Yang Feng takes a drink from his water bottle as he rests in the shade of a tree near the foot of the Poly International Plaza building where he’s installing lights on the roof of the $653-million real estate development in the central Chinese city of Changsha.
From his perch atop a 150-meter (492 feet) residential tower, he can make out workers rushing to complete a tunnel project under the city’s Xiangjiang River that will cost 1.3 billion yuan ($212 million). About 30 minutes’ drive away, preparatory work has begun on what a local company says will be the tallest building in the world, with 202 floors. And China Development Bank Corp., the state lender, has pledged 14.25 billion yuan for completion of an intercity rail line connecting Changsha with other cities in Hunan province.
“Changsha isn’t as shiny as Guangzhou or Shenzhen during the night yet, but this will change,” said Yang, 26, referring to two cities in the southern coastal area that powered China’s industrial boom and where he worked for almost a decade. “Changsha will look like these places very soon with all the high-rise buildings.”
In this city of seven million people, where Mao Zedong went to college, China’s model of investment-driven growth funded by bank lending, bond issuance and land sales remains in force, even as Premier Li Keqiang tries to craft a new blueprint for expansion powered by consumption and private enterprise. Underscoring financial risks that prompted Li to order an urgent nationwide government debt audit, a local financing company raising money for Changsha’s tunnel says its ability to generate revenue is low.
Officials from the National Audit Office began fanning out across the country Aug. 1. The last time they did so, in 2011, they discovered local governments had racked up liabilities of 10.7 trillion yuan to fund a building binge that included expressways, stadiums and a colonnaded government office in one Hunan city nicknamed the “White House” by locals.
Just two years later, the total might have surged as much as 40 percent. The current combined outstanding debt of local government financing vehicles is 14 trillion yuan to 15 trillion yuan, or about 30 percent of gross domestic product, Standard Chartered Plc (STAN) analysts estimated in a research note last month.
“Fundamentally we still have the story that these projects aren’t going to pay back the money and the government isn’t going to pay back the money without selling assets,” said Stephen Green, head of Greater China research at Standard Chartered in Hong Kong. “A lot of these loans are being extended or rolled over, so you push the problems into the future.”
Along the Xiangjiang River, which gained national prominence after Mao described it in a poem, factories and old residential blocks have been flattened to make way for new towers. Real estate projects with names such as Grand Riverside, Fisherman’s Wharf and Brilliant Bay are rising from the banks.
Total fixed-asset investment in Changsha in the first half of the year was 217.75 billion yuan, an 18.1 percent increase, according to the Changsha statistics bureau. In the first half of 2012, total fixed-asset investment was 190.05 billion yuan, an increase of 21.9 percent.
While economic growth in Changsha slowed to 11.6 percent in the first half of the year from 12.9 percent in 2012, projects that were delayed like the intercity rail line are now getting fresh funding. Construction that was under way a year ago on a station for a high-speed train from Beijing to Guangzhou has been completed. So has work on a bridge in the city that will support another high-speed train from Shanghai to Kunming, south-west of Changsha.
Home prices in the city were up 6.9 percent in June from the same time a year ago, according to SouFun Holdings Ltd., China’s biggest real estate website owner, which tracks 100 cities. Sales of property by floor area in the first half of the year rose 31.3 percent from a year earlier, according to the city’s statistics bureau.
Even so, efforts by national policy makers to rein in borrowing growth will pose a constraint on local authorities, said Yao Wei, China economist at Societe Generale SA in Hong Kong. “The room for investment-driven growth is increasingly limited,” she said.
The People’s Bank of China in June engineered a cash squeeze to pressure state-owned lenders to improve their liquidity. Thousands of financing vehicles set up by local governments -- sidestepping rules banning them from directly borrowing from banks and selling bonds -- will come under scrutiny in the national audit.
Efforts to slow lending haven’t deterred Zhang Yue, the chairman and president of Broad Group, who is planning to erect the world’s tallest building in Changsha. The 838-meter-high structure, which the company says will be completed by April 2014, will house 30,000 people and include a school, hospital, amusement park and 720-square-meter swimming pool on the 202nd floor, according to the company’s website.
Plans for the skyscraper -- which would eclipse the 828-meter Burj Khalifa in Dubai as the world’s tallest -- are behind schedule. Broad Group announced in June last year that the project would be completed by January 2013.
China’s official Xinhua News Agency reported July 25 that the development had yet to receive approval. A day later, a spokeswoman for Broad Group, which makes air-conditioners, said in an interview the company had obtained permission for the project.
Facing criticism in local media and on social networking sites over his Sky City plan, Zhang said in comments e-mailed to reporters on July 31 that there was no reason to doubt “the cash flow” for the project. “For many years, every year, Broad was granted billions in credit lines from major banks, and we haven’t used a penny yet from these credit lines,” he wrote.
