Local Credit Systems for Urban Environmental Infrastructure

Miao CHANG, Tao FU, Jining CHEN
Tsinghua University

1.Introduction

Urban infrastructure normally divides into four parts as follows due to the different sector management system in China: (1) Urban public utilities including water supply, gas, heating system, public transportation, etc.； (2) Urban public work construction: including road, bridge, pipeline, sewerage treatment, flood, and light, etc.；(3) Urban environment and sanitation: public toilet, public cleaning, and solid waste collection and disposal；(4) Urban park, garden, and green. This report focuses on water supply, sewerage treatment, and municipal solid waste (MSW) disposal, which defined as urban environmental infrastructure (UEI).

The results of the analysis on the current status of UEI investment and financing illustrate that insufficient investment and lack of sound financial mechanisms are the key problem faced in this area. This problem is obvious in the field of UEI. Evolution of credit financing for UEI is becoming as the central concern of each level governmental policy issues. This study gives a review of investment structure of UEI in China, makes demand and supplies analysis of municipal credit markets, and evaluates the maturity of municipal credit systems in China including Bank Lending for Local-Level (Municipal and Municipal Enterprise), On-Lending to Local Level of Proceeds from State Borrowing, Municipal Bonds and Local Enterprise Bonds, Private Sector or Commercial Enterprise Investment in Municipal-Level Environmental Infrastructure, and accessibility of credit institutions and instruments to water and environmental project owners. Finally, this study tries to develop a strategy for designing competitive municipal credit market in China.

2. UEI investment and financing in China- Insufficient investment, low efficiency, and lack of sound financial mechanisms

2.1 Insufficiency of total investment to meet needs
The development of urban infrastructure was increasing in last two decades, but the level of facilities and urban infrastructure investment scale is still behind its economic development in China compared with the target recommended by World Bank World Development Report 1994: Infrastructure for Development. World Bank report recommended that the rate of investment in urban infrastructure to social fixed-assets investment might be from 9% to 15%, and the rate to GDP might be from 3% to 5% in developing countries (Table 1) (World Bank 1994).

Table 1 Investment in urban infrastructure in ChinaYear Investment for urban infrastructure (100 million Yuan) The rate to social fixed-assets investment (%) The rate to GDP(%) 19788.351.200.23197913.151.900.32198013.541.500.30198119.532.000.40198227.162.200.51198328.172.000.47198441.662.300.58198563.992.500.71198680.072.700.78198790.312.500.751988113.242.500.751989106.972.600.631990121.202.700.651991170.883.100.791992283.173.501.061992521.834.001.501994666.043.901.421995807.634.001.381996948.624.131.4019971142.654.601.5619981477.615.201.8919991590.845.331.9820001893.655.762.12

Source: Construction Industry Publisher of China 2002

In the 1990s, China fulfilled the 8th and the 9th Five-year Pan and the national economy maintained sustained, rapid and sound development. At the same time, China also experienced rapid urbanization and the level of urbanization increased by 0.63 per sent annually. The rate of urbanization has reached about 31% in 2002. It is observed that household drainage is increasing rapidly with expansion of urban population, and improvement in living standards, and it is beginning to exceed the amount of industrial effluent, polluting both surface water and ground water. Although the amount of garbage is increasing rapidly, the rate of processing remained low. In some cities, the reclamation of garbage is transported to dump yards without appropriate treatment. Even in cities that are exceptionally implementing sanitary treatment of solid wastes, the treatment processes are short of standards, causing secondary pollution around the landfill areas. Since the cost and technology are insufficient, garbage incineration has not gained momentum. Thus, in China, the needs for UEI development are increasing rapidly, and financing UEI has been the central concern of the national and local governments. The Chinese government pursues a strategy of sustainable development and continuously devotes its efforts to improve the environment, and accelerates the construction of UEI that are related with urban drainage, urban municipal solid waste disposal and treatment. The measures have helped improve the quality of urban environment substantially. UEI is one area in which investment is growing rapidly； its share of overall environmental investment rose from 33% in 1991 to 55% in 2002. Table 2, 3, and Figure 1 shows the development of UEI in China during the last two decades.

