance

A close examination reveals how the CDB’s state-supported, market-based lending mechanism became a major financing mechanism for China’s infrastructure development in a particular historical context. Since China’s economic transition in 1978, the central government had delegated substantial fiscal authority to local governments, aiming to generate economic growth from the bottom up by allowing local governments to retain more revenue. To avoid sharing revenue with the center, local governments often shielded local enterprises from taxation. As a result, central revenue declined sharply. In 1993, the central government received just over 20 percent of total tax revenues, and thus it faced a vast fiscal shortage.²² In 1994, the Chinese government launched fiscal reform to recentralize taxation and created a tax-sharing system (fen shui zhi) that increased the proportion of the revenue local governments had to pay to the center. For example, the center claimed 75 percent of value-added tax, which has the greatest revenue of any Chinese tax.²³ Furthermore, to restrain excessive local public expenditure, the Budget Law enacted in 1994 prohibited local governments from directly holding debts, cutting off their fundraising channels through bond issuance and bank borrowing.²⁴ In other words, the fiscal reregulation in 1994 limited local governments from using revenue, bonds, or other means of finance to raise funds for their projects. Nonetheless, the financing of infrastructure and industrial development at local levels continued to be the responsibility of local governments, leading to “an imbalance between fiscal autonomy and fiscal responsibility” (caiquan shiquan buduichen), an issue that remains under policy debate.

Against this backdrop, the CDB emerged as a main financier of domestic public projects, employing a peculiar lending mechanism that allowed local governments to massively finance their projects while circumventing the state’s fiscal regulations. What the bank did essentially was to financialize local government organs as well as their assets and revenues, enabling them to fund projects in a market-based manner. A scrutiny of this process shows how the bank practiced financialization step by step. A first step was to set up project sponsors. Since the 1994 Budget Law prevented Chinese local governments from serving as a borrowing entity, the CDB instructed them to set up LGFVs to enable the financing of projects. As corporations in a legal sense, LGFVs could conduct financial practices for the local governments. By creating LGFVs, the bank transformed government organs into market agencies that were able to receive loans, issue bonds, or employ other financial instruments to raise funds.

After setting up project sponsors, the next step was to inject capital to projects. In regular practice, the project sponsor provides the capital base (usually accounting for no more than 20 percent of the total funding). For example, if a project requires 10 billion yuan to complete, the sponsor would normally prepare a billion or two in start-up capital (otherwise known as equity) and borrow the rest from financial institutions. However, in the 1990s many local governments could not even afford to pay 10 percent of the capital for their project. Nor were they allowed to borrow from regular commercial banks to capitalize the first 10 percent, as China’s Commercial Bank Law forbade commercial banks from participating in equity investment. The CDB, as discussed in the previous section, thus capitalized this portion with its low-cost, MOF-subsidized soft loans.

The CDB also financialized assets and revenues owned by local governments in order to enhance the creditworthiness of projects (zeng xin). If a project did not appear financially viable and could not meet the bank’s appraisal requirements, the CDB would suggest that the local government provide state-owned assets and revenues of various kinds as guarantees or collateral. Since lands in China are state-owned or collectively owned, land revenue became a common form of collateral for CDB loans throughout the 2000s, especially when there was an expectation of rising land prices driven by urbanization. Future fiscal revenue served as another possible form of guarantees or collateral. A government organ (usually the department of finance of a local government) could sign an agreement with its LGFV, stating that if the LGFV failed to repay its loans, the local government would fill in the gap with its fiscal revenue.

Another once widely practiced but controversial financial instrument of the CDB was to issue a single loan to finance a bundle of projects. Called “bundled loans” (dakun daikuan), such loans required a high degree of government coordination and often they were used concurrently with the collateralization of government revenues. The CDB would sign an agreement with a local government to bundle multiple projects as one and issue a bundled loan, often backed by the local government’s future land or fiscal revenue, to the LGFV. This means of finance would allow the bank to use profits obtained from some projects to cover losses caused by other projects in the bundle. It could be employed in the financing of industrial parks. Industrial projects that generated profits could cover the losses of infrastructure projects, which were essential for industrial production but not always financially viable. Bundled loans could also be used in financing urbanization, equipping cities with a set of infrastructure facilities at once.²⁵

To summarize, the CDB played multiple roles in facilitating public finance. It transformed government organs into market borrowers, provided low-cost seed capital to jump-start projects, collateralized state-owned assets and revenues, and bundled projects to enhance their creditworthiness. All of these practices reflected a fundamental rationale underlying the CDB’s lending mechanism—a mutually reinforcing relationship between the state and the market. On the one hand, the CDB employed financial instruments of various kinds to enhance local governments’ financial capacity, enabling them to borrow more than their fiscal conditions allowed; on the other hand, the practice of CDB lending relied on the credit support by local governments—creating LGFVs, collateralizing assets and revenues, and signing government-bank agreements to bundle projects.