At the planned site, Zhu Jinwei is mixing cement that he said will be used in laying water pipes for the project. “I have no idea whether the world’s tallest building will stand here,” said Zhu, 59, who worked for 15 years in a Shenzhen toy factory until he lost his job last summer. “But one thing is for sure -- I don’t plan to live in it. I don’t have the money.”
At a nearby property development, a sales slogan scrolls across an LED screen above the entrance: “Be the neighbor of the world’s tallest building,” it reads. Signs for Hugo Boss AG and Starbucks Corp. (SBUX:US) hang outside stores that are still being built.
“Hunan is trying to catch up with the coastal areas,” said Liu Xianfeng, a researcher at the Hunan Academy of Social Sciences, a local government research agency in Changsha. “Investment-driven growth can continue here and the growth rate in central and western China will be stronger for the coming years.”
Changsha’s growth isn’t being driven solely by infrastructure spending and real estate. Volkswagen AG (VOW) is building a new factory in the city with an annual capacity of about 300,000 vehicles that is scheduled for completion by the end of 2015. Want Want China Holdings Ltd., a Shanghai-based maker of rice crackers and dairy products, is investing 2 billion yuan to expand production in Changsha, according to the local government website.
The city has expanded by almost a million people over the past decade as farmers have abandoned their land for jobs in urban areas. With export-driven job gains slowing on the coast, workers like Yang and Zhu are relocating inland.
“Everyone living in the city can see the reason why we need subways,” Liu said, referring to Changsha’s congested roads.
The swelling population of Changsha supports Li’s drive for urbanization as a “huge engine” for the world’s second-largest economy, with almost half the population still outside of cities. The government announced July 24 it will speed up railway construction with a focus on the central and western parts of the country. Li was quoted by Xinhua telling a meeting of the State Council that building railways brings “multiple benefits” as it promotes urbanization and stabilizes growth.
The construction offers a source of expansion as other parts of the economy shrink. The government last month ordered more than 1,400 companies in 19 industries to eliminate excess production capacity by the end of the year.
Li and President Xi Jinping, who completed their succession as China’s leaders in March, have signaled they’re willing to endure slower growth. At the same time, Li has identified 7 percent as the “bottom line” rate for the nation. China’s exports and industrial output rose more than estimated in July, adding to signs the economy is stabilizing.
While the central government has tightened access to credit, the Hunan provincial government on May 27 signed agreements with China Development Bank for 85.25 billion yuan in loans. Besides the intercity rail project, the funds will also go to build roads.
The tunnel under the Xiangjiang River is being funded with the help of bonds issued by Changsha-based Chengtou Group, a financing vehicle for the local government. Chengtou sold 1.8 billion yuan of seven-year, 6.95 percent bonds in April, of which 700 million yuan is for the tunnel.
Chengtou had a liability-to-asset ratio of 60.14 percent at the end of 2012, down from 66.72 percent at the end of 2011, thanks to the injection of land assets into the vehicle, according to an audit report last month by GF Securities Co Ltd. (000776), the underwriter of Chengtou Group’s bonds, published on the website of China’s interbank bond market. The company’s cash-generating abilities from its operations are “still relatively low” and the company has to rely on fundraising to cover cash needs, the brokerage said.
Like other local governments across China, Changsha has raised money by requisitioning land from farmers and selling it to property developers at a higher price.
The city’s non-budget revenue rose 62.8 percent to 19.7 billion yuan in the first six months of 2013, according to the Changsha statistics bureau. Land sales would have been the source for much of that revenue, said Chen Sheng, executive dean of Shanghai-based China Real Estate Data Academy, a research group.
“Some infrastructure projects, like an intercity railway in Changsha, may make sense, especially when they are financed by cheap funds from a state development bank and hopefully one day the project can make money apart from its social benefits,” said Tao Dong, head of Asia economics excluding Japan at Credit Suisse Group AG in Hong Kong. “But many other government projects are borrowing money at interest of 11 percent or 12 percent, and they may not be commercially viable.”
In the Wangcheng district, where the Sky City project is planned, units are on sale in at least 50 newly developed real estate projects, according to a website run by Changsha’s property authority. Some of the buildings occupy land that was once paddy fields and lotus ponds.
Rows of buildings are going up along the route of the intercity rail line. A drive down an adjacent dusty road leads to dozens of desolate villas and townhouses that have no doors or windows. A worker at a cement distribution point at the site, who declined to give his name, said the homes had never been filled and were scheduled for demolition to make way for new buildings.
At the Poly International Plaza site, Yang is counting on Changsha’s construction boom to keep going. He left his job on the coast and moved to the city even though it meant taking a pay cut.
“I had no choice,” he said. “My boss is shifting his focus to this place because it has more work. I had to follow.”
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