China’s Amazing Disappearing, Reappearing Infrastructure

Better infrastructure investment numbers mask weakness in other areas of the economy.

By Nathaniel Taplin

China’s impressive infrastructure, which helps drive demand for everything from copper wires to Caterpillar excavators, is a source of pride for party apparatchiks and an obsession for commodities traders.

The latter are likely to celebrate Tuesday figures showing a sharp rebound in investment in things like roads and railways in early 2017. But investors should be warned: the uptick isn’t likely to last, and it obscures broader weakness which could weigh on growth once it fades.

First, the good news: China’s infrastructure investment rebounded sharply to 21% growth from a year earlier in January and February, up from just 11% in the fourth quarter of 2016, a four-year low.

Yet excluding infrastructure, China’s annual investment growth rate actually dipped to just 5%, from 7% in the last quarter of 2016. Real estate and manufacturing investment both weakened, despite healthy land sales numbers—in line with fourth-quarter 2016 earnings hinting that profit growth for most sectors peaked in late 2016.

For one particular infrastructure sector, power and utilities, the news was unequivocally bad: investment growth slowed to just 1%, the weakest showing since 2011. Higher coal prices and overcapacity have eroded power-sector margins: Copper is already feeling the pain, with the metal down 6% from its year-high set last month.

The outlook isn't much brighter. While economic planners will try to avoid a sharp deceleration in spending ahead of a key Communist Party congress this fall, most infrastructure in China is funded locally, not centrally. And borrowing conditions for local governments have sharply deteriorated after Chinese bonds were pummeled by a market rout in December.

Workers unload coal at a railway coal-storage site in China in 2009. China’s newest round of infrastructure spending should boost commodities, but the uptick isn’t likely to last. Photo: Reuters

Yields on both official municipal bonds and those issued by off balance sheet municipal financing vehicles, which do most of the grunt work raising capital for infrastructure, have risen sharply since then. Net new off-balance-sheet bond financing by local governments totaled just 80 billion yuan ($11.57 billion) from December to February, against 199 billion yuan in November alone, according to Wind Info. Yields on AA-rated municipal-financing vehicle debt are up nearly 200 basis points since mid November.

With financing and raw material costs both heading skyward and central government support unlikely to step up significantly, the headwinds to a sustained pickup in infrastructure building look strong.

Investors should consider themselves warned: if industrial growth in the rest of the world slows as well, or the Chinese housing market seriously stumbles, commodities and infrastructure-linked shares will feel the pain.

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