Table 2 Water Infrastructure Development in Chinese CitiesItemUnit198519901995199920002001Water supply capacity100 million liter128382.3496.6467.5469466Per capital daily consumption of tap water for residential useLiter55.1100.1158.1189.6220216Ratio of water supply%8189.29396.396.772.3Length of sewer pipelinesKilometer3155657787110293134486141758158128Per capital length of sewer pipelinesKilometer2.73.966.76.8-Ratio of sewerage treatment %-14.9203134.236.5

Source: National Bureau of Statistics of China 1986-2002

Table 3 Increasing Water Infrastructure Capacity in ChinaItemUnit1979-19851986-19901991-19951996-1999Urban Infrastructure fixed capital investment100 million207.25112449.65066Urban Infrastructure Fixed capital investment / Total social fixed capital investment %2.22.63.85.2New capacity for water supplyTen thousand m31490167729742500New capacity for sewerage treatmentTen thousand m327254010381000

Source: National Bureau of Statistics of China 1986-2002

Figure 1 Change of the ratio of Municipal Solid Waste Disposal in China

Source: Wang 1999.

By 2010 and 2020, the urbanization rate of the population is expected to increase to 46% and 55%, respectively. Growth in the number of cities and an expansion of existing cities will result in a corresponding increase in the volume of urban domestic wastewater and solid waste. Over the past decade, discharges of urban domestic wastewater have increased by 5% annually. In 1999, the amount of urban domestic wastewater discharged exceeded that produced by industry for the first time. In 2002, the amount of urban domestic wastewater discharged reached to 23.22 billion tons, accounting for 52.9% of China’s total emissions of wastewater, and urban domestic solid waste increased by between 5% and 8%. In 2002, the amount of urban domestic solid waste generated reached 1,360 million tons. It is predicted that by the year 2020, the production of urban domestic wastewater and solid waste will increase by between 1.3 and 2 times the volumes discharged in 2000. Existing facilities for treating urban domestic wastewater and solid waste, however, are seriously deficient, and new construction is lagging behind. By the end of 2001, the rate of primary treatment of urban domestic wastewater was merely 36.4% of the total amount produced, of which only 18% received secondary treatment. The municipal solid waste disposal rate was 58.2%, of which only 10% received sanitary treatment and disposal.

According to China’s environmental protection plan for the Tenth Five-Year Plan period (2001-2005), the treatment rate of centralized urban domestic wastewater is targeted at 45% by 2005, and the rate in cities with populations larger than 500,000 is targeted at 60%. Under the plan, the increased capacity of sanitary treatment and disposal of urban solid waste is supposed to be 150,000 tons per day. In order to realize the above objectives, China will need hundreds of billions of RMB to construct treatment facilities for urban domestic wastewater, and 45 billion RMB to invest in the construction of domestic solid waste treatment facilities. The Task Force predicts that during the Eleventh Five-Year period, the investment required in these two fields will be around 170 billion RMB. Under the current investment mechanisms and capabilities, it will be very difficult to satisfy these demands. For some local areas, the problem of insufficient funding for construction of urban environmental infrastructure will be very serious.

2.2 Low investment efficiency

Due to the growing demand for financing, and despite inefficiencies nationwide, China has started to introduce market-based approaches for pollution prevention and control. The low efficiency of environmental investment in China is mainly reflected by inefficiencies and problems in the construction, operation, and management of urban wastewater treatment and solid waste disposal facilities.

For years, the government has been the main source of funding for construction of UEI facilities, with non-profit organizations[1] responsible for their operation and management. This type of government monopoly excludes institutional competition, which in turn contributes to the problem of low investment efficiency.

With the advancing reforms of the market economy system and the ongoing development of the environmental service industry, a pattern of so-called “marketization“ emerged in China for pollution treatment at the end of the 1990s, based on international trends favoring practices such as PPP and PFI (Private Finance Initiative). Marketization is contributing to a break-up of the government’s monopoly structure. This was carried out at three levels: (1) levying urban residents for household wastewater treatment and waste disposal and opening up the development of urban environmental infrastructure through public bidding； (2) demolishing the system of government-dominated construction and operation by introducing competitive mechanisms (i.e., enterprises[2] take over commercialized management of existing facilities)； (3) encouraging the participation of other economic entities[3] , apart from government agencies, in the construction and operation of the facilities, attracting capital that has accumulated in the society； and (4) establishing a management system, under which various entities participate in facility construction. The corporate operation of those facilities is also based on market mechanisms.