A typical example of the CDB’s state-supported, market-based lending mechanism was the bank’s development finance in Wuhu, a city of Anhui Province, in east China. In 1998, the CDB signed a ten-year, ¥1.08-billion loan agreement with the Wuhu Construction Co. Ltd., a municipal LGFV created by the local government. The agreement covered six municipal construction projects, including highway, water supply, and solid waste facilities, all guaranteed by the Wuhu government’s revenue. The bank also loaned to Chery Automobile, a Wuhu company that later became a main driving force of the city’s GDP growth. If things went as the CDB planned, the loans would propel growth, increase Wuhu’s GDP and tax revenue, and allow the municipal government to repay CDB loans that it guaranteed with revenue. This was indeed what happened, according to the CDB’s evaluation: Wuhu’s fiscal revenue in 2015 was ¥47 billion, almost 26 times its size in 1998; Wuhu’s GDP reached ¥245.7 billion in the same year, 13.6 times its size in 1998. The CDB was proud of this municipal project and named the financing mechanism the “Wuhu model.”²⁶

The Wuhu model has its limitations. Successful implementation relied on a close government-business tie, which triggered controversies. In the early 2000s, multiple news reports spotlighted and criticized the emergence of a group of government officials in Wuhu dubbed “red-hat businessmen” (hong-ding shangren) who held top positions in local companies and LGFVs. Among them, the most debated was perhaps the president of Chery Automobile, because automobile manufacturing had become one of the most prominent local industries since the late 1990s. Some saw a positive side of such dual appointments—local government officials understood policies well and therefore could bring resources and benefits to the business sector, which consequently would accelerate production and growth. “The secretary of our municipal party committee is the president of Chery,” a government official told Xinhua News with pride.²⁷ Others saw these dual appointments as incentivizing corruption and rent-seeking.²⁸ The reports generated a round of policy debate that led to the resignation of Chery’s “red hat” president. CDB lending was not the direct cause of the emergence of red-hat businessmen, and yet its financing mechanism relying on close government-business ties played a role in incentivizing such dual appointments. As the CDB’s bundled loan agreements were signed with LGFVs and often required fiscal guarantees from governments, business people who were better connected with local governments were more likely to obtain loans.

Despite its flaws, the Wuhu model was replicated all over China, especially since December 1998, when the CDB incorporated the China Investment Bank’s provincial branches. Having provincial branches allowed the CDB to undertake more projects at local levels.²⁹ In 2003, the CDB’s Tianjin Branch signed a 15-year, ¥50-billion loan agreement to support the development of public transportation and urban facilities in Tianjin, a provincial-level municipality.³⁰ This bundled loan was unprecedented in two aspects: its size and its repayment method. The borrower of the bundled loan was Tianjin Land Management Center, an LGFV created by the municipal government. The loan was to be repaid with the center’s (essentially, the government’s) land revenue in the next 15 years. As the CDB had expected, the land’s price rose significantly after public transportation was built, which allowed the LGFV to pay back the CDB.³¹ Similarly, Chongqing, another provincial-level municipality, received large volumes of CDB loans in the early 2000s. The CDB capitalized eight major Chongqing LGFVs, allowing the municipal government to mortgage its future tax and land revenues to finance urban infrastructure development. The CBD’s financing of Chonqqing Municipality was termed the “Urban Development Investment Corporation model” by a World Bank report in 2010, which positively anticipated the adoption of a similar financing mechanism by “other reform-minded and high-priority cities” of China.³² Between 1998 and 2010, the CDB on average issued city-level infrastructure loans worth ¥130.2 billion every year to 310 cities, with an average outstanding infrastructure-loan volume of ¥1.1 billion per city-year.³³

With financing urbanization nationwide, the CDB has continued to develop updated versions of the Wuhu model, employing a wide range of financial instruments to fund infrastructure projects. One example is the adoption of financial lease. In 2008, the bank established a subsidiary, CDB Leasing Co. Ltd., with the aim of better serving particular industries such as aviation, shipbuilding, and engineering equipment manufacturing, for which leasing has been a common means of finance to reduce buyers’ costs. The subsidiary also conducts infrastructure leasing. For instance, in 2009, CDB Leasing purchased a ¥3.748 billion highway project from the LGFV Yunnan Provincial Highway Investment and Development Corporation. The LGFV paid rent to CDB Leasing for the project for the next five years.³⁴ Unlike traditional bank lending, sale-leaseback infused the LGFV with cash without affecting the LGFV’s balance sheet, allowing local governments to finance their infrastructure projects without increasing the debt level of LGFVs. According to CDB Leasing’s annual reports, infrastructure leasing has become a major business of CDB Leasing and a common practice in China’s infrastructure-financing market.³⁵ The CDB established CDB Capital Co. Ltd. and CDB Securities Co. Ltd. in 2009 and 2010, respectively. The former specialized in equity investment, and the latter specialized in securities investment. Like CDB Leasing, these subsidiaries allowed the CDB to use a wider range of financial instruments to finance urban and industrial development.

