China Equity Strategy:Featuring PPP Part 4,An inflection point after three-year high growth

We resume our PPP thematic series reports focusing on recently announcedtightening regulations on PPP projects. After three years of rapid PPPdevelopment, the government has become increasingly concerned that localgovernments may misuse PPP as a disguised borrowing vehicle to circumventpolicy restrictions. Since May, Ministry of Finance (MOF) has announced threemajor notices in order to strengthen PPP project controls (Documents No. 50,87 and 92). Document 92, announced last Friday, is a more concrete guidelinefor removing unqualified projects from PPP database, which has been on acontinuous uptrend since 2014. Although we expect modest impact on FAIoutlook in 2018 due to the small percentage of reduced investment within totalFAI, the growing PPP momentum is set to face an inflection point. We providea list of companies with significant PPP order exposure (>Rmb7bn).

    On 16 November, MOF issued Regulating Public-Private Partnership (PPP)Integrated Information Platform (Document No. 92). The Notice urges financedepartments at all levels to exert scrutiny on PPP projects from the databaselist, i.e. tightening the standards of new projects and cleaning up unqualifiedexisting projects by March 2018. Three key regulations are highlighted below.

    1) The payment linked to results appraisal should not be less than 30% of thetotal project cost, which is to prevent social capital from earning excessiveprofits at the construction stage but bearing little responsibility at theoperation stage. This means lengthened payment terms for PPP projectparticipants and the amount of payment will be more closely linked tooperation performance, rather than construction status.

    2) The project’s “two assessment” (value for money and fiscal affordability)should be conducted properly with full procedures; the upper limit of 10%local government general fiscal expenditure cannot be exceeded.

    3) The government is prohibited to provide illegal debt guarantee to socialcapital, including the pledge to repurchase principal and compensate loss,fixed-rate-return guarantee and any form of guarantee for the project debt.

    This is to prevent PPP turning into another debt burden after LGFV debts.

    We also highlight a few other regulations targeting tighter controls on PPPproject eligibility and financing, including Jiangsu government’s localguideline, SASAS’s notice on SOE’s PPP risk control and the draft for guidelineon asset management businesses (investment funds as key PPP stakeholders).

    According to the latest data release from the MoF, total planned PPPinvestment increased Rmb1.4tr to Rmb17.8tr by 3Q17. Quarterly landing ratereached a new high at 35.2% in 3Q17. Total investment of landed PPP projectsin 8M17 represents 3.9% of total FAI in China. We also see an increase inquarterly delisted projects from database and a slowdown of net newly listedprojects in database, mainly due to stricter regulations. Meanwhile, MoF ismulling the fourth batch of demonstration projects focusing on ruralconstruction and ecological environment, which should be announced soon.