Since market-based patterns[4] could increase investment efficiency and secure financing, active reforms have been undertaken in recent years in China. Ground-breaking progress has been made in both shifting policy and practices for the marketization of pollution treatment, although these are still at their initial stages in the context of China’s overall situation.

2.3 Lack of sound investment and financing mechanisms: an important cause of insufficient investment

The shortcomings of existing investment and financing mechanisms are the most significant causes of insufficient investment in environmental protection today. As the country develops a clearer picture of its needs for environmental protection, and as China makes progress with reforms of its economic system (including overall national investment and financing systems), the future structure for environmental investment and financing is taking shape in China, with the involvement of multiple investment entities, financing channels, and instruments. The multiple entities include governments, environmentally-liable social entities (e.g., polluting enterprises), and non-environmentally-liable social entities (e.g., enterprises and other profit-oriented and non-profit organizations). The multiple channels and instruments include public budgets, environmental levies (from enterprises and non-profit organizations for pollution discharge and from urban residents for wastewater treatment and waste disposal), treasury bonds, government loans, funds from enterprises, enterprise loans, and private funds, etc.

In terms of the roles played and contributions made by the entities and various instruments, however, the current mechanisms reflect the following characteristics: (1) they mainly rely on measures and channels under governmental plans, e.g., public budgets, environmental levies, and treasury bonds, etc.； (2) measures related to non-environmentally-liable social entities and public fund-raising approaches are either insufficient or non-existent； and (3) levy systems for urban domestic wastewater treatment and waste disposal are still at an initial stage and they have not been fully utilized. According to initial estimates, about 60 per cent of urban solid waste is subject to a levy to pay for treatment, with the price ranging between 0.2 to 1.2 RMB per ton, while only about 16% of waste is subject to a levy for solid waste treatment and disposal.

The above-mentioned problems in investment and financial mechanisms are the main causes for the insufficient investment in environmental protection, particularly in UEI. Although financing has been increasing significantly in recent years, mainly through governmental channels, the huge need for investment in urban infrastructure construction in China has barely been satisfied. Investment in UEI mainly relies on tax revenues, local financing, and treasury bonds. Over the past decade, investment in UEI increased rapidly. It is necessary to immediately develop a strategy for designing competitive municipal credit market.

3. Overall of credit financing for UEI and its challenges

3.1 Demand and supply analysis of municipal credit markets

As above mentioned, from 2000 to 2020, China is invited to the UEI construction boom. UEI development plan of the central government is driver of municipalities and municipal utilities to borrow for financing of UEI projects. In China, municipality is the major investor for UEI. The financial environment for UEI of local governments is changing with development of social capital, improvement in administrative management capability, and accumulation of capital practical use know-how.

Local government investment mainly includes urban maintenance and construction tax, surtax for public utilities, state Treasury bond, and budget allocation from the central and local governments, etc. Investment via the market mainly includes domestic bank loan, utilization of foreign investment, funds raised by enterprises themselves and other sources. Statistic showed that from 1990 to 2000, the ratio of governmental investment decreased from 64.23 per cent to 12.75 per cent； at the same time, however, the ratio of investment via the market increased from 35.74 per cent to 87.26 per cent.

Figure 2 Investment sources from the government and form the market

Source: Song, XT 2003

Table 4 shows over five years time series data and indicators of social capital investment in urban infrastructure in China. State-owned enterprises, collective enterprises, private enterprises, foreign-funded enterprises, and joint ventures, etc is investor. State-owned enterprises account for a large rate in market and are the leading role of UEI investment. Although the volition of market entry comes out of private enterprises enough, since funding ability is insufficient, state-owned enterprises will to invest the long-term and stable UEI filed with its sufficient funding ability. Collective enterprises, in particular the joint venture company established between state-owned enterprises and multinational company is stronger than private enterprises, and the management system is advanced than state-owned enterprises which might be the major player in UEI market.