Following the CDB, commercial banks, securities companies, trust companies, and various other financial agencies all began to finance LGFVs. In less than two decades, the financing of public projects in China transitioned from a centrally planned system based on the state’s credit allocation to a competitive market with numerous players. Commercial banks do not offer loans that are as long term or large scale as CDB loans, but they could offer more flexible terms and sometimes lower-interest-rate loans if they seek to compete for good projects vis-à-vis the CDB or other commercial banks. They also cofinance with the CDB. According to the Agreement on Syndicated Loan Cooperation issued by the China Banking Association, projects worth more than ¥3 billion or an equivalent amount in foreign currency must be financed through syndication.³⁶ The goal is to share risks and prevent vicious competition among banks. Thus, when undertaking large projects, the CDB would normally organize a syndicate as a leading bank. Commercial banks decide whether to participate in the syndicate based on an estimation of the profitability of the project. “We may be interested in joining the CDB to cofinance a coal industry project, but perhaps not a shantytown redevelopment project or a poverty-alleviation project, because the latter are usually not sufficiently profitable to meet our bank’s project-selection criteria,” a loan manager at a major commercial bank told me in an interview.³⁷ Facing increasing competition from commercial banks, multiple CDB bankers reflected that they were losing comparative advantages in financing public projects. “In the past, we were the only bank that knew how to finance public projects. But after cofinancing with us for a few times, commercial banks learned how to do these projects and can offer loans with conditions no worse than ours,” a CDB loan manager explained.³⁸

CDB provincial branches, which manage most of the CDB’s domestic loans, also compete with each other. As of 2019, the CDB had 37 first-tier domestic branches in addition to Beijing headquarters (also known as the main bank).³⁹ Among these, 31 branches are in the provincial capitals; five are in the port cities of Dalian, Qingdao, Ningbo, Xiamen, and Shenzhen, which are fiscally autonomous municipalities (danlieshi) that do not pay tax revenue to provincial government; and one is in Suzhou, which, like many of the provincial capitals, is one of China’s top-ranking cities in terms of GDP. For the convenience of discussion, the 37 first-tier branches are all referred as provincial branches (as opposed to the Beijing main bank) in this book. Unlike Chinese commercial banks that have branches at provincial, municipal, and township levels, the CDB in general does not have branches below the provincial level.⁴⁰

While most bureaus of the Beijing main bank have administrative functions, the Enterprise Bureau (qiye ju) manages loans to China’s central SOEs (yangqi), the most strategically important SOEs that are supervised directly by the State-Owned Assets Supervision and Administration Commission. If a municipal government or a non-yangqi enterprise intends to borrow from the CDB, it must make a request to the corresponding provincial branch. Similarly, a yangqi would make a request to the Enterprise Bureau. If a project involves more than one province, all of the corresponding branches may be involved. While all loans have to be approved by the main bank, much of the appraisal and loan-management work is conducted by loan managers at the branches or the Enterprise Bureau.

The fact that each branch’s scope of business is explicitly determined by its geographical location prevents competition between branches over the same projects. But competition still occurs, because the CDB main bank evaluates the performances of the branches annually using a complex matrix and rates them based on their aggregated scores. While the component and calculation of the matrix are confidential, loan managers told me that the annual increment in total loan balance, the profitability of projects, and the ratio of nonperforming loans all play a role. A branch that receives a bad rating will receive decreasing funding from the main bank, affecting the income of loan managers. Loan managers at provincial branches therefore are incentivized to disburse loans and maintain the financial balances of their projects.

Competition between provincial branches has been further reinforced by a mutually dependent relationship between branches and their respective local governments. On the one hand, the branches rely on local governments to bring them projects and thereby increase their annual disbursement volumes, as most large infrastructure projects originate with local governments. On the other hand, local governments rely on the provincial branches as major sources of funding for their proposed projects. As figure 2.7 shows, from 2003 to 2013, aggregated annual local government revenue in China ranged from hundreds to thousands of billions of yuan, and the CDB’s annual renminbi loan disbursement was roughly 20–40 percent the size of local government revenue in the same year.⁴¹ The large volumes of CDB loans served as an important source of development financing for local governments in the province. Local GDP growth is an important factor determining government officials’ promotion prosects.⁴² As such, local governments have a strong incentive to maintain good relations with the CDB and acquire financial support from the corresponding provincial branch.

