Events

Challenges for Financing Environmental Infrastructure in China

July 30, 2003 // 12:00am
Event Co-sponsors: 
Environmental Change and Security Program


Presentations by the China Environment Forum's Municipal Finance Study Group, made possible by a grant from the U.S. Environmental Protection Agency.

Investment in Basic Environmental Protection Infrastructure in China

Over the past decade as air, water, and waste problems have grown increasingly serious in China's cities there has been growing pressure on the Chinese government to finance urban environmental protection. And yet, according to Du Ping, in order to accomplish the many goals for improving urban environmental quality set forth in the Tenth Five-Year Plan (2001-2005), Chinese policymakers face a momentous need to improve and expand existing financing mechanisms. Several challenges stand in the way of securing adequate financing for environmental infrastructure: Central and local governments have set aside only a small amount of funds for basic environmental infrastructure. Moreover, enterprises still lack incentives to finance their own pollution control technology upgrades. In those cases when industries borrow money for environmental infrastructure, they often struggle to cover operation costs.

Chinese cities have primarily relied on government allocations or commercial banks for wastewater treatment plants and other environmental infrastructure construction. Over the past few years, however, several new financing channels have emerged in China to fund such projects, such as:

  1. Central government treasury bonds. Beijing has issued over $147 billion in 2002 and 2003, a significant portion of which has been used for infrastructure spending. (For more details on treasury bonds see China Environment Forum's final report on this project)
  2. Foreign sources. The World Bank, Asian Development Bank, and Japanese ODA have financed a broad range of urban environmental infrastructure projects in China.
  3. Security markets. China's security markets include some 30 companies involved in environmental protection.
  4. Build Operate Transfer (BOT) projects. In 1999, the World Bank reported on a handful of urban environmental BOT projects in China. Since then, there are a growing number of both Chinese and foreign corporations emerging in the field.
  5. Provincial environmental protection funds. Environmental protection funds, usually drawing off of international nongovernment organization grants, have been created in more than 20 Chinese provinces.
  6. Foreign investment into local infrastructure. Local governments throughout China have been transforming environmental infrastructure into different forms of assets to attract foreign investment.
  7. Government incentives for small enterprises. The central government has adopted some policy incentives to encourage small enterprises to combine efforts to mitigate pollution effects with more cost-efficient facilities.

To encourage the emergence of more financing channels, China's Tenth Five-Year Plan (FYP, 2001-2005) included many targets to increase investments to improve urban environmental quality. The FYP environmental protection goals are quite ambitious, requiring an estimated 700 billion Yuan in investment. The central government has called upon local governments to resolve the more acute environmental problems, requiring urban centers to finance well over half of the goals (and nearly 400 billion Yuan share of the total investment). To get urban areas started, the central government committed 100 billion Yuan while local governments were expected to foot the remaining three-fourths of the bill—notably, an 80 percent increase over their past local environmental investment. Du Ping provided some examples of how central and local governments might reach these ambitious investment goals:

  1. Increase in central government investment. Central government investments have increased for urban environmental infrastructure through continuous issuance of treasury bonds over the past five years. The question remains, however, how long the central government can provide funds through this venue.
  2. Loans from commercial banks. In the past, the central government could order commercial banks to issue loans to local governments for environmental infrastructure and not be concerned about the ability of repayment. Concerns about potential financial instability from the growing amount of bad debt on bank books have led the central government to become more cautious in allocating commercial loans to local governments. Moreover, today, commercial banks often refuse to cave into government pressures to give loans.
  3. Encourage local governments to come up with more funds. Du Ping believes this is a strategy that needs to be more fully pursued. However, due to limited financing ability, most local governments can do little to generate local funds for environmental infrastructure. For example, even the governments of Beijing and Shanghai struggle to reach the Tenth FYP environmental investment targets due to limited municipal budgets.
  4. Additional foreign investment. During the Ninth FYP, foreign assistance for environmental protection was 5 billion USD. Estimates cite that this figure dropped to 3.5 billion USD during the Tenth FYP period. Future increases in "green" FDI for cities will depend on China creating attractive investment policies.