Table 4 Social capital investment in Urban Infrastructure (1996-2000)

(Unit: Ten thousand yuan) Year Total investment Government Social capital Ratio of social capital (%) National budgetLocal financingDomestic bankBondForeign investmentOthers1996871197534816148613701221920494791055676117536940.219971056679543012455433781652864305851295440161440443.51998134645181002325600424928476154031901101206210593348.0199914532690173843459515443578033559478686394201880747.1200017435411218552768572254285355325226767470301460848.1

（Source：Ministry of Construction）

Much social capital has turned its attention to the long-term and stable investment project by adjustment of the new economy industry which becomes on behalf of the Internet technology since 2001. UEI is becoming as the target of social capital investment. Table5 shows the regulation situation of social-capital participation in UEI. Most of companies are difficult to entry the stock or bond market for financing, because of the high requirements and lack of ability.

Table 5 the regulation situation of social-capital participation in UEI

Service sector Open-markets gradeNote

Water supply Clean waterWith no restriction Waterworks pipe systemParticipation with restrictionRestriction of the shareholding in the large and middle city

Sewerage treatment Sewerage treatmentWith no restriction Drain pipe systemParticipation with restrictionRestriction of the shareholding in the large and middle city

Source: Construction Industry Publisher of China 2002

3.2 Current situation and challenges of financial sources and financial channels for UEI

(1) Treasury bond

In 1998-2001, the Chinese central government invested 76.6 billion RMB generated from issuing treasury bonds in the construction of 967 urban infrastructure projects. The treasury bond investment mobilized bank loans, matching funds from local governments and other kinds of funds, and the total investment in the urban infrastructure reached 330 billion RMB, three times of the normal level in past years. Most of these 967 projects had been urgently needed but the construction could not start due to lack of investment. The 967 projects are scattered in 95% of the municipalities at or above the prefecture level national wide and some cities in the central and western regions, including water supply, sewerage treatment and MSW disposal. 32.6 billion out of the 76.6 billion RMB investment in urban infrastructure was directed to 404 UEI projects. Specifically, 20.8 billion RMB was used to support 214 clean water projects, increasing the national capacity of urban sewerage treatment by 1.4 times； 69 MSW disposal projects were launched, raising the level of innocent treatment of MSW from 57% to nearly 70% nationwide. In 2001, the Chinese government issued 150 billion RMB long-term construction treasury bonds, and funds supported about 1000 projects of urban water supply, sewerage treatment, MSW disposal, and etc., and launched the project of water pollution prevention and control in the Three Gorges area, strength the work of urban environmental improvement. In the Three Rivers and Three Lakes area (Liao River, Hai River, Huai River, and Tai lake, Dian Lake, Chao Lake), which covers twelve provinces and autonomous regions, treasury bond funds supported the construction of 117 treatment plants, with a total treatment capacity of 9.8 million tons/day. By the end of 2000, 44 plants came on stream with a total treatment capacity of 3.3 million tons/day. Treatment plants in operation in the Three Rivers and Three Lakes area can reduce pollution load by more than 200,000 tons annually in term of chemical oxygen demand.

However, due to lack of experience, problems occur in the management of treasury bond and its implementation. Some local governments make false project proposals to snare treasury bond funds； in some projects, treasury bond funds are misappropriated, reallocated without permission or directed to other uses； project management does not conform to norms, and the project entity responsibility system, public tendering system, construction supervision system and contractual management system are not fully implemented； some local governments for not provide matching funds fully and timely (Wang, YX et al 2003).

As for the financial policy to western region development, it cooperates with strengthening of a financial injection policy to the western development infrastructure project by the national government. The purchase of the treasury bond by the commercial bank is promoted positively. The set fund of a treasury bond should be lent out to timely. There are 70 percent of the loan of international development organizations and ODA, and grant which should be invested in the western region. It is strengthen the financial transfer from the central government to central and western region. The term of a loan is necessary to be extended, if the infrastructure project with the long construction period and large investment, according to its construction period and redemption capability.

(2) Bank Loan

The loan from the outside is becoming the major sources of funds of UEI, and the rate is getting large. The reasons are as follows: (i) It is related to the feature of UEI investment (Large initial investment and long-term cost recovery)； (ii) seriousness of the financial deficit of UEI investment.

