Financing urban infrastructure a case of xian, china

FINANCING URBAN INFRASTRUCTURE: A CASE STUDY OF XI’AN, CHINA DONG XIN (HT070173E) A THESIS SUBMITTED FOR THE DEGREE OF MASTER OF SCIENCE DEPARTMENT OF BUILDING NATIONAL UNIVERSITY OF SIN GAPORE 2009 Acknowledgements I would like to express my greatest gratitude to my supervisor, Associate Professor Willie Tan, for his valuable reviews, extensive guidance, and heartful encouragement. I would like to express my deepest appreciation to the government officials and academic researchers in Xi’an who have given me great help in data collection and valuable advice for my study. Lastly, I would like to thank my family for their encouragement and support. ~i~ ~ ii ~ Content Summary ................................................................................................................vii  List of Tables ........................................................................................................... ix  List of Figures ......................................................................................................... xi  Chapter 1 Introduction ............................................................................................. 1  1.1 Research problem....................................................................................... 1  1.2 Scope .......................................................................................................... 2  1.3 Objectives .................................................................................................. 3  1.4 Organization of the study ........................................................................... 4  Chapter 2 Literature Review .................................................................................... 5  2.1 Provision of local infrastructure................................................................. 5  2.2 Financing options of local infrastructure ................................................... 8  2.2.1 Local taxes ...................................................................................... 8  2.2.2 Fees ............................................................................................... 11  2.2.3 Intergovernmental transfers .......................................................... 13  2.2.4 Debts ............................................................................................. 17  2.2.5 Private funds ................................................................................. 21  2.3 Hypothesis................................................................................................ 23  Chapter 3 Methodology ......................................................................................... 25  3.1 Research design ....................................................................................... 25  3.2 Data collection and processing ................................................................ 26  Chapter 4 Xi’an, the Case City .............................................................................. 28  4.1 Political structure ..................................................................................... 29  ~ iii ~ 4.2 Economic development ............................................................................ 32  4.3 Social characteristics ................................................................................ 37  4.3 Level of infrastructure provision ............................................................. 38  Chapter 5 Financing Urban Infrastructure for Xi’an ............................................. 41  5.1 Centrally planned model in Soviet economy (1949-1978) ...................... 41  5.1.1 Macroeconomic context ................................................................ 41  5.1.2 A centrally planned model ............................................................ 42  5.2 Public finance model in Socialist market economy (1978-2000) ............ 46  5.2.1 Macroeconomic context ................................................................ 46  5.2.2 Local taxes .................................................................................... 48  5.2.3 Fees ............................................................................................... 50  5.2.4 Intergovernmental transfers .......................................................... 52  5.2.5 Loans ............................................................................................. 55  5.2.6 A public finance model ................................................................. 58  5.3 Public corporation model in a marketized economy (2000- ).................. 64  5.3.1 Macroeconomic context ................................................................ 64  5.3.2 Xi’an Infrastructure Investment Group (XIIG)............................. 66  5.3.3 Local revenues and transfers to XIIG ........................................... 67  5.3.4 Intergovernmental transfers .......................................................... 72  5.3.5 Loans ............................................................................................. 74  5.3.6 Private participation ...................................................................... 77  5.3.7 Special districts and self-raised funds ........................................... 81  ~ iv ~ 5.3.8 A public corporation model ........................................................... 82  5.4 Issues and challenges ............................................................................... 88  5.4.1 XIIG’s debts, projects and government guarantees ...................... 88  5.4.2 Unstable revenue stream from land assignment ........................... 90  5.4.3 Private participation and policy risks............................................ 92  5.4.4 Lure and risks of other financing approaches ............................... 93  Chapter 6 Conclusion ............................................................................................. 96  6.1 Summary .................................................................................................. 96  6.2 Main findings ........................................................................................... 96  6.3 Limitations ............................................................................................... 98  6.4 Recommendations .................................................................................... 99  Appendix .............................................................................................................. 100  Reference ............................................................................................................. 103  ~v~ ~ vi ~ Summary The purpose of this research is to examine how urban infrastructure is financed in Xi’an City in China during the last 60 years since the People’s Republic of China was founded in 1949. This issue is interesting because little is known about the causes of new financial arrangements and their efficacy, particularly among inland cities in China. Based on the literature review, the study builds up urban infrastructure financing models for different periods. Accordingly, three different periods may be identified, namely, • 1949 to 1978, where a centrally planned model based on the Soviet experience was used; • 1978 to 2000, where a public finance model was used during the experimental stage with free market principles; and • 2000 and after, where a public corporation model with private participation was used in a market economy. In the centrally planned model, the local government collected taxes and enterprise profit and transferred them to the central government. In turn, the local government received project specified funds from the central government to carry out its infrastructure projects. The central government, rather than the local government, was the main actor in urban infrastructure financing. There was no ~ vii ~ incentive and method for mobilizing private funds. In the public finance model, the local government became the key initiator and used a number of sources to finance urban infrastructure. These included earmarked and general local taxes, public service and administration fees, funds raised by local governmental agencies, inter-governmental transfers, domestic loans, and on-lent sovereign loans. In the public corporation model, Xi’an Infrastructure Investment Group (XIIG) was established as the central actor to finance urban infrastructure using project finance. It receives revenue transferred from the local government, obtains on-lent concessional loans (with the repayment guarantee by the local government), raises private capital, and enters into joint ventures or franchise BOT agreements with private companies for infrastructure development. This study focuses on the changing forms of financing urban infrastructure. It also identifies a numbers of risks in the current public corporation model, namely, excessive government guarantee on debt repayment, unsustainable revenue stream from land assignment, a pricing policy that limits private participation, and insufficient understanding of the risks in new financial instruments. Several recommendations are made to mitigate these risks. ~ viii ~ List of Tables Table 4-1: Natural conditions and resources of Xi’an Table 4-2: Key economic indicators (Unit: billion CNY) Table 4-3: 5 major industries’ output (2005) Table 4-4: Major indicator comparison among cities Table 4-5: Demographic feature of Xi’an Table 4-6: Employment situation of Xi’an Table 5-1: Local budget in the centrally planned economy (Unit: million CNY) Table 5-2: Level of infrastructure investment compared to economic development in centrally planned model Table 5-3: Local fiscal contribution to infrastructure finance 1996-2000 (Unit: million CNY) Table 5-4: Contribution of fees to infrastructure finance 1996-2000 (Unit: million CNY) Table 5-5: Contribution of intergovernmental transfer to infrastructure finance 1996-2000 (Unit: million CNY) Table 5-6: Interest rate and repayment period of domestic loans Table 5-7: Term and conditions of sovereign loans Table 5-8: Contribution of loans to infrastructure finance 1996-2000 (Unit: million CNY) Table 5-9: Level of infrastructure investment compared to economic development 1980-2000 Table 5-10: State-owned land assignment of Xi’an 2001-2005 Table 5-11: Transfer of local government revenue to XIIG (Unit: million CNY) Table 5-12: Contribution of local fiscal revenue to infrastructure finance 2001-2007 (Unit: million CNY) Table 5-13: National debt issuance and central budgetary investment in infrastructure 2001-2008 (Unit: billion CNY) ~ ix ~ Table 5-14: Contribution of intergovernmental transfer to infrastructure finance 2001-2007 (Unit: million CNY) Table 5-15: Projects listed on bond issuance instruction (Unit: million CNY) Table 5-16: Contribution of loans in infrastructure finance 2001-2007 (Unit: million CNY) Table 5-17: Contribution of self-raised funds to infrastructure finance 2001-2008 (Unit: million CNY) Table 5-18: Level of infrastructure investment compared to economic development 2001-2007 Table 5-19: Level of infrastructure provision in selected years ~x~ List of Figures Figure 2-1: Economic characteristics of various infrastructure sectors Figure 2-2: Hypothesis of the study Figure 4-1: Administrative region division of Xi’an Figure 4-2: Structure of political hierarchy of China Figure 4-3: Trends of GDP of three sectors in Xi’an (1952-2006) Figure 5-1: Centrally planned model of infrastructure finance (1949-1978) Figure 5-2: Public finance model of infrastructure finance (1978-2000) Figure 5-3: Infrastructure investment in Xi’an (1996-2000) Figure 5-4: Sources of funds of infrastructure finance structure in Xi’an (1996-2000) Figure 5-5: Trends of infrastructure finance composition in Xi’an (1996-2000) Figure 5-6: Importance of revenue from land assignment for XIIG Figure 5-7: Public corporation model of infrastructure finance (after 2000) Figure 5-8: Scale of funds for infrastructure financing in Xi’an (2001-2007) Figure 5-9: Sources of funds of infrastructure finance structure in Xi’an (2001-2007) Figure 5-10: Trends of infrastructure finance composition in Xi’an (2001-2007) ~ xi ~ ~ xii ~ Chapter 1 Introduction Chapter 1 Introduction 1.1 Research problem The purpose of this study is to examine the mechanisms the city Xi’an has adopted in financing its infrastructure since PR China was founded in 1949. The importance of infrastructure provision in a locale to its overall development is a tenet of all development theories (Ostrom Schroeder and Wynne, 1993). In an increasingly integrated world, advanced power, water, and transportation services are critical to sustain the growth and competitiveness of any economy (Aluko, 2005). According to the World Development Report (World Bank, 1994, p7), “the adequacy of infrastructure helps determine one country’s success and another’s failure – in diversifying production, expanding trade, coping with population growth, reducing poverty, or improving environmental conditions.” There are many constraints on the delivery of infrastructure, among which finance is an important one. Generally, central governments only provide limited funds to local government for the construction and maintenance of infrastructure, since the main beneficiaries are within the local jurisdiction. Existing residents also resist higher taxes in developing regions and areas (Savitch and Kantor, 2002). In China, dramatic changes have occurred in the last half century. Urban areas have developed from war-torn towns to modern cities. Still, little is known about the changing forces of new financial arrangements and their efficacy, particularly ~1~ Chapter 1 Introduction among inland cities in China. It is of great value to understand how urban infrastructure is financed in different periods, what key variables are there in the system, and how they evolve as the context changes. Past studies of public finance in China (Holzer and Zhang, 2003; Qiao Jorge and Xu, 2008) focus on the fiscal reform in 1994, which caused significant changes in intergovernmental fiscal relations. Moreover, infrastructure finance researchers (Lin, 2001; Zhu Liu and Chen, 2004; Qin, 2003; Bellier and Zhou, 2003) mostly pay their attention to financing at the national level and in a short historical period, mostly during the recent several years after 1998. This research examines infrastructure finance at city level, and extends the exploration to include various periods with distinct political, economic, and social contexts. 1.2 Scope This study focuses mainly on urban infrastructure finance in Xi’an city in China from 1949 to 2008. In a broad sense, infrastructure is defined as the facilities that provide the society with services necessary to conduct daily life and to engage in productive activities (Mody, 1997). In this study, the definition of urban infrastructure is limited to the urban “lifelines” and networks, including water supply, sewers and storm drainage, solid wastes, energy supply, telecommunication, road and bridges, public transit, as well as waterfront development. Other building-type capital facilities, such as schools, hospitals, jails, ~2~ Chapter 1 Introduction and recreational facilities, although believed to belong to infrastructure by many researchers (Miller, 2000), are not considered in this research. Moreover, telecommunication and waterfront development are also not included in the study, because telecommunication is nationally managed in China and waterfront development does not exist in the inland city of Xi’an. The financing of urban infrastructure in this study concentrates on the new construction and system expansion. Costs associated with operation and maintenance will not be considered. In developed countries, cities need vast amounts of investment to prevent their existing infrastructure from deteriorating. However, the major problem developing cities are facing is to provide essential infrastructure of a certain quality that is financially accessible to the local population. Indeed, in a few decades, the maintenance issue will be increasingly significant as a result of the construction of many new infrastructure projects, but this issue is beyond the scope of the study. The political and economic contexts in the financing of the urban infrastructure will be considered. The special Chinese political order and development pattern have significant implications on the results of the study. 1.3 Objectives The objectives of this study are: ~3~ Chapter 1 Introduction • to build models of infrastructure finance of Xi’an in different periods; • to understand why different models are adopted; and • to identify potential risks and challenges in the current model. 1.4 Organization of the study Chapter 2 provides the literature review and develops the hypothesis. It focuses on the characteristics of infrastructure provision and the various sources of funds that can be mobilized by local governments to finance urban infrastructure. Chapter 3 describes the case study methodology used in this research and methods of data collection. Chapter 4 and Chapter 5 are in-depth studies of the case city Xi’an, on how infrastructure provision is financed. Chapter 4 introduces background of the city, including its political structure, economic development, and social characteristics. Chapter 5 builds structural models of infrastructure financing in three different periods, analyzing the importance of variables in the models as well as the political and economic forces behind their emergences and substitutions. Chapter 6 summarizes the main findings, implications, limitations, and provides suggestions for future research. ~4~ Chapter 2 Literature Review Chapter 2 Literature Review Capital infrastructure is crucial to a city – it affects the economic competitiveness of its business and the living standards of its residents. Developing cities and mature cities all face a formidable challenge in financing their capital expenditures, because of the difficulty in balancing their significant capital requirements and limited sources of financing (Brittain, 2002). This chapter reviews the literature on the responsibility of urban infrastructure provision and its financing. 