While the domestic infrastructure-financing market has become increasingly competitive, the level of competitiveness varies widely by region. In some provinces, the market is rather diverse. Local governments hold infrastructure tenders and invite bidders, and various financial agencies compete with one another to win projects. In other provinces, the market is still largely government-led. Only projects “designated” by local government could be financed, and the CDB is a monopoly on the market. Statements from loan managers of two CDB provincial branches made in interviews illustrate the stark discrepancy.

Case 1: CDB loan manager from a provincial branch in midwest China

“Our bank functions mostly like a government’s fiscal bureau. We loan to the LGFVs, which are essentially run by the same group of people sitting in the government office. When we appraise projects, we are essentially appraising the fiscal capacity of the local government rather than that of the project. The ‘guarantee’ is sometimes just the government’s guarantee letters. Our loans have considerable advantages. Compared to a commercial bank’s loans, our interest rate is lower, loan volume is larger, and term is longer. The local government definitely favors our loans.”⁴³

Case 2: CDB loan manager from a provincial branch in southeast China

“I don’t think our bank has any comparative advantage when competing with other financial agencies in infrastructure project tenders. First of all, the local government is rich. It does not necessarily have to borrow from us. The LGFVs themselves are rich and can use their own money. The commercial banks sometimes offer loans with even lower rates than ours. Perhaps we have a disadvantage—our loan appraisal process is strict and inflexible and takes a long time. There was once a large LGFV project; if we were able to get that, we would accomplish our annual loan increment goal. But a commercial bank offered a much lower interest rate, and the project was taken by them. We were not able to offer loans that cheap. Even if we did, the headquarters probably would not approve. As loan managers, we have to work very hard to win a project.”⁴⁴

According to Chen Yuan, development finance institutions like the CDB should serve as incubators of market, and yet the nurturing of such a market eventually leads to an exit of the institutions.⁴⁵ When the market becomes mature, the “incubators” will have to leave, giving more space to the commercially oriented actors. The second case exemplifies Chen’s expected scenario, where the CDB has lost its advantage to other financial agencies in the local infrastructure-financing market. The first case, by contrast, shows that state power may still be constraining the CDB’s financing mechanism, and the “market” will not function properly if the policy bank leaves it.

A Debt-Generated Virtuous Circle?

The CDB’s financing of Wuhu and the replication of the Wuhu model across China seems to demonstrate a “development miracle”: with the CDB’s development-oriented lending, a region that had neither sufficient fiscal revenue nor a full-fledged local infrastructure-financing market was able to achieve urban and industrial development and economic growth, and ultimately, it could pay back the bank. This debt-generated virtuous circle (figure 2.8), as illustrated in Liu Kegu’s story quoted earlier in this chapter, has expedited China’s urbanization and industrialization since the 1990s against the backdrop of a fiscal shortage. This chapter began by asking the question: Did China intentionally disburse excessive loans to developing regions? The answer is thus a partial “yes,” at least in a domestic context. They were excessive in the sense that the policy bank has allowed China’s local governments to overspend by financializing their assets and revenues.

However, the circle does not work all the time. If the economy does not grow when the money is spent on infrastructure, the CDB may not receive repayment of its loans. Theoretically, local governments could repay CDB loans with increased government revenue under two scenarios. The first scenario occurs when infrastructure development facilitates urban development. As underdeveloped regions become equipped with infrastructure facilities, business and households move in, raising land prices and consequently the government’s land revenue. This was commonly observed in past decades when local governments across China collateralized, leased, or transferred lands to increase revenue and boost economic growth.⁴⁶ A second scenario is when infrastructure development facilitates industrial development. Industrial production drives local economic growth and thereby increases fiscal revenue, as was the case in Wuhu’s automobile industry, as discussed previously.

In fact, the CDB conducts corporate lending in addition to financing government-initiated infrastructure projects, loaning to firms engaged in energy, mining, telecommunication, shipbuilding, aviation, and other industries essential for national economic development. In this aspect, the CDB does not differ much from other countries’ public financial agencies; it offers long-term, large-scale loans to nurture potential national champions that commercial investors seeking short-term profits hesitate to lend. One of the most well-known business partners of the CDB is perhaps Huawei, a privately owned global telecommunication giant. The bank began to finance Huawei’s domestic projects since as early as 1998, when few other financiers had any interest in providing large-scale loans to the company.⁴⁷ In 2000, the CDB committed to issue a ¥1.1 billion loan to support the establishment of Huawei’s research and development center in Bantian, Shenzhen. The lending decision was debated at the time. There was opposition from within the CDB against financing this “ordinary” private company, as the majority of the CDB’s clients then were state-owned. Yet the bank eventually decided to finance Huawei, given the company’s potential in developing a high-tech industry in China.⁴⁸ The story afterward became well-known. Within a few years, Huawei grew into a first-class global telecommunication company, and its CDB loans were well paid off. The bank has continued to be a business partner of Huawei, despite the company’s ability to easily raise funds by borrowing from commercial investors. Thanks to Huawei, the CDB’s Shenzhen branch is still one of the bank’s most profit-generating branches.⁴⁹

The CDB’s financing of companies like Chery, Huawei, and many other business clients across China is not only a story of nurturing industrial champions. It is also a crucial part of the CDB’s financing of the localities where the companies are located. Taxes paid by the companies became an important source of government revenue that ensured the local governments’ repayment of CDB loans. The fact that the CDB was able to offer large-scale loans to finance firm-initiated corporate projects and government-initiated infrastructure projects at the same time allowed industrial development and urban development to occur simultaneously and rapidly in China.