The majority of commercial financing in China, exclusive of treasury bond, is indirect financing via banks. Take corporate financing for instance, the ratio of indirect financing via banks against direct financing is about 9:1. In 1991-2001, bank loans increased by ten trillion RMB, while corporate financing via issuing stocks and bonds amounted to one trillion RMB.

Chinese government encourages banks to extend loans to support the development of UEI. But according to the financial system reform, the People`s Bank of China will not assign plans for special loans to commercial banks. Policy banks like the State Development Bank of China will function as the major financing source for the development of UEI. Bank loans, corporate bond, and foreign investment are the important financial sources of local governments. Table 6 shows bank loans for urban infrastructure construction in China.

Table 6 Bank loans for urban infrastructure construction in China

(Unit: ten thousand yuan) YearUrban infrastructure constructionDomestic bank loansDomestic bank loans / urban infrastructure investment19861314250317162.41%19871442268616014.27%19881845193758294.11%19891835625444942.42%19902104896884294.20%199126611972292738.62%199239347883225968.20%199358119044456587.67%199467480084133276.13%199577437324766546.16%1996847641995685011.29%199711103423165740514.93%199814333158306962221.42%199916271209374197923.00%200019889324414698820.85%

Source: Construction Industry Publisher of China 2002

Policy based loan: the State Development Bank of China

At present, Chinese financial management system has restricted capital investment by the bank including commercial bank and policy based bank severely. Such a fund intervention form of equity investment is still impossible. But along with strengthening of the capability of a supervisor organization and financial company risk management, application in China is possible like the European Bank for Reconstruction and Development. The policy based bank (especially China Development Bank) in China has the large support to the UEI sector. China Development Bank (CDB) was established in March 1994 as a policy bank under a Special Decree of the State Council, with its registered capital of RMB 50 billion.

·　 Wholly owned by the Government，reporting directly to the State Council.

·　 The largest one among the three policy-oriented banks in China, and the only financial 　institution with ministerial status besides the PBOC.

·　 Primary function：(1) To foster the construction of infrastructure, basic industries and pillar industries through financing； (2)To support the nation’s regional development policy； (3) To on-lend loan from the international financial institutions.

Figure 3 Loan Business

Source: China Development Bank 2004

Figure 4 Forecasts of Bond Issuance and Lending Activities

Source: China Development Bank 2004

CDB has already carried out the loan in the UEI project in hundred cities. The amount of fund went up to 100 billion yuan, and encouraged the investment of 100 billion yuan from the local government. CDB is supporting local water infrastructure construction positively. The loan of infrastructure construction including UEI in 2001 and 2002 was 73,992 million yuan, and 115,636 million yuan. 10 percent and 13 percent was occupied. CDB offered 33 billion yuan to the infrastructure project of Shenzhen city. Water infrastructure and the comprehensive measure of river serve as an important investment field in there. The Heibei branch of CDB carries out the loan of 60% of total loan amount to Heibei province for maintaining water infrastructure and its pipeline system. CDB supported Suzhou Industrial Park infrastructure construction project including water supply and sewerage treatment, the total investment amount is 4,800 million yuan. CDB offers the loan of 1,200 million yuan.

CDB contracted the loan contract with Beijing Capital CO., Ltd. at the end of 2003, and performed the loan of 4,370 million yuan. A period is 19 years. This fund is mainly invested in water sector (water supply and sewerage treatment) projects of Beijing Capital CO., Ltd.. Policy banks like CDB function as the major financing source for the development of UEI, but UEI just one small component in there among the focus of leading activities including power, telecommunication, railway, highway, petroleum and petrochemical. The policy based method of “Public Environmental Trust Fund.” raising money through the Social Security is still on the process of study.

CDB receives a loan application of Anhui Guozhen Environment Protection SCI-Technology Co.Ltd. which gained the first international bid BOT project – Dongjiao Sewerage Treatment Plant of Xinhui City in Guangdong province in China, and is examining the feasibility of loan in BOT project. CDB is studying on the loan policy which supports private sector participation in UEI field as a pilot project.