2.1 Provision of local infrastructure This section mainly addresses two aspects. One aspect is the suitability of public provision of local infrastructure. The other aspect is the responsibility of the local government and central government in the provision of urban infrastructure. The foremost characteristic of urban infrastructure is a mixture of public goods and private goods. Private goods are individually purchased and consumed, suitable to be provided in competitive markets, while public goods are non-rival and non-excludable in their supplies and consumption. Being non-rival, serving particular goods to an additional consumer only generates negligible marginal cost, so that any positive price will exceed the marginal cost and therefore is inefficient. Being excludable, it is difficult to exclude non-paying customers from consuming the good or service. As a result, it is uneconomical for private sector to provide the goods (Trebilcock and Daniels, 1993). As a hybrid of public and private goods, ~5~ Chapter 2 Literature Review infrastructure could be provided by the public or private sectors. Figure 2-1: Economic characteristics of various infrastructure sectors (World Bank, 1994) Another possible feature of infrastructure provision is that of a natural monopoly. The provision of these networks involves economies of scale, where large scale consumption could enhance quality and lower cost of providing such goods. The introduction of competition leads to unnecessary duplication of network systems, and this is considered a waste of resources. Public ownership of natural monopolies is justified on the ground that a private monopoly would lead to exploitation of consumers. However, a natural monopoly may be broken up for competition, such as in telecommunications, power industries and some railroads that are owned and operated privately, under the supervision of certain regulating agencies (Hulten and Schwab, 1993). ~6~ Chapter 2 Literature Review The public provision of infrastructure raises the issue of responsibility allocation and distribution between tiers of governments. In practice, each level of government receives a specific “block of responsibilities”, based on its fiscal power and political status. In recent decades, a process of decentralization has been implemented in many countries. Advocators stressed its merits of greater efficiency, accountability, flexibility and innovation in local public service (Wolman, 1983). Dissenters warned of the drawbacks of the arrangements such as inefficiency, waste and corruption (Peterson, 1981). Most public finance economists favor the decentralization of infrastructure provision. Capital expenditure requires initial investment (normally intensive) and subsequent maintenance, with continuous depreciate and eventual replacement. They state that tastes and preferences differ among jurisdictions. Welfare gains are achieved by decentralizing expenditure decisions to the level of government that best incorporates a community of common or similar interests (Musgrave and Musgrave, 1976). Decentralization can improve accountability by clarifying the responsibilities of various units of governments, reducing the costs of constituent participation, and increasing the likelihood that participation will influence policies (Ostrom, Schroeder and Wynne, 1993). Therefore, it is reasonable to assume that identifying local preferences is easier for local governments that are close to the ground, so that a better match between supply and demand of infrastructure can be expected (Oates, 1985; Oates, 1989). However, researchers also point out that decentralization improves infrastructure service only if local ~7~ Chapter 2 Literature Review governments enjoy sufficient political and financial autonomy and are institutionally accountable (Bird, 1993). For infrastructure that cut across local jurisdictions (e.g. rail transport), regional provision is more efficient because of the need for coordination. To sum up, it is possible for the public sector to mainly or at least partly provide local infrastructure, because of its public goods and natural monopoly features. With a natural monopoly, it is possible to carve out areas for competition and private provision. 2.2 Financing options of local infrastructure This section reviews the literature on various financial resources that local government can utilize to finance infrastructure. They are categorized into five types, namely, local taxes, fees, intergovernmental transfers, debts, and private funds. The first three are used for a wide range of purposes including infrastructure; the latter two are usually used especially for financing infrastructure. Each resource is reviewed to clarify its attributes, classifications, pros and cons, as well as its applications. 2.2.1 Local taxes Local governments draw their own revenue from taxes, fees, and other forms of incomes like fines or investment returns. Of the above resources, tax is the most ~8~ Chapter 2 Literature Review relevant to the provision of public services, which also attracts public attention to a large extent. Taxes are generally divided into property tax, consumption tax, and income tax, and is structured at federal (central), regional (state, provincial), and local levels. In the developed countries, the most common form of direct local tax is property tax. The tax normally imposes on various types of properties: residential, commercial, industrial, and institutional properties. As the city develops, although property tax remains the revenue mainstay at local level, consumption and income taxes are increasingly relied upon as well. All the for-and-against arguments on a particular tax item concern its level of “efficiency” as well as “equity”. In an ideal tax system, interference with efficient market economic decisions is minimized and private inefficiencies are corrected. Tax contributions are made in line with the benefit received from public service and according to their economic ability to achieve the redistribution function of the public sector (Musgrave, 1976). Property tax is a type of wealth tax, justified on the basis that surrounding public services provide security to property and increase its value (Dunkerly, 1983; Tideman, 1982). The valuation of properties and land, which determines the tax being paid, is an important issue (Calhoun, 2001; Allen and Dare, 2002; Cooper, 1996). Consumption tax at the local level is studied from three aspects: resident demand (Mullins and Wallance, 1996), taxable business transactions (Fryman, ~9~ Chapter 2 Literature Review 1969; Derrick and Scott, 1993), and visitor/commuter spending (Hawkins and Murray, 2004). Local income tax in various countries is studied carefully and compared comprehensively by the World Bank (Budina and Irwin, 2005). Apart from the general allocation of property tax, income tax, and consumption tax, earmarked tax is often used in financing infrastructure. Tax earmarking is the allocation of certain tax revenues to a designated end use. Newbery and Santos (1999) believe that earmarking taxes for dedicated capital expenditure is an obvious application of the benefit principle of taxation which, properly applied, should lead to a more efficient structure of local service provision. In the US, a major source for transportation infrastructure finance is an earmarked tax – the gasoline tax. Other supporters point out that assigning of receipts – from a particular tax base or a proportion from a wide pool of revenue to specific end use – reflects informed choices of taxpayers and more democracy (Wikinson, 1994). Skeptical opinions (Dilnot, 1993) argue that public spending should be determined by policy decisions, instead of amount of revenue raised by an earmarked tax. They also state that earmarking reduce the flexibility of the fiscal system, because excess revenues may accumulate somewhere while deficiencies occur somewhere else simultaneously. According to Stiglitz (1988), most items imposed on by local taxes are mobile in the long run, especially capital. A community that increases capital tax will have to either offer better public services or ultimately see an erosion of their tax base, such ~ 10 ~ Chapter 2 Literature Review as when investors divest their properties or “vote with their feet” (Tiebout, 1956; Winner, 2005). Therefore, local tax can hardly stand as the only source for local infrastructure finance. 2.2.2 Fees Fees are money paid by citizens to governments to support services they received. They are distinguished from taxes for their voluntary purchase of particular services. Usually, revenues from fees are used to cover the costs of the service provisions. Theoretically, benefit taxes and earmarked taxes such as the gasoline tax are mixtures of taxes and fees, since they are freely purchased and used for particular expense purposes (Ulbrich, 2003). Fees can be divided into two categories, permits and service charges. Permits are authorizations to engage in certain kind of activities. Examples include business licenses, driver licenses, and building permits. Fees for services are charges incurred when a particular publicly provided service is ordered, such as park entry, toll road passage, postal service, and sewer service. In financing urban infrastructure, fees are often preferred, because it is considered more equitable than taxes. Taxes are levied only on residents, while fees are applicable to residents and nonresidents. Those who do not pay local taxes would also contribute to the costs of services they are provided, which internalizes positive externalities of public infrastructure services. Being a non-tax financing ~ 11 ~ Chapter 2 Literature Review source, fees can be spent without incurring too much political implication to voters as taxes would do. Moreover, many administrators believe that supporting facilities through user fees leads to greater administrative efficiency (Porter and Peiser, 1991). Critics against imposition of fees come from the consideration of another aspect of equity – “ability to pay”. Infrastructure is normally a basic service that is consumed by rich and poor to a similar degree. Therefore, poor residents would pay a larger portion of their income for the same amount of service, rendering fees regressive and inequitable (Netzer, 1992). In principle, price discrimination for different age, income group, and other factors could partially address this problem. But the way to set rational prices for certain services, reflecting their marginal costs for various users and areas, is still controversial. In practice, fees related to public infrastructure are levied in most countries. User charges of various public utilities and services are the most common forms of fees. Publicly provided water, gas, and waste disposal are all subject to a certain level of user charges. Sometimes, charges are levied on some services-related items instead of the services themselves. For example, ordinary urban roads are not charged, but vehicle registration fees, annual license fees, and fuel fees are levied to finance the urban transportation system. Other than user charges and services-related item fees, impact fee is commonly used for infrastructure finance of new urban areas in developed countries. Impact ~ 12 ~ Chapter 2 Literature Review fees are imposed on developers in the development process, and are designed to provide infrastructure to the development or to ensure the development’s contribution to larger scale infrastructure expansions (Levine, 1994). It shifts payments from owners of existing property to parties associated with the new developing property (Evans and Lawhon, 2003). It was first employed in the US to overcome the fiscal gap arose from general revenue finance. By using impact fees, new infrastructure becomes cost-free for public treasury, and might even generate a higher tax base because of the rising price of the development. However, it is also criticized that the costs would shift to new homeowners and tenants at the market interest rate of mortgage repayment, rather than the less costly interest of public debts (Jeong and Feiock, 2006). Other local revenues include fines, payment for services to higher tiers of government, interest income on invested cash, and other miscellaneous sources. These constitute a small part of local revenue, and would not be included in the study. 2.2.3 Intergovernmental transfers Intergovernmental transfer refers to grants donated from one tier of government to another, usually from senior governments to subordinate governments. Therefore, local government is often considered as the recipient of transfers from central government, or regional government. In some areas, local fiscal sustainability relies heavily on intergovernmental transfers. As Lewis (2006) noted, central government ~ 13 ~ Chapter 2 Literature Review transfer in Indonesia accounts for 92% of local fiscal resources, whereas taxes and user charges only add 8% to total local revenue. There are two basic types of intergovernmental transfers, general and earmarked. In Canada, they are called unconditional transfer and conditional transfer; in the US, they are called general-purpose grants and categorical grants. General intergovernmental transfer does not put constraints on the expenditure area. It is often distributed on a lump-sum basis automatically according to certain preset criteria. The determination of transfer amount relies on several factors, for instance, population, tax base, and poverty rate of a jurisdiction, etc. In contrast, earmarked intergovernmental transfer must be spent for a designated use, such as parks or disables, or on particular projects. Sometimes earmarked transfer is only granted with an attached condition. For example, donor government may ask for a proportional matching fund from the recipient government. Due to limited pool of funds, these grants sometimes need several applying governments to compete for it (Bergvall, et al., 2006). In some countries like Denmark, there is an equalization transfer system between local authorities directly. Equalization is achieved by taking resources from richer local authorities to poorer authorities, thus making central fund unnecessary in the system (Pedersen, 2002). The literature justifies intergovernmental transfers to local governments on the ground that it is more efficient to collect income taxes centrally to avoid capital ~ 14 ~ Chapter 2 Literature Review flight across local areas or regions. These collected revenues are then transferred to local and state governments according to some equitable formula. A municipality, as a relatively small open economic system and a constitutional creature of senior governments, has limited autonomy and monopoly ability to raise revenue. In many countries, the income tax base and tax rate are determined nationally by higher governments (Gerasimova, 2005). Therefore, a local government has rather limited power to raise funds through income taxes. In other countries where local tax policies are set by municipalities, local tax collection is also restricted due to government’s concern about tax base variation. In the US, and in Europe to a less extent, cities regard themselves as competitors fighting against each other for high mobile labor and capital. A high level of local tax may distant taxpayers from its jurisdiction (Tiebout, 1956). Since people are less likely to move out of a state (province) and a country, it would be appropriate for the higher tier of governments to raise money for local expenditures. Intergovernmental transfer, especially unconditional transfer, is justified on this ground (Kitchen and Slack, 2005). Transfers also have a horizontal equity purpose (Santiago, 2008). Cities, constrained by geographic, historical, and demographic factors, may differ in their taxable wealth (Bradbury, 1983). Transfers are collected from both rich and poor areas. In many circumstances, transfers are allocated to reduce the revenue disparities among local governments, so that low income municipalities could ~ 15 ~ Chapter 2 Literature Review enjoy more redistribution benefits from grants (Break, 1967). From a political perspective, intergovernmental transfers are granted as a steering tool for higher tiers of governments, especially conditional transfers. High tiers of governments may have different priorities compared to those of local governments (Uguy, 2001; Copeland and Meier, 1984). Transfers would encourage local government to provide services in areas where local government may prefer not to provide on their own. Transfers are also means of gaining political support, such as channeling funds away from anti-government areas. Although justified from both economic and political perspectives, intergovernmental transfer also encounters critics for its impacts on local accountability reduction, and unpredictability of local revenue (Sim, 2001). The accountability issue arises from circumstances where more than two levels of government share responsibility in providing certain services. In the case of intergovernmental transfer, local governments perform partly on behalf of senior governments who raise the funds. Less incentive towards efficiency would be generated from an agent’s role than being the revenue raiser. Besides, accountability is blurred with one government raising funds and another one delivering services (Fisher, 1982). Grants, especially those with selection and screening process, are not stable local revenues, because they are discretionary. Various methods have been developed to ~ 16 ~ Chapter 2 Literature Review advantage oneself in the competition of these funds (Caruson and MacManus, 2005). Due to fiscal status of donor government and variations of grant policies, transfers received would vary from year to year. Therefore, heavy reliance on transfers would generate high revenue instability and unpredictability. 2.2.4 Debts Loans to local governments include government loans, commercial loans, and sovereign loans. Government loans refer to loans granted by other tiers of governments or funds, but differentiated from government transfers in terms of the obligation for repayment. Commercial loans refer to loans granted by banks, insurance companies, and other financial entities. Sovereign loans refer to loans granted by multilateral development banks (MDBs) and foreign countries for development purposes. Higher governments may act as lenders to local government for financing infrastructure. On the one hand, the payback period of an infrastructure project is usually long. On the other hand, subsidized lending is often needed in the form of low interest rate. Sometimes, higher governments do not lend directly, but set up a revolving loan fund for urban authorities to borrow (Krishnan, 2007). Central governments may also borrow on their own credit standing to get cheaper loans and then onlend it to local governments. Local governments may borrow from capital markets directly as well, especially in ~ 17 ~ Chapter 2 Literature Review those profitable infrastructure areas. If being sponsored by higher government guarantees against local default, local governments can obtain higher credit ratings and borrow at lower interest rates (ADB, 2003). Sometimes, commercial financing agencies may receive tax reliefs in exchange for lending to the government at lower interest rates. International lending institutions usually provide long-term low interest or interest-free loans and grants to developing counties to assist their development (OECD, 2007). The major MDBs are the World Bank, African Development Bank, Asian Development Bank, European Bank for Reconstruction and Development, and Inter-American Development Bank Group. The central governments of many developed countries, such as Denmark, Spain, Germany, and Japan also provide similar loans and grants to developing countries. Compared with commercial loans, interest rate of sovereign loans are normally much lower. Besides, sovereign loans usually have a long repayment periods and several years of grace period. The major risk in international borrowing is the foreign exchange risk, because these loans are often denominated in international currencies. Governments can also issue bonds to finance local urban development (Lai, 2007). A bond is a transferable claim to repayment of the principal with interest at a time and interest rate stated on its face. A municipal bond is the most widely used type of public loans in the US, which can be bought on issuance or in secondary market. Usually, the funds have to be spent on specific capital projects, with a repayment ~ 18 ~ Chapter 2 Literature Review time from several months to 40 years or even longer. Interest income received by holders of municipal bonds is often income tax exempt. Therefore, bond holders would accept lower interest payment than other types of investment. Municipal bonds may be general obligations bond which are backed by the full faith and credit of the issuer; or revenue bonds which are secured by specified revenues, such as revenue from a road project. Debt financing is widely used in local infrastructure development. The most frequently mentioned rationale for debt financing is the equity principle of public finance, especially the intergeneration distribution of the tax and repayment burden. If debt financing is used, especially if loans are amortized in tandem with physical depreciation, the services citizens get would be closely connected with the amount they pay. Therefore, classic public finance textbooks suggest that while current expenses should be covered from current revenue, urban infrastructure and other capital expenditures should be funded by loans (Musgrave and Musgrave, 1976). Another justification for the use of debt is the fluctuating local revenue and infrastructure expenditure. On the revenue aspect, local revenue is generated from taxes and fees that are influenced by macro-economic conditions. As a rather small economy, local government has a very limited impact on the market conditions that generate fluctuating local revenue. On the expenditure side, capital investment need fluctuates at the local level as well. It is much easier for central governments to even out investments among regions and sectors