While the above investment strategies may cover current urban environmental protection financing, to ensure long-term investment funds many Chinese experts are exploring some U.S. municipal financing practices, such as bonds. Municipal bonds have been the core source of urban environmental investment in U.S. cities for decades. While adopting the U.S. municipal bond system would be very challenging for China, there are several means by which China could begin to create a foundation for establishing a municipal bond system in China:

  1. Adjust some existing laws and regulations. The term of municipal bonds needs to be relatively long. Therefore, without a mature legal framework to guarantee investor's interest, it would be difficult to attract investors to enter municipal bond markets. Du Ping noted that even China's national treasury bond and stock exchange markets over the past decade have suffered from the lack of sufficient laws and regulations to protect investors.
  2. Policy preparation. Du Ping noted that his participation in the Wilson Center municipal bond workshops and training seminars have helped him learn about some policy requirements for municipal bonds, such as taxation benefits. He reflected that while a number of local governments in China have tried quasi-municipal bonds through large enterprises, none have addressed essential policy changes to make this financing tool effective in the long run.
  3. Establishment of nationwide standards. Du Ping believes China needs to have the central government review and approve bond proposals and determine the scale of such bonds, for he did not think that in the near term it would be logistically feasible to have local citizens vote on such decisions in China.
  4. Minimize risks. China has some experience in risk management in terms of bank loans and other financial markets, but not in the municipal bond area. The extensive measures undertaken in the United States to prevent state budget crises around municipal bonds highlights how China could learn much on risk minimization from the U.S. experience.

As the end of the Tenth FYP quickly approaches with many environmental targets unmet, Chinese policymakers feel the pressure to adopt policy changes to reform the financing system for environmental infrastructure. Du Ping speculated that the upcoming Olympic Games and Shanghai World Expo could help to push the concept of municipal bond reforms in Beijing and Shanghai.

Reflecting on the financing demands of his own city Tianjin, which over the next decade will need at least 190 billion Yuan to clean up pollution on the Hai River, Wu Jinghua noted that he sees a great potential to issue municipal bonds in China. Developing a municipal bond market will be an arduous task, particularly because fee rates for wastewater and landfills are currently much too low in China. While water user fees in Beijing were recently doubled, such fees will have to rise much more to help create the necessary market for supporting bonds for wastewater treatment plants.

China's Enterprise Bond Market

Following Du Ping's review of investment in basic environmental infrastructure in China, Xu Xiaobo presented an overview of the past and current trends of the enterprise bond market in China.

Enterprise Bonds

Over the past two decades enterprise bonds have evolved from ad hoc experiments into a more standardized and thoroughly regulated system. Between 1984 and 1986 a handful of Chinese enterprises issued bonds without formal regulations or standards. These ad hoc bond issuances could be viewed as experiments, which helped guide the State Council to issue Temporary Regulation of Enterprise Bonds in 1987. Under this temporary regulation the State Development and Planning Commission and the Central People's Bank oversaw the issuing of enterprise bonds. 1992 was the peak year when 30 billion Yuan in enterprise bonds was issued. In August 1993, the State Council issued the modified regulations for issuing enterprise bonds to expand the range of enterprises. Specifically, in 1987 only nongovernmental enterprises could issue enterprise bonds, but under the 1993 regulations any enterprise with a legal status could issue them. This legal expansion in issuers was increased again later in 1993 when the National People's Congress passed the Corporation Law, which permitted corporations and other enterprises to issue enterprise bonds.

In 1999, the State Council decided that all enterprise bonds will be overseen by the State Development and Planning Commission (now the National Development and Reform Commission). In addition, the State Council decided to begin amending the 1993 Regulation, which now mandates that any new enterprise bond obtain special permission from the State Council.

The development of the enterprise market is significant in China in that it has helped stimulate capital for construction and accelerated economic development. Xu Xiaobo also felt enterprise bonds are significant in that they have introduced a sustainable alternative financing channel besides government subsidies, which has pushed enterprises to enhance their self-discipline and increase awareness of investment and the concept of risk. Such bond markets are also a way to prevent illegal investment mechanisms.

Since 1987, 250 billion Yuan in enterprise bonds were used to develop large projects in energy, transportation, communication, and urban infrastructure. Currently, enterprise bonds are traded in Shanghai and Shengzhen security exchange market, but there is no over-the-counter trading allowed by law.

In the early 1990s, the peak time of issuing these bonds, there were nine types of enterprise bonds—State Investment Bonds, State-Invested Corporate Bonds, Central Enterprise Bonds, Local Enterprise Bonds, Local-invested Corporate Bonds, Residential Construction Bonds, Financial Bond, Short-term Financing Bonds, and Internal Bonds. A tenth type of bond—the Transferable Corporate Bond—began being issued in 1998.