CDB will play a key role in the development of central and western China which is highlight within its the development strategy in the next 5 Years. The loan to the central and western region has occupied 60% of the whole loan since CDB was established. The 140 billion yuan loan was performed till the end of 1999. CDB also support UEI development in central and western region through acting as underwriter of corporate bond, investment and financing adviser, industrial fund investment, and technical support.

Commercial Bank

At present, only relatively small amount of capital are made available in commercial bank loans to support UEI projects. The major obstacle lies in four factors: first, UEI projects requires the long-term investment with the lower profit compared with other economic infrastructure； second, tariff revenue of the project can not satisfy the demand for investment return； third, tariff collecting rights can not be pledged effectively； Fourth, the rate of a debt of municipal-government is high. Every place set up urban construction Investment Company, and are performing the loan of UEI construction as a representative of municipal-government. In fact, the rate of a debt of the investment company of each city is high, and debt payment has been a problem at now. Even though bank loan plays an important role in economic development, but there is a big barrier to finance UEI as a matter of fact.

Recently, under the deregulation of financial sector reform, the People`s Bank of China will not assign plans for special loans to commercial banks, and the low profit, unsatisfied cost recovery, and long-term investment of UEI project make it difficulty taking as the custom of commercial banks. The interest of a domestic bank loan (from 3 to five years) is 5.76%. Preferential treatment interest is 5.184% in UEI field. A part of major company considers the loan from the overseas banks, because of the possibility of up valuation of renminbi and the low interest in there.

(3) Municipal bond and corporate bond

Municipalities now are prohibited from issuing municipal bonds except for special regulation and regulation of the State Council due to the Budget Law in China. But issuing municipal bonds is a common approach in developed countries for financing UEI projects. It is the bottleneck that local governments can not access the capital through the channel of municipal bond. In China, local domestic company under local public sector has issued the bond for construction of urban infrastructure in stead of local government for solving the financial shortages, because of prohibition of local bond issue in recent years. The profit of project is used as payment of loan. Although a bond issue company takes the responsibility and the risk of payment as for a name top, a company can get much assistance from the local government in fact. The character is not a true corporate bond. It is the same as municipal-bond which financing public goods.

For example, Shanghai Urban Construction Investment Company issued Pudong Construction Bond of 500 million Yuan for building the No.2 subway (First Phase) in Shanghai. Water Supply Company of Jinan city issued Water Supply Bond of 150 million Yuan for building storage-of-water dam for water supply in 1999. Changsha city Beltway Construction Company issued the bond of 180 million Yuan for constructing the second beltway. The above bond issued by company, but the use of the lent fund is the same as municipal bond. It is the specific product of financial mechanism in China now. Box 1 CHENGDU: Municipal Bond in planning for private capital

Chengdu city officials announced to make more financing channels accessible for UEI construction at a municipal meeting on urban governance and management held recently. The city will create and provide conditions for the issuance of municipal bonds. At present, local government still have no permission for the issuance of municipal bonds openly, however a broad of bond investment groups have emerged for the further competitive capital market. The relative organizations will discuss on the feasibility of the annual issuance of municipal bonds based on the credibility guarantee of local government, value of urban infrastructure project and prospective cash flow.

Chengdu city has preceded in financing channels for urban water infrastructure with application various financing tools, such as collective consignation loan and corporate bond. The first collective consignation loan project of Sichuan province was launched in Chengdu on 16 Jan. 2003. The Construction Bank of China as depositary issued a new investment service named treatment of water resource with RMB 200 million. The consignation loan interest will be paid with fiscal year and the capital will be repaid one-off at expiration. The annual interest rate is 3.96% for 3-year loan and 4.41% for 5-year loan separately. It also provide individual investors a low entrance of 10,000 RMB for consignation loan that could be transferred. In addition, Chengdu Xingrong Investment Ltd. plans to issue corporation bonds in 2004. According to the bonds project drafted by the agency, Chengdu Xingrong Investment Ltd. could issue 10-year corporation bonds with an amount of 1,000 million. Xingrong plans to sell the corporation bonds by main underwriters and underwriter group. It is also hopeful to transact in Shanghai Stock Exchange.