to create a smooth expenditure stream ~ 19 ~ Chapter 2 Literature Review (Mikesell, 1982). However, debt financing is often seen as risky (Garbislander and Haas, 2002). It is believed that politicians and/or citizens are myopic, and are unable to take future generations into account when making investment decisions for debt financing. Therefore, they tend to engage in costly investments, and the cumbersome debt repayment would be left to future governments and citizens. Once a local government falls into heavy debt burden, it has to raise tax rate or introduce new taxes to generate more revenue. In the public choice theory, residents would respond to this situation by moving, which drag local governments into a fiscal crisis. Therefore, it is reasonable to set constraints to the total amount that debt financing can be used (Myna, 2007). In practice, Belgium, Australia, Denmark, France and many countries all divide local budgets into ordinary budget which affords current public consumption and capital budget which finance capital expenditures including infrastructure (Gilbert and Guengant, 2002). Normally permissions are given to public utilities and some other prioritized areas, with a ceiling on the aggregate value nationwide annually. Other than these restrictions, detailed arrangements such as volume, interest rate, loans duration, and identity of the lender can be freely chosen by local authorities (Vanneste, 2002). ~ 20 ~ Chapter 2 Literature Review 2.2.5 Private funds Project financing of infrastructure provides governments a financing alternative from raising taxes or borrowing (Barr, 1998). These projects are normally financed through non-recourse or limited recourse lending. A special purpose vehicle (SPV) which owns the project is set up by sponsors who contribute equity and management expertise, and it borrows money from capital markets. Revenues generated from products produced or services provided by the project represent the only or principal source of debt repayment. Should the project go into default, the lenders have recourse only to the assets and cash flows of the project company, without further recourse to the sponsors of the project (Tan, 2007). This configuration is suitable for infrastructure project like toll roads, water supply facilities, wastewater treatments, and natural gas, because they can generate stable long-term revenue stream for debt repayment. However, sponsors are often required to provide contingency funds up to a certain limit, such as when a project incurs cost over-runs. Public Private Partnership (PPP) refers to long-term co-operation between public and private sectors in which the actors develop mutual products and services and in which risks, costs, and benefits are shared (Klijn and Terisman, 2000). PPP is frequently used in infrastructure project financing. There are many ways in which PPP may be structured (United Nations, 1998). “Contracting out” means that private sector simply provides management services ~ 21 ~ Chapter 2 Literature Review to a facility for an agreed period and fee without relating to the ownership and financing. “Joint venture” means that public and private sectors jointly finance, own and operate a facility in the form of a jointly sponsored infrastructure company. “Franchise” means that public sector grants a private firm an exclusive franchise or monopoly privileges to supply a particular service within an area. “Build-Operate-Transfer” is the most common form of it in which private sector finances, builds, and operates the facility for a certain period (normally 25-30 years) in order to repay debts and earn returns, and then transfers the facility back to the public sector. In this case, the government maintains formal ownership of the project and certain degree of pricing control. “Private Finance Initiative” (Ball et al., 2007) and “Leasing” (Colucci, 1999) means ownership of the facility remains in private hands, with the public sector purchasing/leasing services provided by the private company. In this case, substantial part of risks associated with financing and operating the facility are allocated on the private sector. PPPs have many advantages. In the finance aspect, the benefits of involving the private sector are the transfer of risk, substitutes for public borrowing and up-front costs, and the protection of users and tax-payers from the financing burden. In the management aspect, the private sector contributes its expertise in specific technical skills, sophisticated budgeting and accounting techniques (OECD, 1991). Hodge (2000) reviews studies examining the cost issue in private provision and finds a 10%-30% reduction in various areas. However, because of measurement problems, such studies should not be viewed as conclusive. ~ 22 ~ Chapter 2 Literature Review On the other hand, PPP is criticized as a maneuver of governments to avoid immediate fiscal deficit or debt restriction, neglecting future fiscal risks and the costs it poses. Complaints include complicated financing arrangements, cost increases, less possibility of networks extension to the poor, adverse environmental impact and more opportunities for corruption. It is argued that high profit sought by private investors will inevitably increase the price of services. Besides, public investment incurs a lower cost than private investment, because the government is able to borrow at a lower cost. The use of PPP in developing countries experienced significant growth in the 1990s. Over 755 billion USD of investments flowed in nearly 2500 infrastructure projects between 1990 and 2001. However, many of them led to renegotiation, discontent, cancellation, and other disappointing results. Actually, PPP became less popular after the Asian financial crisis of 1997-1998 (Harris, 2003). Some studies attribute this problem to unrealistic pricing of infrastructure services, which challenged many political concerns of local governments. To address this problem, the World Bank (Irwin, 2007) proposed a comprehensive way to assess the overall fiscal implications of PPP projects which includes estimation of true fiscal consequences of financing publicly, and assessment of the cost of government’s commitment. 2.3 Hypothesis Based on the literature review, it is seen that the appropriate structure of local ~ 23 ~ Chapter 2 Literature Review infrastructure finance is the mixture of tax, fees, transfers, loans and private capital. Each form of financing has pros and cons, potentials and constraints. The appropriate choice of instruments one city choose would be impacted by national guidelines and directives, cost of funds, as well as the internal characteristics of a city (see figure 2-2). Therefore, the financing model of infrastructure in Xi’an can be divided into three periods: 1949-1978, 1978-2000, and after 2000. Central Guidelines and Directives Sources of Funds: • Taxes • Fees • Transfers • Private capitals • Loans Infrastructure Financing Model Cost of Funds Internal Characteristics of the City Figure 2-2: Hypothesis of the study ~ 24 ~ Chapter 3 Methodology Chapter 3 Methodology 3.1 Research design The case study approach is adopted in this research. A case study can be categorized according to the number of cases, spatial variation, and temporal variation. This research was the single case diachronic study, with little spatial variation but substantial temporal variation. The intent of the case study is to probe intensively into the way urban infrastructure is financed in the city of Xi’an. In order to provide insight into a broader phenomenon, a typical-case approach is adopted to select a city that is as representative as possible of China’s inland urban infrastructure development. Xi’an, the capital city of Shaanxi Province, was chosen. It is a city with 1) temperate climate; 2) an average population, urbanization rate, economic development compared to other parts of China; 3) diversified industries and social sectors; 4) absence of any outstanding peculiarities or acute local problems. The research is of an exploratory nature. The study holistically zooms in the experience of the city using multiple sources of evidence. This encourages a flexible research strategy since data are not restricted to any particular source (Tan, 2004). Under investigation of the case, an in-depth insight of evolvement of urban ~ 25 ~ Chapter 3 Methodology infrastructure finance model is gained. To be sure, although Xi’an is a typical inland Chinese city, the conclusions are difficult to generalize based on a single case. 3.2 Data collection and processing The study is carried out in the field setting of the case city. Both quantitative and qualitative data are collected and analyzed. Quantitative data come from internal and external sources. Data are mainly taken from the following sources: • Statistical data; • Governmental report and information on their official websites/ databases; • Intermal governmental files; • Company profiles; • Published papers and research theses. Qualitative data are both abstracted from reports and collected from discussions. Interviews were organized with bureau officials from Xi'an Municipal Urban& Rural Construction Commission, Xi’an Statistical Bureau, and researchers in related social organizations. The purposes of these discussions are to better understand causes and implications. The preliminary data processing focuses on reliability and consistency of the data. Most of the data come from government bureaus and their statistical publications. ~ 26 ~ Chapter 3 Methodology It is not uncommon that data with the same name suggest different meanings, and the same data vary in different government sources. Carefully comparison and cross referencing eliminate some unreliable data. More importantly, organizing discussions with the government officials help us to understand the exact meaning of each term and to find the original document. Any inconsistency caused by change of calculating method is adjusted or pointed out in the study. ~ 27 ~ Chapter 4 Xi’an, the Case City Chapter 4 Xi’an, the Case City Xi’an, the capital of Shaanxi Province, is one of China’s key inland cities in northwest from political, economic, and cultural perspectives. It lies in the centre of Guanzhong Plain (107°14′E-109°15′E, and 33°14′N-34°14′N), bounded by the Qinling Mountains in the south and the Loess Plateau in the north. The total area within the city jurisdiction is 10,108 km2, in which 35.44% (3582 km2) is urban area. The central urban area contains nine administrative districts, including Xincheng, Beilin, Lianhu, Baqiao, Weiyang, Yanta, Yanliang, Lintong, and Chang’an. Four peripheral counties, namely Lantian, Zhouzhi, Huxian, and Gaoling constitute the other 6526 km2, showing predominantly rural characteristics (see Fig. 4-1). Figure 4-1: Administrative region division of Xi’an Xi’an has a semi-moist monsoon climate. The annual temperature is 14.9℃ on average, with 541.4 mm precipitation including snow in winter time. Other detailed ~ 28 ~ Chapter 4 Xi’an, the Case City natural conditions and resources are listed in Table 4-1. Average annual temperature/℃ 14.9 Annual precipitation/mm 541.4 Total sunshine time/h 1949.4 Average wind speed/m*s-1 1.0 Area of cultivated land/1000 ha 266.8 Area of forestry/1000 ha 522.5 Inland water area/1000 ha 32.3 3 Total water resources/ billion m 2.7 Table 4-1: Natural conditions and resources of Xi’an Source: Official website of Xi’an City People’s Government 4.1 Political structure Since antiquity, China has been governed by multiple administrative levels; because of its broad area, large population and varied ethnics. Currently, there are six de facto tiers of governments: Central, Provincial, Prefectural, County, Township and Village. Township and village only exist in rural areas. In urban areas, a service committee called Administrative District functions similar to township, but the administrative district does not act as a layer of official government politically. Each layer has its own departmental structure. The six layers form a mono-hierarchical system, where lower levels of governments are completely subordinate to higher levels. The structure of political hierarchy in China is shown in Figure 4-2. ~ 29 ~ Chapter 4 Xi’an, the Case City Figure 4-2: Structure of political hierarchy of China The meaning of word “City” in Chinese is determined by context. It could refer to provincial-level cities directly under the central government, like Beijing, Shanghai, and Hong Kong. But more often it refers to prefecture-level city under provincial governance or county-level city under prefectural governance. Normally, several prefecture-level cities constitute a province. Each prefecture-level city contains several counties, county-level cities, and urban administrative districts. By definition, a prefectural city has to meet several criteria: more than 200,000 non-farming population, a relatively advanced tertiary sector that makes up more than 35% of its GDP, and local government budget exceeding 200 million CNY. Xi’an is a prefecture-level city. A special case in prefecture-level cities is “sub-provincial” cities, which means they are actually given a higher level than a normal prefecture politically but still lower than provincial level. These are prefecture-level cities that enjoy a higher degree of autonomy and development priorities. There are 15 cities in the country which rank at sub-provincial level. Usually, they are provincial capitals and large prefectures in a province. Xi’an, as ~ 30 ~ Chapter 4 Xi’an, the Case City the capital city of Shaanxi province, is one of the sub-provincial cities. The term “local government” in China refers to any sub-provincial level of government. In the case of Xi’an, local government is a prefectural level government, called Xi’an City People’s Government (XCPG). Although its sub-provincial position gives it some special political advantages, the essential attributes are the same as other prefectures. The local government reports their work to the people’s congress and the standing committee at prefectural level. It also reports its work to provincial government and accepts the unified leadership of the State council from central government. It directs the economic, cultural, and administrative work of the city. It also directs the administrative affairs of county governments under its jurisdiction. XCPG is composed of a mayor, vice mayors, secretaries-general and directors of various official bureaus, commissions, and agencies. The mayor and vice mayors are elected by the people’s congress, which is the organ local people exercise their power stipulated by China’s Constitution. The People’s congress is comprised of representatives voted by local residents, so only limited residents could participate in the process of mayor election. The term of their services is five years. The bureaucratic system is structured into local departmental agencies, central vertical agencies, public institutions, public state-owned companies, and social organizations. There are currently 28 local departmental agencies. Head officers of these agencies are nominated by the mayor. But the nomination power of mayor is ~ 31 ~ Chapter 4 Xi’an, the Case City not as significant as it seems. In most cities in China, the power of Secretary of Party Municipal Commission is at least as strong as the mayor. The Secretary who represents the Communist Party will in practice impact the head officer nomination extensively. There are another 22 vertical agencies under direct leadership of individual central departmental ministries. Head officers of these agencies are nominated by central ministries rather than local governments. Development zones and industrial parks are special zones within prefectural jurisdiction with economic and policy priorities. Public institutions or public state-owned companies are established to manage the development of these parks. They are given political autonomy; they are also given concessional land price, tax rebate and other favored economic policies. They adopted experience from the US to implement corporate management in the zone. They are responsible for stimulating business and attracting investments, financing infrastructure inside the zone, and implementing new patterns and mechanisms as pioneers. 4.2 Economic development Xi’an has achieved considerable economic accomplishments in the last several decades, especially in the last ten years. In 2006 its GDP reached 147.37 billion yuan, which doubled the number five years before, and equals 780 times the number when People’s Republic of China was founded in 1949. GDP per capita increased to 17,825 CNY (2245 USD) in 2006, which is benchmarked as the first ~ 32 ~ Chapter 4 Xi’an, the Case City time exceeding 2000 USD. Foreign direct investment (FDI) also grows exponentially after China joined the World Trade Organization (WTO) in 2001. In 2006, FDI was 825 million USD, an increase of 44% from the previous year. The Consumer Price Index (CPI) stayed below 102 (compared with the data in previous year) and Producer Price Index (PPI) below 104 in recent years, which represent low inflation. Item 2000 2001 2002 2003 2004 2005 2006 GDP 64.61 73.49 82.67 94.67 110.24 127.01 147.37 GDP /capita1 /CNY 9484 10628 11831 13341 15294 15859* 17825 4.46 4.59 4.78 5.07 6.02 6.60 7.08 Secondary sector 27.71 31.29 35.36 40.74 47.69 53.96 63.89 Tertiary sector 32.43 37.61 42.53 48.86 56.53 66.45 76.40 Fixed asset 23.24 28.77 33.86 47.81 64.67 83.51 106.66 Primary sector2 CPI 100.2 99.9 98.6 100.5 102.3 100.3 101.6 PPI 99.4 99.3 98.2 101.5 102.7 103.9 103.2 256 276 571 825 FDI /mil.US$ 156 177 203 1 Since 2005, GDP per capita is adjusted to residential population, instead of registered population, because of the trend of increasing labor mobility. 2 China categorizes economy into three sectors. Primary sector refers to agriculture, forestry, stock raising and fishing. Secondary sector refers to mining, manufacturing, public utility (power, gas, and water) production and supply, as well as construction. Other from these, the rest is categorized as tertiary sector, including transportation, IT, retail, R&D, finance, real estate, education, sports, entertainment, social welfare, social organization, and so on. Table 4-2: Key economic indicators (Unit: billion CNY) Source: Xi’an statistic yearbook. Fig 4-2 shows the economic increase of primary, secondary and tertiary sectors in Xi’an from the 1950s. Currently, the tertiary sector is the largest sector. In 2006, GDP of the three sectors are 7.077 billion, 63.89 billion, and 76.40 billion CNY; ~ 33 ~ Chapter 4 Xi’an, the Case City which form 4.8%, 43.4%, and 51.8% of total GDP respectively. The share of the secondary sector and tertiary sector started to rise in the 1990s after a relatively sluggish development in the first forty years. The growth of tertiary sector is slightly faster than the secondary sector. In contrast, the primary sector produces relatively stable output every year with imperceptible increases. 