What if infrastructure finance fails to advance urban development or industrial development? This is in fact not uncommon, and when it happens, development-oriented loans may turn into defaulting debts. Starting in the latter half of the 2000s, the negative consequences of this “debt-generated” financing mechanism began to emerge. One of the most criticized outcomes was the collective emergence of “useless” infrastructure projects. An example was “ghost cities”—cities well equipped with apartments, parks, and roads but not enough residents. Around 2010, many Chinese and English media outlets reported the emergence of an “empty” Kangbashi new district in Ordos, a city in northern China.⁵⁰ According to Yicai, a leading Chinese business news agency, the Ordos municipal government planned in 2003 to develop a new district that would have a total population of 300,000 by 2020, and yet the population of Kangbashi in 2010 was only 28,000.⁵¹ The financing of this new district demonstrated a typical case of debt-generated, land-based finance. The local government created an LGFV using 700 acres of land as registered capital. Backed by government credibility, the LGFV borrowed ¥1.15 billion from the CDB in 2004 to facilitate urban development. If the regions became urbanized, the land price would rise, and the LGFV would be able to repay its loans. After building apartments, real estate developers set their prices at an unexpectedly high level, which attracted speculators but not necessarily people who truly sought to move in and reside in the district.⁵² Is the Ordos government going to achieve what was originally planned and turn Kangbashi into a real urban district? In 2016, China Youth Daily reported that despite endless efforts to attract new residents, “destocking real estate property” was still a major challenge for the government of Ordos, as well as the governments of many third- and fourth-tier cities in China that had overinvested in urbanization.⁵³

Similarly, not all infrastructure-financing loans would lead to industrial development. An example was the emergence of “magnificent” touristy architectures that local governments spent enormous amounts of money to build but served no developmental purposes. In July 2020, videos and photos of a 99.9-meter tall, ancient-style “shuisi tower” under construction in Dushan County went viral on China’s social media platform. Dushan is an impoverished county located in southwest China’s Guizhou Province. Taking on billions of yuan in debt, the county government planned that the gigantic building as well as complementary facilities such as hotels and convention venues would “boost the local tourist industry.” Yet the borrowed funding was insufficient to complete the project. The tower stayed under construction since 2017. In an official response to social media stories, the local government blamed the previous government administration of the county for its poor planning, stating that Dushan’s previous county party secretary had sought “political achievements” through reckless borrowing and that the county’s debt level was enormous. The former party secretary had been convicted of bribery and abuse of power and expelled from the Communist Party and public office.⁵⁴

Projects like shuisi tower are not uncommon in China—many localities construct towers and buildings based on ancient architecture with the promise that they will be conducive to tourist industry. While quickly increasing local GDP, these investments have also driven up debts within a short time.⁵⁵ A commentary by Xiakedao, a social media account run by People’s Daily, the official newspaper of the Communist Party, criticized this unsustainable development practice, which relies on local governments’ policy favors for infrastructure and real estate investments. As long as local governments offer policy endorsement, investors will quickly crowd in, creating new industrial clusters from scratch without considering the long-term sustainability of the projects.⁵⁶

Indeed, it is difficult to draw a line between projects that are truly going to boost economic growth and those that do not. In the long run, there is still a possibility that some of the projects seemingly facing default will begin to revive as originally planned. In Ordos, for instance, reports have shown that the population of the Kangbashi district has swelled.⁵⁷ The virtuous circle may eventually complete in many cases. But for those that never do, the CDB as well as the many other financiers that followed the CDB in financing industrial and infrastructure projects continue to be snarled in their “creditor trap.”

Reregulating and Refinancing Local Government Debts

The negative consequences indicate that a strong state-market nexus is a double-edged sword. While they have jump-started industrial growth and accelerated urbanization, government-supported loans have also created a moral hazard, since they allowed projects that should not have taken place according to commercial standards to actually take place. Although the CDB’s financial instruments—bundled loans, soft loans, and loans guaranteed or supported by local governments—contributed largely to China’s development, they also escalated the accumulation of government debts. China’s policymakers were not unaware of the issue. The central government has begun to reregulate various forms of “bank-government cooperation” since as early as the latter half of the 2000s.