Furthermore, some researches and strategies have been conducted for municipal bonds in China. Beihang University researchers announced the secure issuance scale of municipal bonds should be controlled under RMB 11,000 million with the futures right evaluation approach based on KMV model. In Shanghai, World Bank has approved to provide China a loan with 200 million US dollars for readjusting urban planning； part of the loan will be used for local government for financing and institutional reform of urban infrastructure, especially for developing long term municipal infrastructure bonds as new financing tool.

(Source: H2O China 2004)

The problems and measures of issue of corporate bond in China

　　 At present corporate bond financing is nearly nonexistent, and the corporate bond market stagnates. There are very few UEI companies which can clear the issue condition of corporate bond, because in many companies, reconstruction of forms of enterprise has not finished yet for realizing separation of administration and enterprise. There is no achievements record. It does not have the independent management which responds, financial affairs, and staff organization. Compared with bank loans, more restrict requirements are imposed on corporate bond financing, and it takes longer time and cost more to issue corporate bonds. It is due to this factor that enterprises qualified for bond financing would prefer bank loans, and they do obtain bank loans. In addition, the administrative framework for corporate bond financing is not straightened out. These two factors contribute the almost stagnate of the corporate bond market. Apart from the bond issuance approved by the central government for particular reasons in the past two years, the issuance of corporate bonds by local enterprises has almost come to an end.

Table 7 Volume of corporate bond issuance in recent years (Unit: in billion RMB) Year 1995 1996 1997 1998 1999 2000 2001 2002 Volume 30.1 26.9 25.5 14.8 15.8 8.3 14.7 27

Source: The State Development Planning Commission 2003

Since the central government imposes tight control over the issuance of corporate bonds, to date there has not been a precedent of issuing corporate bonds for UEI. Nevertheless the issuance of corporate bonds has a number of favorable conditions. First, the Regulations over the Administration for Corporate bonds, which is being revised, will facilitate corporate bond financing for UEI: (i) A ratifying system will replace the current examination and approval system for issuing corporate bonds； (ii) In reference to the approach of pricing treasury bond through public tendering, the issuing interest rate of corporate bond will also be set in public tendering, which will facilitate the reduction of the cost of corporate bond financing； (iii) It will be allowed to issue foreign currency or RMB corporate bonds to commercial banks located in China with a view to restructuring foreign debt projects. This change will make it possible to repay the foreign loans to environmental projects through issuing corporate bonds. Second, in recent years, with strengthened administration and strict control, the repayment of matured corporate bonds has been made quite well in general. Third, the interest rates of bank deposits are quite low, and the interest rates of corporate bonds are lower than those of bank loans. This scenario makes the option of corporate bond attractive to both investors and enterprises. Box 2 Issue of corporate bond in China

In case a company publishes a corporate bond, it observes in regulation of corporate bond management regulations. In case the central government’s company publishes a corporate bond, it needs to get examination of People’s Bank of China and National Development and Reform Commission. In case the local government’s company publishes a corporate bond, it needs to get examination of the branch of People’s Bank of China and local Development and Reform Commission. The company has to coincide with the following conditions while issue a corporate bond: (1) The scale of a company should fill in national regulation； (2) The financial accounting system of a company must coincide with national regulation； (3) It has the payment capability of a debt； (4) The management situation of a company is good, and profits had come out for continuation three years before issue of a corporate bond； (5) The use of the raised fund is coinciding with national industrial policy.

(4) Stock market

Stock presentation of a company has strict restriction that have to clear in regulation of the supervisor administration and a market. There are still few UEI companies with good achievements and good trust. At present, many of companies which list in the UEI field are synthetic companies (Table 8).

Table 8 Stock issue (the first time) of UEI Construction Company in major cities of China YearTimeAmount

(ten thousand 株 ) Price

(Yuan) Amount of funds

(hundred million Yuan) Investment fieldBeijing Capital co.,Ltd2000160008.9814.3Sewerage treatmentNANJING XINGANG HIGH-TECH COMPANY LIMITED199750007.843.8Sewerage treatmentWuhan Sanzhen Industry Holding Co.Ltd.199877216.915.3Water supplyNanhai Fazhan Co.Ltd.200065006.684.3Water supplyYuanshui Co.Ltd19931924305.2Water supplyShentong Subway Co.Ltd.199424001.50.36Water supplyTianjin Capital Environmental Protection Company, Ltd.199568982.51.72Sewerage treatment