160 GDP/billion CNY 140 120 100 80 60 40 20 1952 1957 1965 1970 1975 1978 1980 1983 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 0 Year GDP Primary Industry GDP Secondary Industry GDP Tertiary Industry GDP Figure 4-3: Trends of GDP of three sectors in Xi’an (1952-2006) Source: Xi’an Local Chronicles The main industrial products of Xi’an include electricity, dairy, soft drink, beer, yarn, paper, sewing machine, detergent, traditional Chinese medicine, cement, shaped steel, industrial boiler, motor vehicle, AC motor, transformer, electric cable, telecommunication cable, color kinescope, meters and instruments. The five major industries are equipments manufacturing, high-tech industry, tourist industry, cultural service industry, and modern service industry (Table 4-3): ~ 34 ~ Chapter 4 Xi’an, the Case City Industry Output /CNY billion Proportion to GDP/% Equipment manufacturing 17.9 14.2 High-tech industry 10.0 7.9 Tourist industry 9.7 7.6 Cultural industry 6.4 5.1 24.7 19.5 Modern service industry Table 4-3: 5 major industries’ output (2005) Source: Xi’an statistic yearbook 2006. As the capital of Shaanxi Province, Xi’an plays an essential role in provincial economic development. In 2005, GDP, fixed assets investment, and export/import of Xi’an made up 34.56%, 35.91%, and 85.23% of those of the province respectively. It is estimated by the provincial government that in the future, Xi’an would continue to be the main engine of provincial economic development, and more resources would be provided by the provincial government. From a parallel perspective, however, the development of Xi’an lagged behind that of large coastal cities such as Shanghai and Qingdao. This is due to two main reasons. Firstly, because of the distribution of central political power in the last two decades, China’s reform policy has always concentrated on the coastal south and east of the country, rather than cities in the inner west like Xi’an. Secondly, inland cities are relatively insulated from the political, economic, and cultural innovations of the dynamic coastal cities. In 2005, GDP per capita of Xi’an was only 1/3 that of the two provincial-level cities Beijing and Shanghai, and 1/2 that of the coastal cities like Qingdao and Hangzhou. ~ 35 ~ Chapter 4 Xi’an, the Case City City GDP /billion CNY Population /thousand GDP per capital/CNY Beijing 681.45 15380 44308 Shanghai 914.39 17780 51428 Shenyang 208.41 6986 29833 Qingdao 269.58 7409 36385 Wuhan 223.80 8014 27926 Nanjing 241.11 5958 40468 Jinan 187.66 5974 31413 Guangzhou 515.42 7505 68677 Hangzhou 294.27 6605 44553 Ningbo 244.93 5567 43997 Chengdu 237.08 10820 21911 Guiyang 52.56 3507 14987 127.01 8008 15859 Xi’an Table 4-4: Major indicator comparison among cities Source: Xi’an statistic yearbook 2006. Although Xi’an is still behind the development pace of eastern Chinese cities, it shows substantial growth and great potential after 2000 when China implemented the new Western Development Program to develop urban areas in the western half of the country. In the new development scheme, the Xi’an city planning authority will use a 4-zone-1-base strategy. The four special development zones are High-tech industry development zone, Economic-tech development zone, Chan-ba ecological zone, and Qujiang new urban zone. The base is Xi’an aviation base, as aviation hub of China. In 2005, fixed assets investment in these areas has already reached 54 billion yuan. These districts will continually promote high-tech industries, environmental friendly industries and foreign investments. They will be the mainstream of future economic development of the city. The local government is very confident about the future prosperity of the city. ~ 36 ~ Chapter 4 Xi’an, the Case City 4.3 Social characteristics Xi’an is one of the birthplaces of Chinese ancient civilization. In 2006, the registered population was 7.531 million. China’s household registration (also known as hukou) policy was implemented in the centrally planned economy to control labor mobility. A person’s residence may be different from his hukou. But the official statistics still report registered population. The natural population increase in recent years is between 3‰ to 7‰ (Table 4-5). There is also a large net immigration every year. Household registration also distinguishes urban hukou from rural hukou. Urban population is calculated by counting the number of people who hold urban hukou. This explains why the urban employment is much more than urban population. Many people who work in the city hold hukou from rural counties nearby or from other cities. Item 2001 2002 2003 2004 2005 2006 Population(registered)/million 6.95 7.03 7.17 7.25 7.42 7.53 Natural increase/‰ 3.20 3.23 3.80 3.32 5.94 6.37 Net immigration/thousand 45.9 55.6 113.3 60.2 123.9 66.8 Urban population/million 2.93 3.00 3.13 3.19 3.33 3.44 Urban employment/million 3.89 3.97 4.05 4.10 4.16 4.22 Table 4-5: Demographic feature of Xi’an Source: Xi’an Statistical Yearbook Xi’an has been one of the most urbanized cities in China since ancient times. In 1957, the urbanization ratio of Xi’an had already reached 33.94%, exceeding most prefectures in the country. After 50 years of gradual growth, the urbanization ratio ~ 37 ~ Chapter 4 Xi’an, the Case City increased to 45.6%. Unlike most cities in China, especially in the east and south, Xi’an did not experience rapid congestion. The employment structure in Xi’an shows a tendency from agriculture towards the service sector. Employment in the primary sector keeps decreasing, while employment in tertiary sector is increasing. Employment in secondary sector fluctuates slightly in recent years. However, compared to the output GDP, there are still a substantially large number of farmers producing low value-added products and living with low income. 32.78% of labor force only generates 5.2% of GDP in primary sector. Year 2000 2001 2002 2003 2004 2005 6.91 6.24 5.78 5.36 5.46 5.20 37.79 37.27 36.02 36.22 34.62 32.78 Secondary GDP/billion CNY sector Employment/% 42.89 42.58 42.77 43.03 43.26 42.48 27.57 27.99 28.10 26.94 27.27 27.46 Tertiary sector GDP/billion CNY 50.20 51.18 51.45 51.61 51.28 52.32 Employment/% 34.65 34.74 35.88 36.84 38.11 39.76 Primary sector GDP/billion CNY Employment/% Table 4-6: Employment situation of Xi’an Source: Xi’an statistic yearbook 2006. 4.3 Level of infrastructure provision Local infrastructure is divided into several sectors in Xi’an, including road and bridges, water supply, gas supply, sewage system and wastewater treatment, greening, and central heating. Power supply and telecommunication are controlled and provided by central government, so it is not considered by the city ~ 38 ~ Chapter 4 Xi’an, the Case City government. In 2005, expenditure on infrastructure provision was 1481 CNY per capital. In the water sector, water consumption per capita was 147.25L/d, and total water supply was 357.76 million tons per day. Total length of piping network was 2315km, which represented 99% level of centrally supply system connection. In road and transportation sector, the length of road has reached 1382 km in 2005. The total area of roads and bridges was 3021ha, and area of footpath was 827ha, which generated an area of road per capita of 8.11m2. The number of mass transit buses was 4762, which equaled to 1.238 buses per thousand people. In the wastewater and sewerage system sector, wastewater generation was 232.43 million tons per day, and the capacity of wastewater treatment plant was 90.35 million tons per day. Only 38.9% of wastewater generated was appropriately treated before discharge. Total length of sewerage system was 1618km, which were around two thirds that of water supply system. In the gas supply sector, level of connection to central gas system was 91.3%. In the central heat sector, area of central heat supply was 2113ha. In the greening sector, total area of public green space was 1569ha, or 5.63m2 green space per capita. Compared to other cities in China, infrastructure provision of Xi’an has reached the average level, in terms of percentage of coverage and amount of investment. In the Annual Report of Urban Competitiveness of China, Xi’an ranked 33rd in the 200 cities reported. The infrastructure competitiveness of Xi’an was ranked 45th. ~ 39 ~ Chapter 4 Xi’an, the Case City The report identified the infrastructure provision of Xi’an as “strongly improved, especially in road and transportation sector”. Indeed, infrastructure provision of Xi’an has improved greatly since 2000. Many of the indicators, such as length of road and wastewater treatment capacity, have increased significantly from the 2000 level. In 2000, infrastructure expenditure per capita is only 234 CNY, which results in infrastructure provision of Xi’an under average level in China. But as the investment increases, the level of provision has reached an average level among middle and large cities of China. ~ 40 ~ Chapter 5 Financing Urban Infrastructure for Xi’an Chapter 5 Financing Urban Infrastructure for Xi’an 5.1 Centrally planned model in Soviet economy (1949-1978) 5.1.1 Macroeconomic context China ended its 3000-year-long emperor regime in the early 20th century. After decades of war, the China Communist Party (CCP) seized power in 1949. In the first 30 years of its administration, CCP implemented a centrally planned system. In this system, resources were allocated predominantly according to national strategic considerations, and implemented through administrative apparatuses. There was no private sector in the country’s economy. State-owned enterprises (SOEs) controlled every industry and produced specific products strictly according to plans, at fixed numbers and fixed prices. The household registration (hukou) system restricted the mobility of labor. Moreover, it was an extremely isolated economy. Until economic reform in 1978, China’s export constituted less than 1% of world trade. It was one of the exceptional economies which had neither borrowing nor lending, either internationally or domestically, for decades. Capitalist public finance and budget process did not exist in communist planned economy, because there was no separation of public and private sectors. The budget served as an accounting device for implementing planning programs. This Soviet-type fiscal system drew revenue heavily from profit remittances of SOEs rather than taxes (Wong, 1997). The central government maintained monopoly on ~ 41 ~ Chapter 5 Financing Urban Infrastructure for Xi’an tax and profit delivery policies and administrations, while local governments only acted as subordinate collecting agencies. On the expenditure side, local governments controlled little over their service programs and the way these programs were financed. All programs were financed by the central budget according to dictated instructions of the central planning authority. After the PRC was founded, Xi’an played a strategically significant role in the reconstruction of the country. The first and the second 5-year-plans (1952-1957, 1958-1962) of China contained 156 key proposed projects, of which 17 projects were located in Xi’an. These crucial projects formed the industrial base of the city. In the 1960s, the central planning authority organized many national defense and military projects in the city, and many scientific and technological resources were relocated here. Before the market reform in 1978, the GDP of Xi’an used to stay in the first 6th in the country, with dominant advantages in several industries. 5.1.2 A centrally planned model However, economic advances led to neither abundant fiscal revenue nor sufficient funds for infrastructure finance. In the central-planned economy, nothing belonged to an individual city or a company. The entire economy nationwide was pooled together and then broken down again according to central government dictates. Table 5-1 shows local listed budget incomes and expenditures of Xi’an in the period. ~ 42 ~ Chapter 5 Financing Urban Infrastructure for Xi’an Year GDP Income 1949 189 3.84 1952 337 1957 Expenditure Income/GDP /% Expenditure /Income /% 2.28 2.03 59.38 52.93 28.54 15.71 53.92 802 148.90 60.73 18.57 40.79 1965 1276 223.23 98.57 17.49 44.16 1970 1776 426.79 120.74 24.03 28.29 1975 2133 555.73 157.12 26.05 28.27 1978 2535 672.67 223.98 26.54 33.30 Table 5-1: Local budget in the centrally planned economy (Unit: million CNY) Source: Shaanxi Provincial Statistics Bureau In the first 20 years, local budgeted income only represents less than 20% of the local GDP. Most of the resources were directed to industrial expansion, especially heavy industries and military, following the Soviet model. The ratio between the budgeted expenditure and the budgeted income is also very low. Since resources were nationalized and the local budget was only an accounting device, balance at local level was neither necessitated nor existing. Revenues were delivered to the central government, pooled, and then allocated back to finance the planned expenditure. In the case of Xi’an, a large part of its revenue was used by the central government in financing projects in other parts of the country. In the 1970s, expenditure only represented 30% of local fiscal revenue. Therefore, the capacity of infrastructure investment was rather limited. ~ 43 ~ Chapter 5 Financing Urban Infrastructure for Xi’an Figure 5-1: Centrally planned model of infrastructure finance (1949-1978) Source: author The channel of infrastructure finance in the Soviet economy from 1949 to 1978 is summarized in Figure 5-1. In the structure, rectangles represent institutions, ellipses represent funds, and diamond represents infrastructure projects. In the model, the local government collects revenues and transfers them to the central government. According to mandatory planning and required budget appropriation, the local government receives funds from the central government. Then it carries out the plan and invests the funds to corresponding infrastructure projects. The main features of the model are: 1) The role of the central government is more critical than the local government. The infrastructure projects carried out are subjected to central planning. 2) The general budget, which is mainly financed by profit delivery instead of taxes, is the most important source of infrastructure investment. 3) The investment is treated as ordinary current expenses rather than ~ 44 ~ Chapter 5 Financing Urban Infrastructure for Xi’an long-term financing activities. The investment is listed on general budget together with any other current expenditure. Unfortunately, urban infrastructure was not a favored expenditure area in the planning agenda. In this period, local fixed assets investment was divided into productive unit and living (non-productive) unit. Factories and equipment belonged to the productive unit, and public services including urban infrastructure belonged to the living unit. With the rule of “producing first, living last”, overwhelming investments were directed to the productive unit. Table 5-2 shows local GDP, investments in fixed assets and investments in infrastructure in this period. In the first 10 years from 1952 to 1962, investment in infrastructure represented only 1-2% of GDP and about 7% of fixed assets investments on average. From 1963, add-ons of public services, urban industry & commerce surtax, and urban real estate tax were earmarked to infrastructure investment. However, the stable sources of funds did not lead to sufficient infrastructure development. Because of the low rate, problematic way of calculation, and continuous funding rearrangement, the actual investment in infrastructure stayed at an extraordinarily low level. In 1970, it reached the bottom at only 0.66% of total fixed assets investment of the city, which contributed a minimal fraction of 0.07% to local GDP. ~ 45 ~ Chapter 5 Financing Urban Infrastructure for Xi’an Year GDP /million CNY Infrastructure investments /million CNY Infrastructure investments/ GDP/% Fixed assets investments/ million CNY Infrastructure /fixed assets/% 1952 337 5.61 1.66 43.66 12.85 1957 802 18.78 2.34 342.37 5.49 1960 922 14.45 1.57 409.78 3.53 1965 1276 11.67 0.91 204.50 5.71 1970 1776 1.26 0.07 191.18 0.66 1975 2133 9.58 0.45 169.22 5.66 1978 2535 12.28 0.48 272.91 4.50 Table 5-2: Level of infrastructure investment compared to economic development in centrally planned model Source: Xi’an Local Chronicles This financing model is built on two bases: the absence of competition and the special political hierarchy. In the centrally planned economy, government forbade free competition domestically. As an economically closed country, international competition did not exist, either. Therefore, there was no incentive to finance infrastructure to attract business. Moreover, the political hierarchy was less concerned about democratic issues, so that advanced public infrastructure services for residents could easily be sacrificed without much political consideration. 5.2 Public finance model in Socialist market economy (1978-2000) 5.2.1 Macroeconomic context PRC embarked on the “market oriented reform and openness policy” in 1978 towards a “socialist market economy” and “socialism with Chinese characteristics”. ~ 46 ~ Chapter 5 Financing Urban Infrastructure for Xi’an According to neoclassical economics, ownership does not matter as long as there is competition. As a result, in the socialistic market reform, the state continually held ownership of the majority in most sectors, while allowing competition among all the entities in the market. Price was partially freed up to market forces, and the economy was increasingly opened up to the outside world. China adopted a “piecemeal” and pragmatic approach in this reform process, which generated a mixture of planned economy and market economy. The reform was taken gradually from coastal areas to inner cities, from large cities to small prefectures, from commerce to industry, and from the capital market to the fiscal system. In the transition period, as market exchanges gradually replaced plan directives, the local government was faced with huge appetites for outlays in infrastructure to lure business investment, and increased demands to support the growing population and urban agglomeration. Increased budgetary allocations on infrastructure and new sources of revenues were pursued to generate more funds for infrastructure financing. The local government became the major initiator and key actor of the urban infrastructure finance system in this period. The system includes the following types of sources, which will be analyzed individually in the following sections: • Local taxes; • Administrative fees; • Transfers from the central and the provincial government; and ~ 47 ~ Chapter 5 Financing Urban Infrastructure for Xi’an • Loans from domestic banks and onlended sovereign debts. 5.2.2 Local taxes The market reform abandoned the centrally pooled fiscal system and rearranged the relationship between the central and the local government. Tax distribution between the central and the local followed a policy of “lumpy fiscal contract” implemented in 1980, which enhanced local fiscal autonomy substantially, probably to an excessive extent. In the 1980s and the first half of 1990s, the local government collected almost all taxes, remitted an agreed amount to higher levels of governments, and kept the rest for its own. The tax submitted to central government was on a lump-sum basis instead of proportional sharing. The disbursement of the rest of the fund was almost fully determined by the local government. After the restructuring of the tax systems in 1994, taxes were collected in two separate channels, namely the local tax system and the central tax system. Tax revenues of the central government and the local government covered different areas. Still, the local government drew its funds from broader tax items than many other countries. The revenues of local government included business tax, income tax of local state-owned enterprise, personal income tax, tax on the use of urban land, tax on investment in fixed assets, tax on the use of vehicles and ships, contract tax, 25% of value added tax, 50% of stamp tax, as well as tax on resources other than marine petroleum. ~ 48 ~ Chapter 5 Financing Urban Infrastructure for Xi’an The tax item that is most related to infrastructure finance is the urban construction &maintenance tax, which was first imposed in 1985 as an earmarked tax to infrastructure. It was levied on all entities where value added tax and corporate income tax applied. Along with its imposition, the previous 5% profit delivery policy1 was abolished. It was an important step of fiscal reform in infrastructure area, which turned the Soviet “profit delivery” to the new form of “tax payment”. The urban construction &maintenance tax and add-ons of public utilities dating back from 1960, became the two main sources of infrastructure funds in the 1980s. In the 1990s, more administrative fees and other financial sources emerged, but these two were still the major sources from local fiscal general budget until the end 1990s. Table 5-3 shows local fiscal contribution to the investment on infrastructure. Sources of funds 1996 1997 1998 1999 2000 9FYP2 Urban construction & maintenance tax; Add-ons of public utilities 144 191 180 181 195 891 State-owned land assignment 50 61 39 62 230 442 Water resource tax 14 8 9 7 10 48 Other non-earmarked taxes 65 28 20 88 55 256 273 288 248 338 490 1637 Local taxes (total) Table 5-3: Local fiscal contribution to infrastructure finance 1996-2000 (Unit: million CNY) Source: Xi’an urban &rural construction and development commission 1 Before this, 5% of the profits of state-owned enterprises were submitted to sustain urban infrastructure instead of imposing tax. From 1980s, China launched a variety of “profit delivery to tax payment” policies for establishing the modern corporate system. 