The state’s first regulatory attempt was to ban the use of bundled loans—that is, packaging several projects as one and having local governments guarantee the entire package. In April 2006, five central government organs—National Development and Reform Commission, Ministry of Finance, Ministry of Construction, People’s Bank of China, and China Banking Regulatory Commission (CBRC)—co-issued an official document prohibiting banks from issuing new bundled loans to local governments and local governments from offering guarantees and collateral to borrow new bundled loans.⁵⁸ However, a simple ban did not suffice to resolve the debt-or-development dilemma because local governments needed capital to finance infrastructure projects and boost GDP growth. This demand for capital incentivized local governments and their related LGFVs to circumvent the state’s regulation and continue using various means of guarantees and collaterals, except for bundling projects together, to borrow from the CDB and other financial agencies.

As a result, domestic credit expansion led by infrastructure finance did not slow down but accelerated, especially after the outburst of the global financial crisis, when China’s State Council initiated a 4-trillion-yuan stimulus package to revitalize domestic economy. The stimulus package produced a loose fiscal and monetary environment where capital became abundant and assets became relatively scarce. Financial agencies all would like to get a slice of pie investing in the seemingly “safe” government-guaranteed LGFV projects that used to be financed primarily by the CDB. At the same time, local governments established more LGFVs to take advantage of the state’s loose credit policies. The number of LGFVs mushroomed, increasing from over 3,000 in 2008 to over 8,000 by the end of 2009.⁵⁹

Despite the stimulus plan, the central government still intended to reregulate state-backed finance. In 2008, the CBRC prohibited the CDB from issuing new soft loans, for two reasons.⁶⁰ First, it sought to prevent borrowers and lenders from exploiting government support for excessive credit expansion. Second, it sought to deprive the CDB of its state-granted privileges. As discussed in chapter 1, in 2007, the State Council announced that the CDB should transition to a regular commercial bank. Soft loans were essentially loans for equity investment, which China’s Commercial Bank Law prohibited commercial banks from issuing. As the planned commercialization of the CDB progressed, its privilege of using state-subsidized low-interest loans for equity investment led commercial banks to complain of an unfair disadvantage.

The CDB actually kept issuing soft loans in an alternative way—that is, by transferring its equity investment business to CDB Capital Co. Ltd., the bank’s wholly owned subsidiary established in 2009. According to the official website of CDB Capital, the subsidiary has been engaged in merger and acquisition, pre–initial public offering investing, and equity investment in rural and suburban finance, among other kinds of investment businesses.⁶¹ In fact, the state’s soft-loan ban was never fully implemented by the CDB, as a 2010 CBRC document, urging the bank to stop disbursing new soft loans, suggested.⁶² In 2013, the State Council gave the CDB permission to use funds received from recollected soft loans to finance shantytown renovation, partially renouncing the ban.⁶³

In other words, the state never entirely prohibited the CDB from using financial instruments grounded in the idea of associating government credibility with market mechanisms, despite an explicit policy objective to restrain local government debts. The high demand for credits to capitalize infrastructure and industrial projects fueled the continuation. At the end of the day, some financial agency needs to fund China’s growth if the government’s fiscal revenue could not provide sufficient capital. Wang Dayong, a member of the CDB’s specialist committee, explained, “For local governments, holding a certain level of debts is a fair thing to do when financing urban infrastructure. The question is not whether they should be allowed to borrow, but how they could borrow legally and reasonably.”⁶⁴

While reregulating banks’ use of financial instruments, the state also disciplined LGFVs. In June 2010, the State Council issued a document about “strengthening the regulation of LGFVs.” According to the document and a subsequent clarification, LGFVs that depended on government’s fiscal revenue (as opposed to the revenue of their own projects) for 70 percent or more of repayment of loans should not borrow additional money from financial agencies.⁶⁵ To translate this into plain language, only LGFVs that could repay some of their loans (at least 30 percent) on their own were allowed to borrow more. This made it clear that policymakers wanted to curb local governments’ excessive credit support for LGFVs and transform LGFVs into financially self-sustaining corporations.

In October 2014, the State Council went a step further and issued its Document No. 43 to “strengthen the management of local government debts.”⁶⁶ While previous documents left some room for state-backed repayment, Document No. 43 sought to cut off the connection between local governments and LGFVs completely, stating that LGFVs should no longer rely at all on local governments’ fiscal repayment or guarantees.⁶⁷ This left few opportunities for survival for a large number of LGFVs. Losing local governments’ credit support, they could either turn entirely self-sustaining or declare bankruptcy. Neither banks nor local governments were willing to see LGFVs go bankrupt because this would lead to a rapid upsurge of the creditors’ nonperforming loan rate as well as the borrowers’ debt levels. At the same time, it was rather challenging to transform all the LGFVs into self-sustaining corporations, because many public projects that LGFVs had sponsored were simply not that profit-generating by nature. After Document No. 43 was released, creditors including the CDB were no longer able to lend to the LGFVs through the old financial mechanisms. Without local governments’ credit support, few infrastructure projects could pass banks’ financial appraisal and obtain loans.

