Just Released: "China Infrastructure Report Q4 2013"

We see a credit crunch spreading and persisting in the infrastructure and wider construction sector in China and as such we have moved to downgrade our 2014-2022 industry value forecasts. Despite the revisions, we still note strong downside risks to our forecasts stemming from the curtailment in liquidity that fuelled the most recent surge in fixed asset investments. We believe that the prevalence of shadow banking assets in infrastructure and real estate is currently the single largest risk facing the entire construction sector in China as it can prompt a steep and deep recession in the sector.

Our view on the temporary and short lived nature of the uptick in railways in particular was based on the issues with diminishing return on expenditure, meaning that each round of easing needs to be larger than the last in order to generate same impact on headline growth. The stimulus announced in September 2012 that included US$100bn for railways for 2013, while sizeable, was a fraction of the 2009 stimulus that fuelled nearly 50% in railways construction and other infrastructure. In addition, the break-up of the Ministry of Railways, which for the past decade has epitomised China's massive infrastructure programme, in our view signals the upcoming moderation (and in some ways, rationalisation) in the infrastructure spending. The 2012/2013 stimulus was also fuelled by a massive liquidity surge in off balance sheet assets. Tighter government control over the expansion of shadow banking practices in China will have an impact on the ability of local governments and large scale developers to develop infrastructure and property. Though data is elusive, it is estimated by BMI's China Country Risk analysts that off balance sheet assets are equivalent to 80% of the GDP.

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The new government has been quick to implement changes to the infrastructure programmes in China, starting with the break-up of the powerful Ministry of Railways (MoR). The environmental ministry also seems to be more empowered; no doubt on the back of increasingly vociferous public opposition to the deteriorating environmental conditions. These changes suggest to us that the new government is re-thinking several of the previously announced infrastructure projects in transport (especially railways) and power generation and utilities. The massive US$103bn spending for railways in 2013 that was going to add another 5,200km of new tracks (announced in 2013) may be severely scaled down, especially in light of the fact that a principal priority of the new railways entities (China Railway Corporation and State Railway Administration) is to pay down the debt amassed by the MoR.

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