Chizhou deal expected to open the PPP floodgates

Anhui project could blaze new trail for infrastructure financing in China

The government of Chizhou in Anhui province signed an agreement on Monday with Shenzhen Water Group Co to give the company control of the city's sewage treatment plants and its sewer system－a deal which marks a significant shift in how the city's public utilities might be run in the future.

But for the country, the contract represents what could become a much broader policy.

The contracting out of Chizhou's vital public services could now be replicated across the country, as local governments continue to struggle with spiralling debt levels.

And as in the case of Chizhou, such a public-private partnership could be key to China's ability to pay for its growing future infrastructure demands.

On Dec 5, the Ministry of Finance unveiled 30 "exemplary projects" earmarked for similar PPP－including those for sewer systems, water and heating supplies, garbage disposal, medical care, sports facilities－amounting to 180 billion yuan ($28.9 billion), including the Chizhou contract, which is the first to be officially announced.

The government in Chizhou offered to sell at the start of this month 26 years of ownership and operational rights to its sewage plants and sewer system.

In winning the bid, SWG has now agreed to take over the facilities previously owned and run by the government, for 712 million yuan.

In exchange, the government has promised to pay a fixed price (22.5 million yuan per year) for the services the company provides. In other words, the government has unloaded its assets and turned itself into a service buyer.

The work will be carried out as a joint venture between the two sides via a special purpose vehicle, 80 percent owned by SWG, and 20 percent by the government. The SPV has promised to invest another 1.34 billion yuan on building new facilities.

Zheng Qingzhang, a senior executive with SWG, said the SPV already has paid-up capital of 217 million yuan, with the remaining 499 million yuan expected to come from bank loans.

It has already been given "high-level official endorsement" of its financing model, said Zheng, with around 10 banks interested in providing the funds.

In Western markets, PPP generally refers to long-term cooperation between governments and private companies on infrastructure or public service projects. The public sector side grants the SPV long-term operating and earning rights, relieving it of future investment responsibilities.

In China, the partnership is more loosely defined as one between government and any entities beyond government, for example State-owned enterprises.

The PPP model has been touted by the central government throughout the year, and various initiatives (including the 30 "exemplary projects") have been announced to encourage the new financing model.

Liu Zhi, a professor with Peking University and a former World Bank official, said, however, that PPP is hardly a new concept in China, having first been introduced as early as the 1990s and used since then, albeit sporadically.

Experts said that when the central government's 4 trillion yuan stimulus package of additional fiscal spending was launched in 2008-09, there were few opportunities for PPP-type projects.

That process did, however, increase borrowing by local government financing vehicles to unprecedented levels, mainly to finance infrastructure construction.

Amid the credit binge, local governments had little trouble in either raising money or cooperating with non-public entities.

The result today is a credit hangover for local governments right across the country, with many now grappling with gigantic debt.

Last June, total local government debt was estimated to have swollen to 17.9 trillion yuan.

The infrastructure spending soaked up credit－but too many projects proved to be unproductive.

The cash flow generated by them often just covered a tiny proportion of the debt, and to ensure repayments were made, the LGFVs relied heavily on frequent renegotiations of financial terms.

A recent report by Industrial Securities Co Ltd estimated that interest payments made this year on local government debt (not including the principal) accounted for 53 percent of total social spending. Local governments, it said, have accumulated assets larger than any other countries.

The central government has realized the situation cannot be allowed to continue.