Policymakers in the central government were aware of the risks of slowing down the growth rate caused by insufficient funding. They turned to continued financialization to allow local governments to finance projects and maintain growth. While limiting the use of existing financial instruments such as bundled loans and soft loans, the central government introduced alternatives. These include “government procurement of services” (zhengfu goumai fuwu, GPoS). The basic idea was that local governments would outsource their public services, such as the financing of infrastructure projects, to a “nongovernment agency,” usually an LGFV, and buy the services back from the agency after the work was completed.⁶⁸ To do so, a local government department would sign a procurement contract with an LGFV, and a bank would then lend to the LGFV, allowing the latter to begin conducting the project for the government. After the project was partially or fully completed, the government would pay for the LGFV’s services using fiscal revenue.

Theoretically, GPoS could prevent local governments from mortgaging their assets to overspend, as they had to pay for services with money already in their coffers. But in practice, the new financial mechanism did not differ much from previous ones, except that government “repayment” was replaced by government “procurement,” because local governments without sufficient fiscal revenue could extend the time period of their procurement by paying in installments. “Besides all the new approval paperwork we have to complete, everything else stays the same,” commented a few CDB loan managers in my interviews. The unruly practices soon triggered another round of discipline. In 2017, the MOF issued a document to restrain “rule-violating finance under the name of GPoS,” highlighting that fiscal revenue must be ready before procurement takes place.⁶⁹

Another substitute for government-guaranteed financing is public-private partnership (PPP), a financial mechanism widely practiced by development finance institutions around the world. According to the World Bank’s definition, PPP refers to “a long-term contract between a private party and a government entity, for providing a public asset or service, in which the private party bears significant risk and management responsibility, and remuneration is linked to performance.”⁷⁰ Adopted from overseas, PPP was soon localized and widely promoted across China by the MOF. In the Chinese context, PPP has been interpreted as cooperation between government and “social capital,” as opposed to cooperation between public and private capital, because many enterprises engaged in infrastructure and industrial projects are state-owned.⁷¹

The main difference between PPP and GPoS is that the partner that provides “social capital”—the corporation that conducts an infrastructure or industrial project—serves as an equity investor (shareholder) rather than a contractor (service provider) of the project. This distinction allows public and social partners to coinvest in projects. The purpose of having joint ownership was to incentivize corporations involved in PPP projects to pursue a profit-maximization strategy. However, commercially oriented investors were reluctant to partake in infrastructure projects that seemed unlikely to be profitable. To reduce risks for potential “social partners,” local governments often promised to repurchase shares from the collaborating corporations at a given time. When doing so, local governments were essentially borrowing from corporations temporarily to form a joint ownership on paper in order to finance the project. They still needed to pay back the corporation later on with future revenue so that the corporation did not have to bear the risk of serving as a project owner. The result was a rising volume of “shares on the facade, debts in reality” (ming gu shi zhai). The MOF issued a document to reregulate PPP in 2017 as well.⁷²

A third alterative financial instrument is local government bonds. By contrast to GPoS and PPP, the adoption of these bonds represented a major institutional change in China’s public finance system. As discussed previously, the Budget Law enacted in 1994 forbade local governments from holding debts, against which backdrop emerged the CDB’s peculiar lending mechanism that relied on LGFVs to finance public projects. For two decades, LGFVs served as “agents” of local governments—it was the LGFVs, which were “corporations” in a legal sense, that raised funds for public projects through various means, such as borrowing from banks and issuing LGFV bonds. Nonetheless, an issue that has remained unclear, despite the burgeoning volume of LGFV debts, is whether these debts are corporate debts or government debts. Many investors held the belief that either central or local government would bail out LGFVs regardless of how bad their financial performances were, although formal institutions never supported this expectation.

In 2011, a black swan event occurred in China’s financial market—Yunnan Highway Development Investment Corporation, Yunnan provincial government’s LGFV, officially notified its creditors that it would only be able to repay its loans’ interest and not the principal. According to a report by Caixin, the LGFV had an outstanding loan balance of more than ¥90 billion, including about 70 billion owed to large commercial banks and about 20 billion owed to the CDB.⁷³ The announcement caused turbulence on China’s bond market. Investors began to sell LGFV bonds quickly.⁷⁴ The creditors immediately started a negotiation with the LGFV and the Yunnan government, and a long journey of debt recovery began.