2 9FYP refers to the ninth five-year plan of China, launching from 1996 to 2000. ~ 49 ~ Chapter 5 Financing Urban Infrastructure for Xi’an In the 9th five-year plan from 1996 to 2000, over half of the allocation to infrastructure area from local general budget was sourced from the two earmarked taxes: urban construction &maintenance tax and add-ons of public utilities. Every year, they were able to provide over 100 million CNY for infrastructure finance. The water resource tax was earmarked to water supply system finance, and it only formed a relatively minor fraction. State-owned land assignment was also used, which will be explained in detail in section 5.3, because it is much further developed after 2000. Infrastructure was also considered when general budgetary expenditure was determined, but the amount from the non-earmarked general budget was rather limited, due to other expenditure priorities. 5.2.3 Fees Using taxes to finance infrastructure with the tax item, tax base, and tax rate determined by the central government became insufficient for the local government in the 1980s. As a result, the local government began to draw its revenue from various fees, which were applied to much looser control from senior governments. Xi’an started to levy public facility hookup fee since July 1988. According to the instructions, all construction, extension, and renovation projects were subject to the hookup fee to access public infrastructure systems. Different fee levels, from 25 yuan/m2 to 90 yuan/m2, were applied according to location, land ownership, and characteristics of the projects. Funds collected were earmarked to support the financing of infrastructure. ~ 50 ~ Chapter 5 Financing Urban Infrastructure for Xi’an User charges of tap water, gas, central supplied heat, add-ons of road construction, vehicle registration fee, and wastewater treatment fee were levied gradually in 1990s. These fees and user charges were not deposited to the general budget account of the local government. Instead, they were held in separate accounts for infrastructure finance and management. Table 5-4 shows their contribution to urban infrastructure finance of the city. Sources of funds 1996 1997 1998 1999 2000 9FYP Local administrative income 445 461 479 515 532 2432 Public facility hookup fee 88 91 111 162 115 567 User charge 64 58 175 187 157 641 Other incomes 293 312 193 166 260 1224 Self-raised funds 20 10 58 66 60 214 Table 5-4: Contribution of fees to infrastructure finance 1996-2000 (Unit: million CNY) Source: Xi’an urban &rural construction and development commission Local administrative income managed by the Fiscal Bureau but deposited to special accounts was often called “extrabudget”. Self-raised funds were kept in the account of various governmental agencies and not transferred to the Fiscal Bureau, and they were sometimes called “extra-extrabudget”. Compared to local general budget, different service charges and fees constituted a larger proportion of funds for infrastructure financing. Public facility hookup fee generated about 100 million CNY each year. User charges grew substantially in 1998 and, from then, exceeded the hookup fee, mainly because of the imposition of the natural gas fee and the rise of tap water fee. Other incomes comprised various registration charges, ~ 51 ~ Chapter 5 Financing Urban Infrastructure for Xi’an permissions, fines, commercial incomes, and facility rents. 5.2.4 Intergovernmental transfers Before the fiscal reform in the late 1990s, grants from the central government barely existed. Instead, the flow of revenue was in the opposite direction, in which the local government transferred “contracted” amounts to the central government. In public finance theory, intergovernmental transfer ensures equity by using formulas to determine the amount to be transferred to each locality. However, this approach was not applied in China. Instead, the central and local governments signed periodic contracts according to the past expenditure of the local government and the growth rate of the local tax revenues. This arrangement led to budget deficit at local level and extensive tax hidden activities, which resulted in a weak central fiscal capacity. The central government hardly had any capacity to assist local infrastructure investment. After the 1994 tax reform, the central government strengthened its fiscal capacity. As a result, it started to be involved in local infrastructure financing. The intergovernmental transfer from the central government to the local government was realized by issuing national bonds. The central government is the only government authority that can legally issue bonds, and infrastructure was one of targeted areas for debt financing. Long-term development bond was first issued in 1998, distinct from previous deficit bond, key industry bond, indexed bond, and special purpose bond. The issuance of this bond was to stimulate economic ~ 52 ~ Chapter 5 Financing Urban Infrastructure for Xi’an development and to increase domestic demand, even though it “crowds out” other investments by raising interest rates. The fund raised was specially invested in infrastructure development across the country. National debt issuances reached CNY 100 billion in 1998, 110 billion in 1999, and 150 billion in 2000 respectively. The central government has undertaken two investing mechanisms to utilize bonds issued through long-term development national debt, namely, direct investment and national debt on-lent. When using direct investment, the central government allocates funding directly to specific local infrastructure projects. It is the central government who bears the national debt repayment in future. Therefore, this approach acts as a conditional intergovernmental transfer earmarked to special infrastructure projects. The matching funds at local level are sometimes required, but seldom happened in the case of Xi’an. In contrast, national debt on-lent is in fact local debt. The local government claims the amount and the purpose of the fund. Then it borrows from the central government on the same interest rate and repayment period as the national debt. The burden of repayment lies with the local government. Theoretically, the central government has higher credit standings than the local government, so that national debt on-lent would incur lower cost of financing than the local government’s own issuance. From central government’s perspective, it obtains greater macro-economic control over local behaviors. In this period, onlended national debt was mainly lent to coastal cities which have a greater fiscal capacity. Most of the national debt allocated to Xi’an was through ~ 53 ~ Chapter 5 Financing Urban Infrastructure for Xi’an direct investment instead of on-lent. Besides central transfer, the provincial government sometimes participated in local infrastructure financing as well. However, funds from the provincial government were rather limited every year, because the provincial government mainly focused on cross prefectural infrastructures such as regional highways, railways, and telecommunications. It would not be involved in any local infrastructure project unless the project generated substantial direct regional impacts. Table 5-5 illustrates contribution of intergovernmental transfer from the central and the provincial governments. Sources of funds 1996 1997 1998 1999 2000 9FYP 9 36 441 391 170 1047 Central transfer (National debt) 9 8 405 365 150 937 Provincial transfer 0 28 36 26 20 110 Central/Provincial transfer Table 5-5: Contribution of intergovernmental transfer to infrastructure finance 1996-2000 (Unit: million CNY) Source: Xi’an urban &rural construction and development commission In the 9th five-year plan, intergovernmental transfer channeled over 1000 million CNY to infrastructure finance in Xi’an. All of them are project specified transfers, which belong to the “conditional” category. Over 90% of grants are from the central government, and the rest (10%) were contributed by Shaanxi Provincial Government. The disparity of central government investments is clearly seen before and after the long-term development national debt issuance. In 1996 and 1997, central transfers were only 9 million and 36 million CNY respectively. But ~ 54 ~ Chapter 5 Financing Urban Infrastructure for Xi’an in 1998, it rocketed up to 441 million CNY. Thereafter, transfers started to decrease moderately, because of the global recession and “only ongoing projects would receive more national debt” (People’s Congress, 2000). 5.2.5 Loans Loans are attractive financing sources because they allow the government to spend without raising taxes immediately. Concerns regarding local borrowing relate to the capacity of local governments to eventually repay them from future revenues. Thus, local governments should be cautious with debt financing, in case they incur unsustainable deficit or have to raise taxes substantially in the future. With this consideration, debt financing should be restricted to the profitable infrastructure or quasi-profitable infrastructure areas that will generate sufficient income streams to repay the previous investment. In China, the central government forbids the issuance of municipal bond, so the local government can only borrow from banks. Bank loans are borrowed solely from local branches of the four state-owned commercial banks before the development bank was established in China in 1994. In this period, loans were mainly used for roads and bridges financing, and were repaid from tolls or vehicle license fees. Both the loans and the repayments were channeled through accounts separated from the general local government account. Being inexperienced in debt recovery and project management, these loans are not well managed. For several years in the 1990s, governmental agencies had to issue new loans only to repay ~ 55 ~ Chapter 5 Financing Urban Infrastructure for Xi’an their previous debts. This practice led to a costly remedy from the central government in the late 1990s. Thereafter, new regulations are introduced to prevent similar problems in the future. The China Development Bank (CDB) was established in 1994. The Bank's primary function was to foster economic development of China through financing of key projects and initiatives in the government's national economic development plan and industry policies. In this role, the bank directed its lending activities to construction and technological renovation projects involving infrastructure facilities, basic industries and pillar industries in China. Compared to commercial banks, the interest rate of CDB was lower, and the repayment period was much longer (see Table 5-6). The repayment could be even longer than national debt on-lent, which made it suitable for infrastructure investment. Name of institution Interest rate /% Repayment period /year Grace period/ year CDB National debt on-lent Commercial bank 5.5-6.5 5-5.5 6-7 5-15 6-10 ≤10 -- 2 -- Table 5-6: Interest rate and repayment period of domestic loans Source: CDB website, “Guidelines of national debt on-lent management”. Sovereign debt is issued to the central government from multilateral development banks (MDB)1 and other countries, with repayment guaranteed by the central 1 A multilateral development bank (MDB) is an institution, created by a group of countries that provides financing and professional advising for the purpose of development. MDBs have large memberships including both developed donor countries and developing borrower countries. MDBs finance projects in the form of long-term loans ~ 56 ~ Chapter 5 Financing Urban Infrastructure for Xi’an fiscal revenue. In financing the development of Xi’an, the World Bank (WB), Asian Development Bank (ADB), and Japan Bank for International Cooperation (JBIC) are the major international actors. Since 1981, the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA) had provided loans to China. While the IBRD provides loans with a relatively low interest rate (comparable to LIBOR), the IDA’s "credits" are interest-free. In 1999, China graduated from IDA – the institution that provides loans to the poorest countries, and was only qualified to receive IBRD loans (Hu and Hu, 2005). ADB started to provide loans to China’s projects after PRC officially joined in ADB in 1986. Compared to WB, ADB had a clearer investment emphasis on agriculture and transportation infrastructure. JBIC is a Japanese governmental financial aid institution. The loans it provided to China projects are mainly in the environmental related area, and are usually combined with compulsory technical equipment purchase and training programs from Japan. Table 5-7 illustrates terms and conditions of these international sovereign loans. Name of institution Interest rate /% Repayment period/year Grace period/ year WB ADB JBIC floating, 1-6 Floating, around 5 Before 1998: 2.1 Hard loan: 20 Soft loan: 35-40 10-30 Before 1998: 30 After 1998: 40 5 -- 10 Table 5-7: Term and conditions of sovereign loans Source: WB, ADB, JBIC official website at market rates, very-long term loans (also known as credits) below market rates, and through grants. ~ 57 ~ Chapter 5 Financing Urban Infrastructure for Xi’an The financial cost of the sovereign loans is less than that of domestic loans. Low amortization is another advantage of sovereign loans, since these loans normally have an unusually long repayment period and grace period. A disadvantage of sovereign loans is that they are quite unstable and limited, because many cities are waiting in line for such loans. Besides, local governments in China are unfamiliar with the documentation the sovereign loans required. Moreover, there is always exchange rate risk inherent with international debts, if they are denominated in different currencies. In the 9th five-year plan, contribution of loans to infrastructure finance in Xi’an is shown in Table 5-8. In 1999, loans dwindled because of default. The loans recovered after stricter measures were imposed. Sources of funds 1996 1997 1998 1999 2000 9FYP Domestic bank loans 108 65 198 10 204 585 50 145 227 0 74 496 Sovereign loans on-lent Table 5-8: Contribution of loans to infrastructure finance 1996-2000 (Unit: million CNY) Source: Xi’an urban &rural construction and development commission 5.2.6 A public finance model Along with the termination of the old Soviet economy, centrally planned model soon became ineffective as a tool for infrastructure finance in Xi’an. A public finance model was gradually introduced. In this model, the local government became the essential initiator of infrastructure projects. The structure of this public finance model adopted between 1978 and 2000 is summarized in Figure 5-2. ~ 58 ~ Chapter 5 Financing Urban Infrastructure for Xi’an Figure 5-2: Public finance model of infrastructure finance (1978-2000) Source: author Compared to the centrally planned model, financial instruments were more complex in this period. Local fiscal system was created; public services and administrations were charged; and loans from home and abroad were used. In this model, the local government financed infrastructure through general local budget, extrabudget, intergovernmental transfers, self-raised funds at local governmental agencies, domestic loans, and on-lent sovereign loans. General budget allocation was sourced from earmarked and general taxes. Extra-budget allocation was supported by administrative fees including user changes. Self-raised funds were provided by revenues of the local departmental agencies. Intergovernmental transfers were both offered by the central government through national debt issuance and by the provincial government through the provincial budget. ~ 59 ~ Chapter 5 Financing Urban Infrastructure for Xi’an Domestic loans were borrowed from state-owned commercial banks and development banks. International loans were on-lent by central government from its sovereign loans borrowed from international development institutions. Before 1990s, total infrastructure investment of Xi’an in the 42 years from 1949 to 1990 was only 1297 million yuan. This amount is less than infrastructure investment in a single year of 1998, 1999, or 2000. This inadequate fiscal capacity led to a large gap between development demand and infrastructure provision. It was not uncommon that potential business investments from outside the region were not realized because of inadequate urban infrastructure. 2000 million CNY  1600 1200 800 400 1996 1997 1998 1999 2000 Year Figure 5-3: Infrastructure investment in Xi’an (1996-2000) Source: Xi’an urban &rural construction and development commission During the 1990s, Xi’an speeded up its infrastructure development. Figure 5-3 shows total investment in infrastructure annually from 1996 to 2000. The total investment in the five years reached 6,812 million, or about 1,150 million yuan per year on average. Investments in 1998, 1999, and 2000 were more than those in the ~ 60 ~ Chapter 5 Financing Urban Infrastructure for Xi’an earlier two years, mainly because of the increase of national debt transfer in urban infrastructure. 7.3% 8.6% Intergovernmental  transfers Local general budget 15.4% 3.0% Local administrative  income Other sources 6.0% 24.0% Self‐raised funds Domestic bank loans 35.7% Sovereign loans Figure 5-4: Sources of funds of infrastructure finance structure in Xi’an (1996-2000) Source: see Appendix B Financing structure  100% 80% 60% 40% 20% 0% 1996 1997 Year 1998 Intergovernmental transfers Local administrative income Self‐raised funds Sovereign loans 1999 2000 Local general budget Other sources Domestic bank loans Figure 5-5: Trends of infrastructure finance composition in Xi’an (1996-2000) Source: see Appendix B Figure 5-4 and Figure 5-5 illustrate the contributions of various sources in ~ 61 ~ Chapter 5 Financing Urban Infrastructure for Xi’an infrastructure finance from 1996 to 2000 and their variation in different years. Funds from higher tiers of governments constituted 15.4% of the total investment, and their contributions were volatile. In 1996 and 1997, their investments were less than 5%, followed by a considerable increase to approximately 25% in 1998 and 1999, and then a plunge to around 10% again. The general local budget, local administrative incomes from extrabudget, and self-raised funds from local bureau accounts, formed 24.0%, 35.7%, and 3% of the total financing sources, respectively. Fiscal and administrative revenues at local level stayed as the mainstay of infrastructure financing, representing over 50% of financing sources except in 1998 when central investment grew substantially. Domestic loans and sovereign loans constituted 8.6% and 7.3% of the total finance amount. In 1999, few bank loans were issued from home and abroad. Other than 1999, loans represented 20% of finance sources every year, but the ratio between domestic loans and international loans still varied extensively. In various sources, administrative fees raised by local government ranked the first in its contribution to infrastructure finance. Detailed numbers of each source and their annual variation are shown in Appendix A. From the expenditure side, 5.9% of the investment was used for office overhead and salary of the management team. 11.5% of the fund was used for maintenance of existing projects. 