China’s Forgotten Cities Miss Boom as Credit Squeeze Bites

Apr 21, 2014 11:23 pm ET

(Adds new-home price data in seventh paragraph.)

April 22 (Bloomberg) -- In front of construction-site billboards depicting Tiffany and Louis Vuitton shops, Liu Cuiying squats on the bank of the Han river, washing orange bedsheets.

“What do I have? I have nothing!” she says repeatedly as she beats the sheets on the bank with a wooden bat. “My land is gone. What are we going to do?”

Liu lives in a run-down house in the village of Luying on the outskirts of the city of Laohekou in central China. She says her land was bought by the local government as part of a plan to expand the city to more than twice its size, but she hasn’t been relocated to a new home. In other villages nearby, farmers say the government promised to buy their houses and then didn’t have the money to pay.

They are caught between a local government that wants to extend China’s three-decade investment spree and President Xi Jinping’s determination to rein in lending and real-estate development that caused debt to soar. With Xi’s cash squeeze, inland cities that are trying to urbanize to reduce poverty are relying on private developers who can tap the estimated $7.7 trillion in the nation’s shadow-banking industry.

“This is a litmus test for whether Xi Jinping’s reforms are working,” said Tom Miller, managing editor of the China Economic Quarterly at GaveKal Dragonomics in Beijing and the author of “China’s Urban Billion: The Story Behind the Biggest Migration in Human History​.” “Cities in the interior are trying to grow along the same model as the cities in the east did 10-20 years ago that made them rich. If they start building and then it gets stopped that’s a disaster because it will end up a white elephant.”

Failed Developer

An economic slowdown and the credit squeeze are already claiming victims. Last month, Shanghai Chaori Solar Energy Science & Technology Co. became the first company to default in China’s $4.2 trillion bond market since the central bank started regulating the industry in 1997. Days later, news emerged of the collapse of closely held Zhejiang Xingrun Real Estate Co., based in the eastern town of Fenghua, with 3.5 billion yuan ($563 million) of debt.

China’s broadest measure of new credit fell 9 percent in the first quarter from a year earlier, while new-building construction tumbled 25 percent, the government said last week. New-home price increases eased across the country last month as tighter credit prompted developers to give discounts.

“Cities in China are facing some serious real estate bubbles, and the bubbles in third-, fourth-tier cities have the risks of total collapse,” said Tao Ran, director of the China Center for Public Economics and Governance at Renmin University in Beijing, in a phone interview on March 31. “The central government and banks tightened credit in the property market because they realized the risks.”

City Merger

That makes it harder for Zhu Houlun, 43, who took over as Laohekou party secretary in August 2012 with plans to merge with neighboring Gucheng by building a new urban center on 70 square kilometers (27 square miles) of farming communities between the two. The project would create a city of 700,000 by 2020, more than double Laohekou’s existing urban population, according to a Xiangyang government report.

Zhu must rely on private developers like Liu Pingfeng, from neighboring Hunan province, who is building a 5 billion yuan project north of Laohekou called the Red River Valley Eco- Tourism Resort that includes apartments, a five-star hotel, a theme park and a polo club.

“Raising funds is very difficult,” said Liu, 47, who has been building in Hunan for a decade. “I used to use land as collateral -- as long as I got the land certificate I could get the loan. Now it’s almost impossible.”

Liu said three years ago he could get loans from China Construction Bank Corp. and Agricultural Bank of China Ltd. for half the value of the land at about 6 percent to 7 percent interest. Now he’s forced to rely on “friends with connections” and pay rates of about 20 percent.

Musical Fountain

In Red River’s muddy construction site by the river, there are clusters of concrete skeletons that Liu says are due to open in October as shops, cafes, bars and a fitness center. Nearby is a hole in the ground the size of a football field that will be a musical fountain.

The soaring cost of loans means Liu will build and sell Red River in stages. “As we sell our first batch of apartments, we’ll have cash flow to build the next stage,” he said in an interview in February in Laohekou.

Qin Zunwen, vice director of Hubei Academy of Social Sciences and the chief architect of the Laohekou expansion, says plans by inland cities like Laohekou to use investment to develop don’t clash with Xi’s effort to curb unbridled gains in the nation’s gross domestic product because they are part of a goal to urbanize and reduce poverty.

“De-emphasizing GDP does not mean getting rid of economic growth,” he said in a telephone interview in February. “Growth is necessary to resolve the problems in people’s lives.”

No KFC

Downtown Laohekou shows how far the city has lagged behind development in the east. Rows of weather-stained four- and five- story buildings line the streets, with shopfronts selling liquor, cheap household goods and clothes.

There’s no department store, no passenger railway station, no KFC -- the Yum! Brands Inc. chain found in 900 other Chinese cities and townships. The nearest civilian airport is an hour’s drive away.