The unregulated LGFV bond issuance and the growing implicit government debts led to policy discussions on revising the 1994 Budget Law. The rationale behind this major institutional reform was straightforward—to curb implicit government debts by creating explicit fundraising channels (xiu mingqu, du andao). In May 2014, the MOF initiated trials of “debt swaps” in a few selected municipalities and provinces, where local governments were allowed to issue new bonds to swap their old debts.⁷⁵ Five months later, the People’s Congress passed a new budget law, legitimatizing bond issuance by local governments. This allowed China’s local governments to issue bonds without borrowing a “legal identity” from LGFVs. The amount of local government bond issues increased dramatically since the enactment of the new law. According to official statistics, the total volume of local government bonds was ¥398.8 billion in 2014, and the volume grew almost ten times to ¥3,840 billion in 2015.⁷⁶ The number kept increasing in the following years. In 2019, local government bonds were the largest category in China’s bond market, accounting for 32 percent of the market’s total bond issuance, surpassing central government bonds (24 percent) and policy-bank bonds (24 percent).⁷⁷

Who refinanced those local governments debts? According to official statistics, purchasers of China’s local government bonds were dominantly commercial banks (86 percent) and policy banks (8 percent) (see figure 2.9).⁷⁸ They were also the main creditors of LGFV debts. That is to say, local governments have been raising new capital by issuing bonds to banks in order to repay their old debts owed to the same creditors. Or, to put it reversely, banks have been extending new credits to the same borrowers to allow them to repay their old loans. The creditors are willing to perform the credit swap because they consider the government-issued new bonds to be more creditworthy than the LGFV-borrowed old loans. LGFVs are corporations in a legal sense, and their association with local governments has never been formalized and will perhaps never be formalized, given the policymakers’ determination to end local governments’ credit support for LGFVs. The new bonds, on the contrary, are issued by local governments per se, and thus their credibility is directly associated with the governments’ fiscal capacity.

China’s adoption of local government bonds as a new means to enhance local governments’ financing capacity does not imply the CDB will no longer play a role in facilitating public finance. Rather, the bank continues to be an important player in resolving debt issues. In October 2018, the State Council officially stated that as long as financial agencies do not expand debts, they should continue refinancing LGFV projects to prevent cash flow shortages.⁷⁹ As the main creditor of a large number of LGFV projects, the CDB played a leading role in debt restructuring. In December 2018, the CDB Shanxi Branch organized a syndicate with seven other financial agencies and signed a loan worth ¥260.7 billion with the Shanxi Transportation Holdings Group, an LGFV of Shanxi Province, to refinance the latter’s highway projects.⁸⁰ This was said to be the first debt restructuring project officially acknowledged by the CDB. The solution offered by the syndicate was swapping old loans, of which the banks were major creditors, with newly issued, longer-term loans. Though highly recognized by the Shanxi government as a role model for resolving implicit government debts, the CDB’s debt restructuring mechanism led to controversies. Fundamentally, what the syndicate did was extending the time for repayment. The same amount of principal has to be repaid once the new deadline approaches. If Shanxi Transportation Holdings does not manage to generate profits from its highway projects before the moratorium is lifted, the same debt problem will occur again.

The process of refinancing and restructuring implicit government debts continues today, and every once in a while, a new government document is released, either to promote novel financing mechanisms or to reregulate old ones. The reason that debt restructuring has been challenging is straightforward—policymakers in China do not seek to choose between boosting growth rate and controlling debt levels; they seek to achieve both. It remains unknown whether the newly introduced financial means would eventually resolve the debt issue or simply postpone the problem. Yet, one thing has been consistent, as reflected in rounds of reregulation and refinancing: the government has no intention to wipe out the debts with taxpayers’ money; it sees the debt issue as a market issue that should be resolved through a market-based means.

Financialization for State Purposes

The CDB’s domestic lending demonstrates China’s sui generis state-market relation. While state-led, China’s development finance is also significantly market-based. The creation of the policy banks per se is an outcome of a state-led financialization of a centrally planned fiscal system. When financing domestic projects, the CDB has adopted market instruments, transformed local governments into market actors, and collateralized state revenues to fund infrastructure projects across China. As a result, the bank has facilitated the emergence of a nationwide infrastructure-financing market, fundamentally altering China’s infrastructure-financing system from one that relied on the state’s credit allocation to one that relies on market competition.

The financialization of the state has significantly accelerated China’s urban and industrial development in the past decades. With fiscal spending alone, a billion yuan in government revenue can finance a billion-yuan project. But with all these financial tools, revenue of a billion yuan can finance projects worth several billions of yuan, and the projects can start years before the revenue becomes ready. Yet the rapid financialization has also created a moral hazard because it allows local governments to go beyond their fiscal constraints and overspend. When facing debt issues caused by excessive replication of the state-supported, market-based financing mechanism, China’s policymakers have continued financialization, introducing various alternative financial instruments instead of performing bailouts to resolve nonperforming loans.