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FROM THE ECONOMIST INTELLIGENCE UNIT
After another year of phenomenal growth, China's rail network reached nearly 100,000 km in 2011 and is set to become the world's largest this year, overtaking the US. However, ambitious plans to have the network reach 120,000 km by 2015 are looking increasingly implausible as investment is scaled back and existing lines struggle to break even. As the government tries to support ongoing construction, private investors will likely start to see a warmer welcome.
China's network is not only about to become the world's largest, but it is also the busiest, with 25% of global traffic on just 7% of global track. In 2010 China's trains carried 1.3bn passengers and handled 2.7bn tonnes of freight. Still, considering China's size and population, its network density (as measured by kilometres of line for every 1m inhabitants) is less than one-tenth that of Russia, the US or Canada.
Hefty rail investments in 2009-10 partly made up for the long neglect of China's railway system. The rail sector, and in particular the high-speed rail network, was one of the main beneficiaries of China's Rmb4trn (around US$630bn) stimulus package in response to the 2008-09 global financial crisis. However, the spending blitz was accompanied by considerable waste and corruption. As the extent of the abuse became apparent, the central government slashed funding to the sector. As a result, as much as 90% of all rail construction across the country was halted in the second half of 2011.
Financing problems
As of September 2011, the debt of China's Ministry of Railways (MOR) stood at Rmb2.3trn (or about 5% of China's GDP). Financing this level of investment has become an increasing burden and is unlikely to be sustainable. Apart from internally generated funds, MOR spending is financed primarily by loans from state-owned banks and bond sales. In 2010 the ministry's bank borrowing reached Rmb685bn, and it issued bonds worth Rmb160bn as low interest rates drove down project-financing costs.
But fundraising efforts hit the wall in 2011, as corruption problems surfaced and it became apparent that high-speed trains in China would not be able to draw sufficient passengers to pay off construction costs as quickly as previously thought. The Wuhan-Guangzhou high-speed link, which came into operation in late 2009, had been expected to break even by end-2011. But with losses on the route estimated at around Rmb3bn annually, it is now unlikely to break even before 2013. Indeed, many analysts question whether China's high-speed networks will ever be able to generate an operational profit.
Until recently, the government's current five-year plan (2011-15) was expected to be a historic peak for rail construction in China, with some Rmb3trn-4trn in capital expenditure anticipated for the period. However, the official target of a 120,000-km network by 2015, which includes 16,000 km of high-speed track, is now likely to be scaled back. According to a November 2011 report in the China Securities Journal, the State Council (China's cabinet) has ordered an adjustment of the medium- to long-term plan for rail-network expansion, and suggested that investment would be scaled back from Rmb800bn to Rmb500bn annually to 2015.
Enter private investors
In general, non-government investment in rail-construction projects has fallen far short of target. The government had originally hoped that the private sector would provide 40% of investment in rail infrastructure. In reality, the figure is somewhere below 5%. Railways have therefore been far less successful than highways in attracting foreign and private investment. This is partly because low ticket prices prevent rail-infrastructure projects from becoming profitable. It is also because before the dismissal of the railways minister, Liu Zhijun, in February 2011, private firms were reportedly given a hostile reception by the MOR, which saw them as a threat to its dominance of the industry.
With further railway reform in the air, private investors can expect friendlier treatment from the MOR. However, although many restrictions on foreign and private investment in rail infrastructure have been removed, the MOR still largely controls the pricing structure. With the government committed to maintaining low ticket prices, the assets offered for sale have not attracted foreign investors. This is especially so given that the MOR has not offered prime projects, such as the Guangzhou-Wuhan and Beijing-Shanghai railways, to international investors.
In an attempt to attract more outside investment to the sector, the government reportedly plans to restructure some assets into joint-stock companies and to loosen restrictions on rail tariffs for both passenger and freight. It would do well to do more. Not only would opening the sector further to foreign investment help to address its funding shortfalls, but the introduction of more efficient pricing and modern management systems might allow China's ever-expanding rail lines to actually turn a profit.
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