On a February evening in the unheated lobby of the town’s priciest hotel, the Aohua International, staff wear calf-length, padded coats with black faux-fur collars to ward off the chill. A room is 238 yuan a night, the price of six Burger King meals in Beijing.

“Laohekou was left behind -- living conditions are poor by today’s standards,” said Li Lecheng, director of Hubei Development and Reform Commission and a former deputy party sectary in the city of Yichang in Hubei, in an interview in Beijing in March. “The city needs to develop, so the government has to assume some responsibility for public infrastructure.”

China Dreamland

South of the old city, on land where farmers like Liu once grew cabbages and spinach, Zhu plans to build a new center. Four- and six-lane boulevards criss-cross mostly vacant lots with billboards showing brightly-lit apartment blocks, offices and hotels. The government is relocating No. 1 Middle School here. A hospital and civic buildings are planned.

Further downriver is “China Dreamland Valley,” a 7.5 billion-yuan residential housing and tourism project by closely held Sichuan Hengxinyuanda that started construction in December.

The company declined to give details of the project’s financing. Its website in January advertised a wealth-management product offering returns of up to 1.6 percent per month, or more than 19 percent a year, through a unit, Fortune Gathering Financing & Consulting.

Liu Cuiying, the local villager, said she was paid about 20,000 yuan per mu (1/6 of an acre) for her land. Without a field to farm, she now works 12 hours a day in a restaurant for 1,000 yuan a month and says she can’t afford running water.

New Apartment

A few hundred meters from her house is a high-rise development called New Luying Village, where some of the farmers are supposed to move to. Liu says she doesn’t know whether she will be given a home there or when the developers will demolish her house.

“My son can’t get a wife!” she shouts, in a thick local dialect. “The girl came and said my house is too shabby. If we build a new one, they will just tear it down.”

Chen Jing, 31, and her two young sons are living with her uncle after her house was razed on Dec. 25. There’s no sign of the 90,000 yuan compensation they were offered, said her husband Zhang Guangfu, 37, in a phone interview on April 17. In February, Chen said village officials promised her about 89,000 yuan for the land where she grew cauliflowers and other vegetables, but then said the government does not have any money so they couldn’t sign a sale contract.

Zhu and local government officials declined to be interviewed or comment on the city’s development plans and financing. In a speech published on a local government website in February, Zhu said 2014 should be “the year of construction.”

Municipal Debt

To raise money to buy the land and pay for roads, sewers, power lines and civic buildings, the city established local government financing vehicles, the funding system that helped China’s municipal debt to balloon in the past five years. These entities raised 2.96 billion yuan in 2013, according to a government work report.

With credit scarce, Zhu also challenged branches of the local administration to get money from provincial and central governments, publishing a table to show which departments were meeting their goals.

The city’s government forecast in December that fixed-asset investment would rise at least 35 percent this year and economic growth would jump more than 13 percent, compared with the government’s target for China of about 7.5 percent.

Social Problems

“Local government officials are still very fixated on economic growth,” said Lynette Ong, an associate professor at the University of Toronto who wrote the 2012 book “Prosper or Perish: The Political Economy of Credit and Fiscal Systems in Rural China.” “Without growth, a lot of social problems like unemployment will surface.”

Liu Pingfeng, the Red River Resort developer, said he was attracted to Laohekou by the attitude of the local government, which he relies on to acquire the land and build the roads, drains and power lines.

“In China, the government has a huge impact,” said Qin at the Hubei Academy of Social Sciences. “If the government says a place is going to be the hotspot of investment, private businesses will likely follow. There is an old saying: ‘A duck always knows when the spring river gets warm.’”

China’s smaller cities are trying to emulate the success of the Pudong district of Shanghai, which grew in the 1980s and 90s when capital and labor were plentiful.

Pudong Model

“It worked very well in Pudong -- they had a few hundred thousand people in this marshland area and now you have 6 million people,” said Miller at GaveKal Dragonomics in an interview on Feb. 14. “The problem is, this model has been copied by smaller cities where they just don’t have the economic growth and population growth to make them work.”

The expansion on the coast was largely fed by immigrants from provinces like Hubei that are now struggling to lure them back. On a February morning in Laohekou’s cavernous and unheated labor exchange, a single jobseeker scans the vacancies posted on the back wall, while five female staff clutch thermoses of hot drinks to keep warm.

“It’s hard to hire people here,” said Zhang Hongju, one of the staff. “The young people have all gone to Guangdong and those who haven’t need to stay home to take care of elderly family or kids.”

In Chen Genxin’s village, slated to be demolished to make way for China Dreamland, he says everyone is over 50. His sons left during the boom to get jobs in other cities.

“If the country wants us to tear it down, we’ll tear it down,” said Chen, 71, as he harvests spinach from his small plot with his wife in the afternoon sun. “The earth will bury me wherever I go.”

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