0.5% was spent in the preparation stage of the project. The remaining shares were spent on infrastructure projects of road and bridges, water supply, gas supply, wastewater treatment, greening, sewage system, and central ~ 62 ~ Chapter 5 Financing Urban Infrastructure for Xi’an heating (Details are presented in Appendix B). Increased local revenue fostered the rapid growth of infrastructure stock. However, infrastructure construction was still below the rate that was believed to be necessary to sustain its regional growth. Table 5-9 shows infrastructure investments as percentage of local GDP. Year Local GDP /million Infrastructure investments Infrastructure investments CNY /million CNY as percentage of GDP/% 1980 3166 29 0.91 1983 3589 43 1.20 1984 4414 56 1.26 1985 5758 72 1.25 1986 6578 124 1.88 1987 8016 122 1.52 1988 9922 129 1.30 1989 10938 166 1.52 1990 11651 150 1.29 1996 40695 966 2.37 1997 48882 1075 2.20 1998 52585 1746 3.32 1999 57729 1412 2.45 2000 64613 1613 2.50 Table 5-9: Level of infrastructure investment compared to economic development 1980-2000 Source: Xi’an Local Chronicles In 1980, it only represented 0.91% of the gross GDP. Although the percentage has increased to 1%-2% in the 1980s and 2%-3% in the last five years, it was still below the recommended level of 4% for developing countries (World Bank, 1994). In fact, infrastructure construction mainly responds to bottlenecks, as rapid growth ~ 63 ~ Chapter 5 Financing Urban Infrastructure for Xi’an quickly outstripped the capacity of existing facilities. Therefore, new project finance mechanisms are needed to mobilize more resources in the new century. 5.3 Public corporation model in a marketized economy (2000- ) The new century ushered in a new stage of infrastructure financing in Xi’an for several reasons. The first justification is China’s entry into the World Trade Organization (WTO) at national level in 2001; the second is the central government’s new Western Development strategy at regional level; and the third is the responsibility transfer to Xi’an Infrastructure Investment Group (XIIG) at local level. 5.3.1 Macroeconomic context China’s entry into the World Trade Organization is a significant step in its economic transformation in the new century. According to the terms of Agreement, China would regulate its various sectors according to international standards and open them up to foreign and domestic private investors. The sectors included finance, water, and transportation, which were crucial to infrastructure finance. The changes paved an accessible way for project financing and private participation in economic activities. The Western1 Development Program commenced operation in Jan. 2000 under the 1 The Western China comprises 12 provincial districts, with a total area of 6850 km2. Shaanxi Province, where Xi’an is located in, locates in the east part of this region. ~ 64 ~ Chapter 5 Financing Urban Infrastructure for Xi’an leadership of then-Premier Zhu Rongji. The objective of this program is to minimize the imbalance of development between coastal regions of eastern China and the western inner half. Xi’an, located at the entrance from the east to the west, is in a leading role in this new development scheme. The main components of the program strategy are: • development of infrastructure, especially transport, water supply, energy, and telecommunication; • enticement of foreign investment with new approaches and mechanisms; • increased efforts on ecological protection such as reforestation; and • promotion of education and retention of talented people from flowing to richer coastal regions. Previous market reform emphasized development in southeast part of China because of its geographic advantage and suitable industrial structure. Natural resources from western China were used to support the development of the east, especially the coastal cities. After 20 years of development, a large regional disparity existed between the east and the west. Under the new development scheme, many national policies favored the western regions. Concessional taxation, national debt transfers, central budget investments, and cooperation with multilateral banks all gave priority to western localities. ~ 65 ~ Chapter 5 Financing Urban Infrastructure for Xi’an 5.3.2 Xi’an Infrastructure Investment Group (XIIG) Xi’an Infrastructure Investment Group (XIIG) was founded in Jul. 2000. In 2005, the local government transferred the ownership of 15 entities in the public areas to XIIG, including water supply, gas supply, heat supply, wastewater treatment, public transport and toll roads. Currently, XIIG is a fully state-owned company owned by Xi’an People’s Government, with a registration capital of 8.5 billion CNY. The function of XIIG is to develop infrastructure as an “agent” of the local government. It is responsible for all infrastructure provision, from financing to construction, operation, and management. It is the legal entity for public infrastructure projects, responsible for fund raising, allocating, auditing, and debt repayment. It also mobilizes and manages related state-owned assets under the authorization of the city government. XIIG fully owns 11 subordinate companies and 3 other entities. The 11 subordinate companies are Xi’an Natural Gas Company, Xi’an Heat Supply Company, Xi’an Water Supply Company, Xi’an Taxi Company, Xi’an Public Transit Company, Xi’an Infrastructure Construction Company, Xi’an Third-ring Road Development Company, Xi’an Elevated Expressway Company, Xi’an Wastewater Treatment Plant, Xi’an Bei-shi-qiao Wastewater Treatment Center, Xi’an 3rd &4th Wastewater Treatment Plant Preparation Office. The other three non-company entities are Second-ring Road Construction Headquarter, Xiao-yan Pagoda Historical Park, and Municipal Sewage System. The subordinate companies are all transformed ~ 66 ~ Chapter 5 Financing Urban Infrastructure for Xi’an into public corporations from previous public agencies. The comprehensive organizational chart of the Group is shown in Appendix C. Some of the subordinate companies are sectional companies with franchises to operate certain natural monopoly infrastructure areas, such as tap water supply, and public transit. Some subordinate companies are project companies, such as Third-ring Road Development Company, Xi’an Elevated Expressway Company, and Xi’an Bei-shi-qiao Wastewater Treatment Center. These projects are all constructed using project finance. XIIG acts as the sponsor of these projects, and onlends some low-cost government debts to them. The project companies may draw capital from other resources or borrow from commercial banks. 5.3.3 Local revenues and transfers to XIIG The distinctive features of local fiscal contribution to infrastructure finance are the inclusion of administrative fees in general budget, the popularity of land assignment, and the transfer of fiscal revenues directly to XIIG. Many fees, instead of user charges for service consumption, were levied on various “permits” and “authorizations”. The items were determined by the local government and associated agencies. The exact size, source and distribution of these funds were difficult to identify and regulate. The central authorities have tried to regulate these fees several times in 1996 and 2001 to restrict the list of fee items and bring them in the formal revenue-reporting system. Local governments ~ 67 ~ Chapter 5 Financing Urban Infrastructure for Xi’an in China were asked to include the administrative fees into the general budget gradually from 2002. Until 2008, Xi’an has adjusted most administrative fee items from the extrabudget to the general budget. These items include registration fees, various add-ons, and fines. At the same time, user charges of water, gas and other public services are separated from administrative fees and are managed by individual public corporations. Wastewater treatment fee is shared between wastewater treatment center and the local general budget, because currently sewage system does not belong to any public corporation. In order to improve management of state-owned land, strengthen land administration and promote urban development, the Chinese government implemented a law to regulate the right of state-owned land assignment and transfer in 1990s. According to the law, ownership is separated from the using right of the land. Therefore, the right to use state-owned land in urban areas could be assigned and transferred, with the exclusion of the underground resources. The State as the owner of the land assigns the right of using the land within the term of a certain number of years to land users who shall in turn pay fees for the assignment thereof to the Sate (State Council of PRC, 1994). The assignment may be carried out by reaching an agreement, by invitation to bid or by auction. The revenues are earmarked to develop urban infrastructure. In the 9FYP, Xi’an government only assigned 1667 ha of state-owned land, generating a revenue of 422 million CNY. After 2000, state-owned land assignment became a significant source of revenue for infrastructure financing. Table 5-10 shows state-owned land assignment by the ~ 68 ~ Chapter 5 Financing Urban Infrastructure for Xi’an city government from 2001 to 2005. Item 2001 2002 2003 2004 2005 Land assigned/item 202 383 388 482 312 Agreement 200 376 358 416 241 Tender 0 0 1 0 0 Auction 2 7 7 6 8 Listed transaction 0 0 22 60 63 Total area assigned/ha 3115 1032 1367 1997 986 Total revenue/mil. CNY 384 1275 1496 1444 890 Table 5-10: State-owned land assignment of Xi’an 2001-2005 Source: 2006 Xi’an statistic year book In the 10th five-year plan from 2001 to 2005, this revenue source expanded to 5,489 million yuan, more than 10 times of that in the 9th five-year plan. Local governments “create” marketable land by expanding urban boundaries at the rural fringe to provide land suitable for assignment. From 2006, the importance of land assignment started to decrease again, because of the decline in the supply of land available and stricter national regulation on land assignment. The city government transfers revenues from vehicle passage fee1, assignment of state-owned land, wastewater treatment, and outdoor media advertisement to XIIG. These incomes are used to fund infrastructure projects (see Table 5-11). The subordinate companies earn revenues from their operation of toll roads, heating system, natural gas supply, mass transit, and tap water supply, and so on. These revenues are used to cover the capital costs and to finance system expansions and 1 Vehicle charging policy was suspended in 2003, but resumed from 2008. It is levied on vehicles registered in other cities. ~ 69 ~ Chapter 5 Financing Urban Infrastructure for Xi’an renovations. Types of revenue 2003 2004 2005 2006 Wastewater treatment fee 55.71 67.69 132.59 154.49 State-owned land assignment 621.56 767.00 741.65 701.67 Outdoor media advertisement 16.77 18.45 19.37 20.07 694.04 853.14 893.61 876.23 Total Table 5-11: Transfer of local government revenue to XIIG (Unit: million CNY) Source: 2007 short term financing bills publication instruction   100% 89.90% 89.56% 83.29% 82.99% 80% 53.13% 60% 40% 41.56% 20% 0% 2003 2004 2005 XIIG's revenue from land assignment/Revenue from land assignment XIIG's revenue from land assignment/XIIG's  total revenue from the local  government Figure 5-6: Importance of revenue from land assignment for XIIG Source: Xi’an urban &rural construction and development commission Among the three main revenue items transferred, land assignment is the most significant one, which is illustrated in Figure 5-6. As promised by the local government, an increasing percentage of revenues from state-owned land assignment were transferred to XIIG, from 41.56% in 2003 to 83.29% in 2005. At the same time, this is the predominant revenue source for XIIG, which constitutes over 80% of its total revenue. ~ 70 ~ Chapter 5 Financing Urban Infrastructure for Xi’an Table 5-12 illustrates the contribution of local fiscal revenue to infrastructure from 2001 to 2007. State-owned land assignment revenues and some revenues under the “other income” category are transferred to XIIG, user charges are managed by various public corporations, and the others are direct local budgetary investments. Source of funds 2001 2002 2003 2004 2005 2006 2007 Urban construction & maintenance tax; Add-ons of public utilities 280 360 433 498 627 865 830 98 76 59 90 164 128 138 State-owned land assignment 384 1275 1496 1444 890 702 837 Public facility hookup fee 188 217 255 240 514 578 489 Other incomes 120 130 161 218 660 630 410 User charges 324 357 401 584 632 772 837 Non-earmarked taxes Table 5-12: Contribution of local fiscal revenue to infrastructure finance 2001-2007 (Unit: million CNY) Source: Xi’an urban &rural construction and development commission Compared to the 9th five-year plan, fiscal revenue investment in infrastructure increased considerably. The expansion of urban area and new development projects led to the increase of tax and add-ons. The boom of land assignment created a new major source of funds for infrastructure investment. In 2005, equivalent infrastructure hookup fee replaced the public facility hookup fee. The new regulation adjusted the fee levels to 150 yuan/m2. Other incomes increased along with the economic development as well. Outdoor media advertisement income increased quickly. Vehicle registration fee also increased substantially because of the growth of population and incomes. Natural gas, wastewater treatment and centralized winter heating system were ~ 71 ~ Chapter 5 Financing Urban Infrastructure for Xi’an added to charged public infrastructure services after 2000. The systems keep expanding, and the standard prices of user charges also have increased several times. For example, more districts are now connected to centralized wastewater treatment system and heating system, and they are subject to these charges. Wastewater treatment income has been increasing at 20%~40% per year in the recent 5 years. Water fee was adjusted in 2004 and 2007, and the prices were raised by about 20% on average each time. Toll roads have also generated substantial income after the construction of third ring road in 2004. 5.3.4 Intergovernmental transfers Intergovernmental transfers in this period continued to be in the form of conditional grants from the central and provincial governments. The central government continues to issue long-term development national debt, which started from 1998 under China’s “active fiscal policy”, to support basic capital investments nationwide. However, under the new “prudent fiscal policy” since 2002, the central government has reduced the amount of the bond issuance substantially, at the rate of 10-50 billions every year. In 2008, it declined to only 30 billion CNY, 1/5 of the amount in 2002. To partially compensate for the gap caused by the fall in national debt issuance, the central government with increased fiscal resources has, since 2003, allocated part of its general budget to local infrastructure investments. The amount of general budgetary investment grew every year and exceeded the amount of national debt in 2007. The amount of ~ 72 ~ Chapter 5 Financing Urban Infrastructure for Xi’an long-term development national debt and general budgetary investment are shown in Table 5-13. It should be noted that the data are not investments to Xi’an city but to infrastructure projects nationwide. Year 2001 2002 2003 2004 2005 2006 2007 2008 Long-term development national debt 150 150 140 110 80 60 50 30 Central general budgetary investment 0 0 30 35 45 55 80 122 150 150 170 145 125 115 130 152 Total Table 5-13: National debt issuance and central budgetary investment in infrastructure 2001-2008 (Unit: billion CNY) Source: Government Work Report 1998~2008 (published annually) The distribution of central government transfer after 2000 differs from the previous years. With the implementation of Western Development program, national debt prefers to invest in projects in western regions in terms of amount and approval criteria. According to the Government Work Report (GWR) 2001, all national debt investments in Western projects are categorized as intergovernmental transfer, while investments in other parts are mixtures of transfer and on-lent. In 2002, the Report underscores that all national debt transfers to Western projects do not require matching funds locally. However, western cities did not enjoy a large fund increase, because national transfer also prioritized rural development, cross regional mega projects, and projects in progress. ~ 73 ~ Chapter 5 Financing Urban Infrastructure for Xi’an Source of funds 2001 2002 2003 2004 2005 2006 2007 79 180 220 382 461 410 354 National transfer 69 170 200 310 346 186 187 Provincial transfer 10 10 20 72 115 224 167 Central/Provincial transfer Table 5-14: Contribution of intergovernmental transfer to infrastructure finance 2001-2007 (Unit: million CNY) Source: Xi’an urban &rural construction and development commission Table 5-14 shows the funds received by Xi’an government from the central and the provincial government to finance infrastructure. It can be seen that national transfer reached the bottom in 2001 and then increased from 2001 to 2005, followed by a sharp decrease afterwards to the level of 150-200 million CNY now. The Western Development Program did benefit Xi’an in several years, but more and more national funds are directed away to the surrounding poor regions in the province. In contrast, the provincial government contributed more to the infrastructure finance in recent years. It is mainly because of the expansion of the city, which enclosed more public provincial lands within Xi’an jurisdiction. Besides, national investment partially relieved the poverty reduction liability of the provincial government, so that it was willing to support key projects in the city1. 5.3.5 Loans One of the features in infrastructure financing after 2000 is bond issuance. 1 The provincial government transfers 150 million/year to XIIG to support the subway system development from 2006. It is the major target project of provincial transfer currently. ~ 74 ~ Chapter 5 Financing Urban Infrastructure for Xi’an Although local/municipal bond is proscribed in China, corporate bond is allowed. Therefore, the establishment of XIIG paved a way for bond financing. The composition of various public corporations, the ownership transfer of these corporations to XIIG, and the contracted revenue transfers from the local government further qualified XIIG for bond issuance, which required certain asset and profitability criteria. XIIG started to use bond financing since 2007. By the end of Sep. 2008, it has issued one short-term bill and one long-term bond. The short-term financing bill was issued in Sep. 2007, with an interest rate of 4.57%. The issuing scale was 800 million CNY, and the repayment period was 365 days. Previously, short term funds were borrowed from commercial banks, which incurred higher financing costs (see section 5.2.5). In 2008, XIIG issued its first long-term corporate bond. A fixed discount rate of 6.7% with 5-year repayment period was used. The interest was paid annually; while the principal would be paid at the end. The total amount issued was 1.5 billion CNY. All funds raised would be used in the three infrastructure projects shown in Table 5-15. All the three projects, which were initiated in the recent five years, used diversified financing sources in the design of their project finances. The Xi’an urban transport project was a joint effort of XIIG and ADB, and the Xi’an environmental project acquired half of its total funding from Japanese loans. They are pioneer projects in terms of financing mechanisms for the local government ~ 75 ~ Chapter 5 Financing Urban Infrastructure for Xi’an and XIIG. Project Total General budget Bond Bank loans Self-raised fund Xi’an 3rd-ring road project 6.258 2.321 0.700 3.237 0 Xi’an environmental project 3.141 0.979 0.700 1.462 0 Taihua centralized heating system 0.327 0 0.100 0.129 0.098 Total 9.726 3.300 1.500 4.828 0.098 Table 5-15: Projects listed on bond issuance instruction (Unit: million CNY) Source: 2008 long-term corporate bond publication instruction Before the issuance of XIIG bond, the local government has already agreed to build a special reserve to guarantee of the bonds and other loans borrowed by XIIG for the purpose of financing infrastructure. The debt will be repaid by future revenues of XIIG. But if XIIG fails to fulfill its payment obligation, it will receive fund transfer from the reserve built by the local government for the due debts. The local government guarantees increased the credit rating of the XIIG bond, which yielded a relatively low interest rate. Domestic loans in this period are mainly government credit loans from China Development Bank. From 2003-2007, debts from China Development Bank reached 6,000 million CNY. In the next 5 years from 2008, debts will be 21,188 million CNY. In 2005, there are 100 million CNY national debt on-lent included in domestic loans. The local government and XIIG rarely borrow directly from commercial banks in this period. But when project finance is employed, commercial loans are borrowed by the SPVs based on the profitability of the specific project. ~ 76 ~ Chapter 5 Financing Urban Infrastructure for Xi’an Onlended sovereign loans increased extensively in the new century. The Xi’an Comprehensive Urban Transportation System Improvement Project1 is the first World Bank project in infrastructure area in Xi’an, which acquired 150 million USD to the finance of urban infrastructure. Other active international partners include ADB, JBIC, the Spanish government, and so on. Table 5-16 shows various types of loans involved in infrastructure finance of Xi’an in this period. Source of funds 2001 2002 2003 2004 2005 2006 2007 Domestic bank loans 747 990 1620 3000 3960 2110 1420 Sovereign loans 110 0 320 520 920 1360 1150 Corporate bonds 0 0 0 0 0 0 1300 Table 5-16: Contribution of loans in infrastructure finance 2001-2007 (Unit: million CNY) Source: Xi’an urban &rural construction and development commission 5.3.6 Private participation Xi’an also started to adopt public private partnership arrangements after 2000. Being politically sensitive about the term “privatization”, China used the word “marketization” to describe the trends of mobilizing capitals from private sector to finance infrastructure. Similarly, it used the term “social sector”, “social resources” to substitute the words related to “private”. The first step of marketization is the land assignment, which appeared in the end of 1990s. Entering the 21st century, Xi’an also started other forms of marketization reforms. 