Main Obstacles to Enterprise Bonds in China

Xu Xiaobo concluded her talk by highlighting some of the challenges to China's enterprise bond market:

  • Security exchange market scale is small. Enterprise bonds occupy a very small and slowly developing portion of the security market. Even though the bond and stock markets were started at the same time in China, the latter has developed much more rapidly in the 1990s. Because of the slow development in bond market investors are losing interest.
  • The interest rate of enterprise bonds is less competitive. Current interest rates were set early to stabilize the entire market and bond interest rates cannot exceed 40 percent of total savings, which is not following the market rate.
  • Bond investors demonstrate short-term behavior. Investors lack knowledge of investment and awareness of risk.
  • Lack of a system to evaluate the issuing enterprise. A mechanism to promote self-regulation of issuers has not yet been fully established. The quality of service provided by intermediate institutions to monitor bonds is low.
  • Lack of robust mechanism for risk management of bonds. Investors look up to the government whenever instability in the enterprise market occurs. There is no true social monitoring mechanism for the enterprise bond markets.

The Future of China's Enterprise Bond Market

While the enterprise bond market has become more standardized in China, Xu Xiaobo recommended additional changes crucial to assure a more thriving, sustainable market. The scale of the current market should be increased, while preparations should also be made to develop a second market. Additionally, the interest rates for enterprise bonds should be set by the financial market and not by the government. Xu also contended that to create a sound environment for the development of enterprise bonds, China needs to strengthen the fiscal self-discipline of enterprises, expand and strengthen the investor pool by building up their awareness of risk, and accelerate the disclosure of information on bond issuance.

In addition to the need for a monitoring mechanism for bond issuance, Xu suggested that China needs to consolidate a safety net for enterprise bonds. That is to say, an ability to pay back debt should be a prerequisite of bond issuance. Such a safety net would ultimately demand a reform of bond supervision and management; moreover, new independent intermediate institutions, not just the Chinese government, would need to play a supervisory role.

Drawing from some information she learned during the Wilson Center's weeklong municipal bond training, Xu Xiaobo emphasized that China's enterprise bond market should introduce an insurance system, create tax exemptions for bond investors, and utilize short-term mechanisms during the 30-year terms of the municipal bonds

Seeking New Mechanisms to Fund Wastewater Treatment

In major China's urban areas, the proportion of treated wastewater is the highest in the country, reaching nearly 70 percent. The situation in the countryside is starkly different. Despite the growing number of urban wastewater treatment plants, the quality of China's rivers is degrading rapidly—in great part from untreated waste flowing from industries in villages and townships. The main tool the government currently has to remedy this problem is to encourage commercial banks to approve special loans for these village and township enterprises to treat wastewater. However, Zhou Hongchun did not feel this is the best solution because these small enterprises are economically weak and it is unfair to tell them to "rely on the market." This problem underlines the need for new financing channels to meet these small-scale infrastructure needs. Zhou Hongchun and others in the study tour team felt the example of how the Maine Bond Bank pools bonds to help small cities build environmental infrastructure holds a promising model for China.

Zhou Hongchun discussed the challenges of funding wastewater treatment plants in China where despite the growing number being constructed only one-third are functioning well. Many wastewater treatment plants suffer from insufficient funding due to low fee collection and insufficient government monitoring and law enforcement. Notably, the quality of waste management in coastal provinces such as Zhejiang is much higher than the national average because of innovative public-private financing partnerships. Most common have been wastewater treatment plants built with government and international grants, with operations then financed by the enterprises. Most innovative have been private enterprises that are raising investment funds themselves and then inviting the local government to share in the investment (usually through bank loans, but sometimes with bonds). Because of the growing difficulty in getting bank loans, in some industrial parks private enterprises are combining funds to build and manage a large wastewater treatment facility for the whole park. Some of the more successful private wastewater funded plants have created a management committee of professionals to manage the fund. Build-operate-transfer wastewater treatment plants also are increasing in number in Zhejiang.

Despite some successes with public-private partnerships for funding wastewater treatment plants in Zhejiang province, Zhou Hongchun noted some obstacles that prevent such financing countrywide. Most seriously is the lack of mutual trust between the local governments and enterprises and the limited governing capacity of the local government to coordinate and set proper preferential policy and taxation among different enterprises.

Other participants:

Interpreter
Sheree Willis, Center for East Asian Studies, University of Kansas

Additional Study Tour Members:
Fang Zhi, State Environmental Protection Administration, Department of Planning & Finance
Shen Bing, NDRC, Institute of Spatial Planning & Regional Economy
Shi Yulong, NDRC, Institute of Spatial Planning & Regional Economy

Drafted by Jennifer Turner, Fengshi Wu, Heather Hsieh, and Timothy Hildebrandt.

 
Event Speakers List: 
  • National Development and Reform Commission
  • Division of Finance, National Development and Reform Commission
  • State Council Development Research Center, Division Chief Research Professor
  • Tianjin Municipal Finance and Economic Office
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