1 Total investment is 2,975 million CNY. The project commences in 2008 and will finish in 2012. ~ 77 ~ Chapter 5 Financing Urban Infrastructure for Xi’an In 2001, an “Instruction of promoting and assisting social capital investment” was released by the central government. This guideline stated that the government encouraged and would assist private participation in the area of infrastructure construction and public welfare, in the forms of CJV (contractual joint venture), EJV (equity joint venture), WOS (wholly-owned subsidiary), and concessional franchised operation. In 2002, the central government published report titled “Index of industries for foreign investments”. In this report, areas like gas, heat, water supply, and sewer system, which were regulated to prohibit private and foreign participation, are now open to competition. In 2004, the central government further endorsed preferential tax treatment and specific measures to promote private participation. The methods being experimentally used in Xi’an are equity joint venture (EJV) and Build-Operate-Transfer (BOT) franchise arrangements. Natural gas is the first area experimenting joint venture operation between a public and a private corporation. Xi’an Gas Supply Company was founded in 1994, with registered assets of 524 million CNY and a total asset of 1,605 million CNY in 2005. It operated the natural gas supply system for Xi’an, with pipeline network of more than 2000 km. Ratified by Xi’an People’s Government and National Asset Supervision &Management Commission, XIIG started to launch the reform of this subsidiary company in 2005. The private investor is the Hong Kong and China Gas Company Limited (Towngas). It is the first public utility company in Hong Kong, founded in 1862, with a pipeline network of over 3000 km. Its core ~ 78 ~ Chapter 5 Financing Urban Infrastructure for Xi’an business comprises the production and distribution of gas, the marketing of gas and appliances and comprehensive after-sale services. Cooperating with Towngas, a new joint venture company with 1.6 billion CNY registered assets was set up in 2006, named Xi’an Qin-hua Natural Gas Supply Company. Xi’an Gas Supply Company owns 51% of the stock and Towngas has 49% of the ownership. The city government guaranteed a franchise right of gas supply to the company, and the company should carry out their activities and service provisions under “Franchise Operation Agreement” and related regulations. The privatization brought 540 million up-front funds for natural gas infrastructure finance. After the successful operation of marketization of natural gas sector, XIIG turned its efforts to the water supply area. It published an announcement inviting investment from domestic and oversea capital markets to Xi’an Water Supply Company. The company was founded in 1952, with registered capital of 411.8 million CNY, and is fully owned by XIIG. Its main business is urban tap water production, supply, as well as piping network design and construction. In 2006, water sales of the company were 250 million m3, generating a revenue of 500 million CNY and a profit of 15.85 million CNY. The amount of investment required was determined by net assets of current water company and the funds needed in the new water supply system extension and renovation projects. A joint venture company will be similarly set up, with XIIG accounting for 51% of stock ownership and the investor for 49%. The city government guarantees a franchise right of tap water supply to the company. This deal is still in process. ~ 79 ~ Chapter 5 Financing Urban Infrastructure for Xi’an BOT is a form of project financing where a private entity receives a concession from the private or public sector to finance, design, construct, and operate a facility for a specified period, usually about 20-30 years. After the concession period, control is transferred back to the granting entity. During the concession, the project proponent is allowed to charge tolls, fees, and rentals subject to approval. This enables the project proponent to recover its investment, operation and maintenance expenses in the project. There is no successful experience of BOT transaction in Xi’an yet, but the local government and XIIG are strongly promoting this arrangement. In 2007, Xi’an Elevated Expressway Company – another subsidiary company of XIIG – published BOT invitation for the second stage of Xi’an Expressway Project. The project is the toll road system around the urban area which connects to the airport. The first stage of this project has been completed in 2004 with a total investment of 979 million CNY, including 360 million in bank loans. It is now being operated by Xi’an Elevated Expressway Company, who draws revenues from tolls, gas station operation, and adjacent land development. The second stage of this project is estimated at a cost of 1958 million CNY. XIIG is looking for investors who are willing to finance and operate the second stage of the project in the form of Build-Operate-Transfer on a long-term basis. Another option that investors can choose is to purchase the right to operate the first stage of the project for certain years, and then transfer it back to the government, which is actually a Transfer-Operate-Transfer (TOT) contract. With the funds paid by the ~ 80 ~ Chapter 5 Financing Urban Infrastructure for Xi’an investor for operation right purchasing, the public corporation will be able to finance the second stage by itself1. In 2008, the wastewater area also started to invite BOT investments. The companies involved in are Xi’an Wastewater Treatment Plant, Xi’an Bei-shi-qiao Wastewater Treatment Center, and Xi’an 3rd &4th Wastewater Treatment Plant Preparation Office. 5.3.7 Special districts and self-raised funds Most administrative and service charges at local agencies have been regulated through general fiscal budget, but the “self-raised funds” still contribute to the urban infrastructure finance. The concept of the term has changed, because sub-prefectural level entities are granted substantial fiscal capacity in the new century. It now refers to funds raised by the county level governments and special district management committees. Following a further decentralized process, some fiscal power was transferred to the county level. When infrastructure is located in its jurisdiction, the county is responsible for financing it collaboratively. “County self-raised funds” refers to the contribution of infrastructure financing at the county government level. Special development districts (see Chapter 4.2) were founded after 2000 in the expanded urban area. Management committees were established to manage the development of the districts. They attract economic investments and provide 1 The project is also open to joint venture finance for the second stage. ~ 81 ~ Chapter 5 Financing Urban Infrastructure for Xi’an infrastructure for business investors. The committees raise funds mainly by assigning using right of lands in the new urban area within the districts. They also collect hookup fees and other administrative charges in the districts. “Special district self-raised funds” are used to finance infrastructure within these districts. Table 5-17 shows self-raised fund at the county level and special district to finance infrastructure. The remarkable increase in 2003 is mainly due to the setup of Xi’an Economic & Technological Development District. Source of funds 2001 2002 2003 2004 2005 2006 2007 Self-raised funds 133 55 2225 2447 2156 2800 2964 106 0 1183 1301 1131 1700 1980 27 55 1042 1146 1025 1100 984 Special district self-raised funds County Self-raised funds Table 5-17: Contribution of self-raised funds to infrastructure finance 2001-2008 (Unit: million CNY) Source: Xi’an urban &rural construction and development commission 5.3.8 A public corporation model The rapid economic development of China and the new scheme of inner land development policy changed the economic context of urban infrastructure provision. The acute financing problem forced the local government to pursue new mechanisms in the newly developed socialist market economy, which encourages international competition and private participation. As a result, the public sector corporatized itself and invited private partners in infrastructure delivery. By using both public finance and project finance, a new model of infrastructure finance – the public corporation model – has evolved from the ~ 82 ~ Chapter 5 Financing Urban Infrastructure for Xi’an public finance model. XIIG, the public corporation, became the key initiator in this model. The structure of the public corporation model employed after 2000 is summarized in the Figure 5-7. Figure 5-7: Public corporation model of infrastructure finance (after 2000) Source: author Compared to the public finance model, financial instruments are further diversified in the public corporation model. XIIG is founded as the agent company of the local government to finance infrastructure. It receives revenue transfers from the local government, obtains on-lent concessional loans with the repayment guarantee of the local government, raises capital to build SPVs, enters into joint ventures or BOT franchise agreements with private companies for infrastructure ~ 83 ~ Chapter 5 Financing Urban Infrastructure for Xi’an development, and oversees the services delivered by the infrastructure assets it owns. China Development Bank loans, on-lent national debts, on-lent sovereign loans will be provided only to XIIG, while commercial loans are lent to project SPV directly. The local government also invests in infrastructure projects directly and obtains intergovernmental transfers from higher levels of governments. Repayment reserve is set up to assist XIIG with on time by payment of various loans. 12000  10000  million CNY  8000  6000  4000  2000  0  2001 2002 2003 2004 2005 2006 2007 Year Figure 5-8: Scale of funds for infrastructure financing in Xi’an (2001-2007) Source: see Appendix D As a result of the enhanced fiscal capacity of the local government as well as the diversified financing sources introduced, the scale of funds for infrastructure finance has increased dramatically after 2000 (Figure 5-8). From 2001 to 2005, the total amount grew from 2,463 million to 10,985 million yuan. After that, the amount of funding stayed at around 10,000 million in 2006 and 2007. ~ 84 ~ Chapter 5 Financing Urban Infrastructure for Xi’an 8.0% 2.4% 3.8% Intergovernmental  transfers Local general budget 14.9% User charges 7.1% 25.3% State‐owned land  assignment Private capitals Self‐raised funds Domestic bank loans 12.8% 2.4% 23.3% Sovereign loans Bonds Figure 5-9: Sources of funds of infrastructure finance structure in Xi’an (2001-2007) Source: see Appendix D Financing structure  100% 80% 60% 40% 20% 0% 2001 2002 2003 2004 2005 2006 Year Intergovernmental transfers Local general budget State‐owned land assignment User charges Private capitals Self‐raised funds Domestic bank loans Sovereign loans 2007 Figure 5-10:Trends of infrastructure finance composition in Xi’an (2001-2007) Source: see Appendix D Figures 5-9 and 5-10 illustrate the sources of funds that are used in infrastructure finance in the period from 2001 to 2007 and their respective changing patterns. Compared with the year from 1996 to 2000 in Figure 5-4, the composition of ~ 85 ~ Chapter 5 Financing Urban Infrastructure for Xi’an infrastructure finance has changed. Bonds and private capitals appear; and user charges and state-owned land assignment are separated from general fiscal revenue as outstanding sources. Self-raised funds from special districts and county levels form 23.3% of the total funds, showing an exceptional strong financial autonomy at sub-prefectural level after 2003. Combining taxes and administrative fees together, local general budget is responsible for only 14.9% of the funds, which is especially low in the year 2003, 2004, and 2005. State-owned land assignment controlled by XIIG represents 12.8% of the total funds, while user charges controlled by other public corporations represent 7.1% of the total. Intergovernmental transfers only accounts for 3.8% of the funds, with an increasing share from the provincial government. The sharp decrease of intergovernmental transfer in this period is replaced by the strong increase of debt financing. Domestic loans and sovereign loans represent 25.3% and 8% of the total, respectively. Private capital involvement and bond financing form a small proportion of 2.4% and 2.4%, because they have just emerged since 2005 and 2007. Detailed numbers of each source is recorded in Appendix D. Adopting the public corporation model, infrastructure investments increased rapidly, as is seen in Table 5-18. Compared with the previous 2%-3% in the public finance model, the level of investment has reached 6%-8%, achieving the rate of 7%-11% that found in developed countries (World Bank, 1994). ~ 86 ~ Chapter 5 Financing Urban Infrastructure for Xi’an Year GDP/million CNY Infrastructure investments Infrastructure investments /million CNY as percentage of GDP/% 2001 73486 2463 3.35 2002 82668 3640 4.40 2003 94666 7190 7.59 2004 110239 9422 8.55 2005 127014 10985 8.69 2006 147370 10355 7.03 2007 173710 10729 6.18 Table 5-18: Level of infrastructure investment compared to economic development 2001-2007 Source: author The achievements can also be reflected from the increased level of infrastructure provision. Table 5-19 shows infrastructure provision conditions in terms of gas supply, water supply, central heat supply, roads, public transit, wastewater and solid waste in year 1949, 1978, 1990, 2000 and 2005. For example, the length of urban roads increased 371 km from 1990 to 2000, and further increased 407 km in the following five years. Along with the increase of roads, the number of public buses rose by about 1,700 and 2,200 in the respective periods. In 1990, the length of the sewer piping system was only 691 km, with 17% centralized wastewater treatment capacity. In 2000, the length of sewer system increased to 835 km, which and reached 1,618 km in 2005. The wastewater treated by treatment plant in 2000 represented 23.1% of the total amount discharged, and in 2005 has reached nearly 40%. ~ 87 ~ Chapter 5 Financing Urban Infrastructure for Xi’an Item Unit 1949 1978 1990 2000 2005 Gas supply rate % -- 1.1 31.2 81.5 91.3 Tap water system km 30 567 1074 2237 2315 Area of central heat supply Ha -- -- 246 854 2113 Buses -- 17 332 875 2573 4762 Length of urban roads km 59 278 604 975 1382 Area of urban roads Ha 57 312 675 1263 3021 Sewer system km 25 317 691 835 1618 Wastewater treatment rate % -- -- 17 23.1 38.9 Safe disposition of solid waste % -- -- -- 90.89 90.36 Table 5-19: Level of infrastructure provision in selected years Source: Statistical year book, Xi’an Local Chronicles 5.4 Issues and challenges Although the public corporation model in the market economy successfully mobilized more resources to finance infrastructure, which resulted in a higher level of investment in proportion to GDP and a higher level of infrastructure provision, potential risks still exist in the current model. Four issues are identified risky for future financing activities, namely, excessive government guarantee on debt repayment, cyclic revenue stream from land assignment, a pricing policy that limits private participation, and insufficient understanding of the risks in new financial instruments. 5.4.1 XIIG’s debts, projects and government guarantees As a public-owned infrastructure company, XIIG is fully guaranteed by the local government in terms of its debt repayment. The projects financed by XIIG, its ~ 88 ~ Chapter 5 Financing Urban Infrastructure for Xi’an subordinate companies, and its joint venture companies are also guaranteed by purchase contracts, on-lent public credit loans and other agreements with the local government. Even if commitment is not provided, the government is still likely to bail out the projects from financial distress, if any. Although issuing a guarantee requires no instant cash, the government bears insolvency risks of the projects, explicitly or implicitly. One of the reasons why government engages in guarantees voluntarily is that if one company goes bankrupt, the service it provides will be suspended. Since the service is vital to the city, even a small chance of disruption would be beyond the acceptance of the local government. More importantly, the failures of the projects are politically unpalatable. It would, no matter whether it is true, be seen as a failure of the government and its policies. It would also damage the personal political lives of the decision makers. Therefore, they would rather increase service prices, offer grants, and provide concessional loans, than invite political embarrassments. Insolvency risk, or unpredictable variation in value and its distribution, will rise with the increase of the company/project’s leverage (Irwin, 2007). It will be a mismatched risk allocation if the government that bears insolvency risks is unable to control the leverage of the company. However, leverage control is not feasible, because it contravenes the local government’s intention of transferring responsibilities of infrastructure assets and liability management to the hands of the ~ 89 ~ Chapter 5 Financing Urban Infrastructure for Xi’an professional enterprises. It is also irrational if the government who is trying to use project finance to insulate recourse at the same time guarantees all the debts incurred. Therefore, further unbundling of XIIG, other public corporations, and the local government is required. It is difficult for the government to avoid guarantees, because of the political implications discussed above. But it is possible to undertake some measures to mitigate the possible risks caused by the vague financial relationship and guarantees. Firstly, the local government should separate revenues granted to XIIG from other fiscal revenues clearly. Currently, on local budget statement, one cannot distinguish the income items transferred to XIIG and items deposited into the debt repayment reserves from other general purpose incomes. Secondly, profitable infrastructure, quasi-profitable infrastructure and non-profitable infrastructure should be financed with different mechanisms. The local government’s decision to bear debt repayment, offer guarantees, or provide subsidies should be based on the nature of the infrastructure area. Thirdly, decision makers should be aware that guarantees incur costs. A mechanism to estimate the value or the cost of a guarantee should be established. Last but not least, decision makers should try to avoid reaching implicit agreements on guarantees. In this way, guarantees are documented clearly for all stakeholders. 5.4.2 Unstable revenue stream from land assignment Currently, land assignment is the most important revenue stream of XIIG. In ~ 90 ~ Chapter 5 Financing Urban Infrastructure for Xi’an another word, it is the mainstay to enable the capital investment of XIIG into infrastructure finance. It is also a key factor to keep a good corporate performance on the balance sheet, so that the company is able to attract capital in the bond market. However, land assignment as a powerful revenue source is an unstable alternative in future. The role of state owned land in fact extends beyond direct assignment. Some loans borrowed from domestic banks are secured by these lands. Debt is repaid by selling using rights of parcels of land whose value has been enhanced by the infrastructure projects financed by the debt (for example, third ring road, land appreciation). The local government keeps expanding the urbanized area according to its master plan. When the government acquires land from rural communes, only minimal subsidy is paid. After turning into urban land, the value of the land can increase as much as 10 times according to the market value. Another novel way to acquire land for commercial assignment is moving the city hall and administrative buildings of municipality to new developed area outside the urban center. On the one hand, it creates a new urban center where municipal offices is relocated with up-valued surrounding land; on the other hand, it frees up highly valued land for assignment at the existing urban center. This type of land marketing activities is criticized as aggressive profit-maximizing monopolizing. Besides, the supply of land available for leasing will eventually run out, rendering land assignment a transitional infrastructure-financing strategy. In some other cities, their public assets management companies have already exhausted potential lands within the ~ 91 ~ Chapter 5 Financing Urban Infrastructure for Xi’an jurisdictions and started to organize land transactions in other regions as consultants. 5.4.3 Private participation and policy risks It is quite clear that the local government is promoting private participation in infrastructure provision and management. However, currently policy risks as perceived by investors are still significant obstacles for private participation, especially the risks related to pricing of services. When user fees were first levied in China, they were controlled by the central government at a level far below the financial costs of providing the services. The central government restricted the level of user charges on the ground of redistribution and macroeconomic control. Some researchers argue that subsidy for service is inefficient for redistributional purpose since it benefits higher income users as well. They also believe that holding down user charges to control inflation is treating a symptom rather than the cause. Moreover, if subsidy to the service is financed by deficit, it may even fuel inflation (Dillinger, 1995). Lately, the central government has encouraged the use of user charges for local infrastructure like water supply, refuse disposition, and wastewater treatment to be priced at the level which can cover their costs. Since 2002, Xi’an government has begun gradual price reform in public service areas. However, in 2005, the government implemented another regulation prohibiting any price increase including the above areas to control inflation. ~ 92 ~ Chapter 5 Financing Urban Infrastructure for Xi’an Such price control may introduce more policy risks in the future, thus would divert investments from infrastructure. Similar risks could also arise from the possibility of the government’s unexpectedly changing quality standards, creating/abolishing franchise, cutting subsidies, or expropriation without sufficient compensation. In a heavy capital-sunk area which is especially vulnerable to risks, infrastructure companies consider policy risks conservatively. Therefore, Xi’an local government has to prepare more effective mechanisms to assure investors of stable policy with compensation. One solution is to include the effects of policy changes into contracts. 5.4.4 Lure and risks of other financing approaches As noted in the study, Xi’an is not the infrastructure financing pioneer in China. Other financing approaches have been implemented in other cities. However, the decision whether these mechanisms should be adopted in the future must be made carefully. BOT is the most widely used innovative financing method in China’s infrastructure provision. There have been dozens of such projects in operation now. The central government has already provided a model and relevant regulations for BOT projects. A relatively new development is the raising of funds from securities backed by a pool of infrastructure assets. For example, in 1996 the Guangdong Provincial Expressway company raised HK$477.9million (US$62 million) through issuing B shares on the Shenzhen exchange, backed by stakes in completed revenue ~ 93 ~ Chapter 5 Financing Urban Infrastructure for Xi’an generating toll expressway and bridge. The money raised was used to finance the new expressway. $100 million is raised by the Anhui Expressway Company in a similar way (World Bank, 1997a). Current studies in China promote various new financing methods. Advocators of local bond finance have campaigned for the use of municipal bonds for a long time (Su and Zhao, 2007; Wang, 2005). Based on the analysis of the successful operation of municipal bonds in America and Japan, they introduced many suitable specific designs for China in their studies. Government funds for particular infrastructure areas (Chen, 2007) and Asset-backed securities backed by existing infrastructure (Quan, 2004) are also suggested. It is of course beneficial that more successful mechanisms of infrastructure finance could be tailored to application in China. But equally important is that the economic and political prerequisites and potential risks are identified. Currently, the domestic research area is focusing on novelty of financing mechanisms. Nevertheless, studies often ignore or underrate the risks associated with the new approaches. The proponents of bonds argue that central injunction and restriction come from fear of inability to control the local economy. However, in most countries, local public finance is also strictly limited, especially in terms of borrowing. In urban politics, theory states that government officers stay shorter in office than the lifetime of a project. In this case, they tend to overspend to gain more votes. So the restriction is to stabilize the long-term financial capacity and repayment ability of ~ 94 ~ Chapter 5 Financing Urban Infrastructure for Xi’an the local government. The new financing tools all require a mature financial market, which China is still struggling its way towards. Shares, bonds, trusts, funds, derivatives, and a credit rating system are in different developing stages. The legal system and economic policies on these issues are still inadequate. These new mechanisms are risky until a mature capital market system is built and stable policies are implemented. Expertise and skills are required in the government to manage the tools as well. Many officials in the current government are more familiar with the traditional fiscal system than the other financial mechanisms in the capital market. On this ground, it is a good step to transfer infrastructure financing to public corporations which could hire professionals. If dedicated funds are established for each infrastructure area, the management of these funds could be challenging. It is very important to avoid a possible bias in favor of new mechanisms simply because they involve new financing approaches. ~ 95 ~ Chapter 6 Conclusion Chapter 6 Conclusion 6.1 Summary This thesis examines how urban infrastructure has been financed in Xi’an City in China since PRC was founded in 1949. Based on literature review and field investigation, data were collected and processed. The study divides mechanisms of infrastructure finance into three periods, where different structural models are built. The important variables in each model are analyzed and compared to reflect their emergence, evolvement, and substitutions. Potential risks and challenges are identified for the current model. 6.2 Main findings 1. Structural model of infrastructure financing The research divides infrastructure finance of Xi’an into three different periods, where structural models are established accordingly. The infrastructure financing models built are • a centrally planned model based on the Soviet experience, from 1949 to 1978; • a public finance model during the experimental stage with free market principles, from 1978 to 2000; and • a public corporation model with private participation in a market economy, ~ 96 ~ Chapter 6 Conclusion from 2000 and after. 2. Emergence and substitutions of variables In the centrally planned model, the local government collected taxes and enterprise profit and transferred them to the central government. In turn, the local government received project specified funds from the central government to carry out its infrastructure projects. The central government, rather than the local government, was the main actor in urban infrastructure financing. There was no incentive and method for mobilizing private funds. In the public finance model, the local government became the key initiator and used a number of sources to fund urban infrastructure. These included earmarked and general local taxes, public service and administration fees, funds raised by local governmental agencies, inter-governmental transfers, domestic loans, and on-lent sovereign loans. In the public corporation model, Xi’an Infrastructure Investment Group (XIIG) was established as the central actor to finance urban infrastructure using project finance. It receives revenue transferred from the local government, obtains on-lent concessional loans (with the repayment guarantee by the local government), raises private capital, and enters into joint ventures or franchise BOT agreements with private companies for infrastructure development. 3. Potential risks of current model ~ 97 ~ Chapter 6 Conclusion The current public corporation model, although advantaged in the market economy, suffers from several risks. The study identifies four potential risks, namely, excessive government guarantee on debt repayment, unstable revenue stream from land assignment, a pricing policy that limits private participation, and insufficient understanding of the risks in new financial instruments. Several recommendations are made to mitigate these risks. 6.3 Limitations The research design of case study may be inherently biased. The result is restricted by specific characteristics of the case. Xi’an, as a city in China, is essential different from New York or London. It is suddenly exposed to an industrialized and globalized economy after 1978. It is facing old problems which have been experienced by western cities, and also new problems that have just emerged. Moreover, it is located in a socialist market country controlled by a single political party. Investigation of this single case does not allow much board generalization. Another limitation of the study is the relatively fewer qualitative data available in the first period from 1949 to 1978. In the first several decades after independence, budgetary, statistical and documentation systems were not as well developed as the recent years, especially at prefectural level. Therefore, more qualitative data are used to illustrate the financing mechanisms in this period. These data are ~ 98 ~ Chapter 6 Conclusion acquired through cross disciplinary search and interviews. 6.4 Recommendations The first recommendation to future research is undertaking studies in a larger temporal scope. Most previous studies in China have been focusing on either the 1990s or the most recent several years. Although this research has already extended the temporal scope to 1950s, it still does not cover the war period and earlier periods. It is also recommended that comparative studies be carried out based on previous cases. A multi-case comparison study would assist a more broad generalization of the conclusions. ~ 99 ~ Appendix Appendix Appendix A: Infrastructure financing sources 1996-2000 (Unit: million CNY) Sources of funds 1996 1997 1998 1999 2000 9FYP Central/Provincial transfer 9 36 441 391 170 1047 National debt investment 9 8 405 365 150 937 Provincial transfer 0 28 36 26 20 110 Local general budget 273 288 248 338 490 1637 Urban construction & maintenance tax; Add-ons of public utilities 144 191 180 181 195 891 State-owned land assignment 50 61 39 62 230 442 Water resource fees 14 8 9 7 10 48 Other non-earmarked taxes 65 28 20 88 55 256 Local administrative incomes 445 461 479 515 532 2432 Public facility hookup fees 88 91 111 162 115 567 User charges 64 58 175 187 157 641 293 312 193 166 260 1224 Other sources 61 80 95 92 83 411 Local agency self-raised funds 20 10 58 66 60 214 108 65 198 10 204 585 50 145 227 0 74 496 966 1075 1746 1412 1613 6812 Other incomes Domestic bank loans Sovereign loans on-lent Total Source: Xi’an urban &rural construction and development commission ~ 100 ~ Appendix Appendix B: Infrastructure construction expenditures 1996-2000 (Unit: mil CNY) Items 1996 1997 1998 1999 2000 9FYP 60 70 85 90 95 400 100 133 168 170 215 786 2 6 10 9 10 37 804 866 1483 1143 1293 5589 Water supply 225 248 557 343 348 1721 Road and bridges 358 281 322 397 513 1871 Sewage system 16 22 85 43 75 241 Central heating 17 16 30 62 11 136 103 203 351 120 61 838 Wastewater treatment 68 78 93 91 140 470 Greening 17 18 45 87 145 312 966 1075 1746 1412 1613 6812 Salary and office overhead Maintenance Project preparation Project construction costs Gas supply Total Source: Xi’an urban &rural construction and development commission Appendix C: Organizational chart of Xi’an Infrastructure Investment Group Source: Xi’an Infrastructure Investment Group ~ 101 ~ Appendix Appendix D: Infrastructure finance sources 2001-2008 (Unit: million CNY) Source of funds 2001 2002 2003 2004 2005 2006 2007 79 180 220 382 461 410 354 National debt 69 170 200 310 346 186 187 Provincial transfer 10 10 20 72 115 224 167 Local general budget 1010 1140 1309 1630 2057 2473 2454 280 360 433 498 627 865 830 Other non-earmarked taxes 98 76 59 90 164 128 138 Public facility hookup fees 188 217 255 240 514 578 489 User charges 324 357 401 584 632 772 837 Other incomes 120 130 161 218 120 130 160 384 1275 1496 1444 890 702 837 0 0 0 0 540 500 250 Self-raised funds 133 55 2225 2447 2156 2800 2964 Special district self-raised funds 106 0 1183 1301 1131 1700 1980 County Self-raised funds 27 55 1042 1146 1025 1100 984 Domestic bank loans 747 990 1620 3000 3960 2110 1420 Sovereign loans on-lent 110 0 320 520 920 1360 1150 0 0 0 0 0 0 1300 2463 3640 7190 9422 10985 10355 10729 Central/Provincial transfer Urban cons.&maint. tax; Add-ons of public utilities State-owned land assignment Private capitals Bonds Total Source: Xi'an Municipal Urban and Rural Construction Commission ~ 102 ~ Reference Reference ADB (2003), Local Government Finance, Private Resources and Local Credit Markets in Asia. 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(2004) “Financing Sources of Urban Infrastructure Construction in China.” Theory Guidelines, (8), 22-23 (in Chinese). ~ 108 ~ [...]... responsibility of urban infrastructure provision and its financing 2.1 Provision of local infrastructure This section mainly addresses two aspects One aspect is the suitability of public provision of local infrastructure The other aspect is the responsibility of the local government and central government in the provision of urban infrastructure The foremost characteristic of urban infrastructure is a mixture of. .. company In this case, substantial part of risks associated with financing and operating the facility are allocated on the private sector PPPs have many advantages In the finance aspect, the benefits of involving the private sector are the transfer of risk, substitutes for public borrowing and up-front costs, and the protection of users and tax-payers from the financing burden In the management aspect,... transfer and conditional transfer; in the US, they are called general-purpose grants and categorical grants General intergovernmental transfer does not put constraints on the expenditure area It is often distributed on a lump-sum basis automatically according to certain preset criteria The determination of transfer amount relies on several factors, for instance, population, tax base, and poverty rate of a. .. earmarking is the allocation of certain tax revenues to a designated end use Newbery and Santos (1999) believe that earmarking taxes for dedicated capital expenditure is an obvious application of the benefit principle of taxation which, properly applied, should lead to a more efficient structure of local service provision In the US, a major source for transportation infrastructure finance is an earmarked... fiscal sustainability relies heavily on intergovernmental transfers As Lewis (2006) noted, central government ~ 13 ~ Chapter 2 Literature Review transfer in Indonesia accounts for 92% of local fiscal resources, whereas taxes and user charges only add 8% to total local revenue There are two basic types of intergovernmental transfers, general and earmarked In Canada, they are called unconditional transfer... the main beneficiaries are within the local jurisdiction Existing residents also resist higher taxes in developing regions and areas (Savitch and Kantor, 2002) In China, dramatic changes have occurred in the last half century Urban areas have developed from war-torn towns to modern cities Still, little is known about the changing forces of new financial arrangements and their efficacy, particularly... local tax is property tax The tax normally imposes on various types of properties: residential, commercial, industrial, and institutional properties As the city develops, although property tax remains the revenue mainstay at local level, consumption and income taxes are increasingly relied upon as well All the for-and-against arguments on a particular tax item concern its level of “efficiency” as well... income taxes centrally to avoid capital ~ 14 ~ Chapter 2 Literature Review flight across local areas or regions These collected revenues are then transferred to local and state governments according to some equitable formula A municipality, as a relatively small open economic system and a constitutional creature of senior governments, has limited autonomy and monopoly ability to raise revenue In many countries,... (Kitchen and Slack, 2005) Transfers also have a horizontal equity purpose (Santiago, 2008) Cities, constrained by geographic, historical, and demographic factors, may differ in their taxable wealth (Bradbury, 1983) Transfers are collected from both rich and poor areas In many circumstances, transfers are allocated to reduce the revenue disparities among local governments, so that low income municipalities... Local governments may borrow from capital markets directly as well, especially in ~ 17 ~ Chapter 2 Literature Review those profitable infrastructure areas If being sponsored by higher government guarantees against local default, local governments can obtain higher credit ratings and borrow at lower interest rates (ADB, 2003) Sometimes, commercial financing agencies may receive tax reliefs in exchange ... carried out in the field setting of the case city Both quantitative and qualitative data are collected and analyzed Quantitative data come from internal and external sources Data are mainly taken... categorized according to the number of cases, spatial variation, and temporal variation This research was the single case diachronic study, with little spatial variation but substantial temporal variation... general allocation of property tax, income tax, and consumption tax, earmarked tax is often used in financing infrastructure Tax earmarking is the allocation of certain tax revenues to a designated