Source: Construction Industry Publisher of China 2002

Note:

(5) Private sector participation

The following reasons could be considered as why China needs to encouraging private sector participation and develop PPP: (1) Local governments are playing an increasing role in UEI construction and operation, but their financial capacity can not meet the huge demand due to the lack of subsidy system from central government as well as limited flexibility of independent fiscal management. The current situation of local credit market is as follows: (i) Bank loans play a key role in China`s financial system, but UEI just one small component in there and the limitation of capacity is clear. The policy based method of “Public Environmental Trust Fund.” raising money through the Social Security is still on the process of study. Recently, under the deregulation of financial sector reform, the People`s Bank of China will not assign plans for special loans to commercial banks, and the low profit, unsatisfied cost recovery, and long-term investment of UEI project make it difficulty taking as the custom of commercial banks； (ii) The budget Law prohibits the issuance of municipal bonds, corporate bonds are used to finance UEI projects instead； (iii) Treasury bond investment has played a significant role in accelerating the construction of UEI, but there are also problems with the use of treasury bonds is too broad and the supervision of projects funded by treasury bonds is not effective enough； (iv) there are increasing role of stock market and corporate bond. It is necessary to expand the investment bodies and utilize the social capital financing the UEI for meeting the investment target during the construction boom. (2) Trends in government monopoly have been squeezing out competition institutionally and, hence, they lack efficiency. The existing UEI did not operate properly, which actually deteriorated the insufficiency of UEI. Enterprise [5] shall undertake commercialized management over the existing facilities. The corporate operation of these facilities should based on market mechanisms. (3) Introducing advanced environmental technology from foreign countries, as well as developing domestic environmental technology could be achieved according to the deregulation and privatization. It coincides with the policy for improvement of environmental technology and promotion of environmental business in China. China has a large-scale market of UEI, environmental industry will increase with 14-17% per year during 2000 -2015. It is good business chance for foreign and domestic company. In particular, the domestic companies are facing the saturation of industrial pollution control equipments market, UEI is considered as a new market that positively response from private sector.

Compared with lack of contents of UEI construction and market-oriented operation in environmental protection laws, the policies of promoting UEI construction and market-oriented operation by encouraging the private sector participation (PSP) has made headway in recent years, especially the issue of charging policies of sewage and garbage and opinions of promoting industrialization of urban sewage and MSW disposal. The progress in five aspects: (i) Determine the developing direction of expansion of investment body, corporation based operation and market based management system； (ii) Formulating charging policies of sewage and garbage, creating the necessary conditions for PSP； (iii) Reforming management system, implementing franchise operation, initially creating a fair and competitive market environment； (iv) Formulating favored policies, fostering industrialization of urban sewage and MSW disposal； (v) Working out supervision and management measures, normalizing market and guaranteeing a healthy and ordered industrialization development. There are 6 policy guidelines for encouraging economic entities other than the public sector participation.

·　1999, Notice concerning trial implementation issues of sewage fee in the cities of Huai He River, (issued by ministries jointly)；

·　2000, Notice of the State Council on strengthening urban water supply, water save and water pollution control；

·　2000, Notice concerning further promotion of price reform of water supply ( by ministries jointly)；

·　2002, Notice concerning levy of garbage treatment fee and facilitation of industrializing garbage treatment ( by ministries jointly)；

·　2002, Opinions on facilitating industrialization of sewage and garbage treatment (by ministries jointly)

·　2002, Industrial catalogue guidelines for foreign investment

Table 9 the major policy issues on construction and market-oriented operation of UEI (issued since 1999) PoliciesTime of issuanceIssuance departmentMain contents Notice of Strengthing Collection of Sewerage Treatment Charges, Setting up Sound Operation Mechanism of Urban Sewage Discharge and Centralized TreatmentMay 1 1999State Planning Commission； Ministry of Construction； State Environmental Protection Administration (SEPA)Collect sewage disposal fee besides the water supply fee； establish the principle and extent of authority for the sewage disposal charging standard； set up and improve the supervision mechanism of management of sewage disposal charging and operation of sewage treatment in order to ensure healthy implementation of sewage disposal charging.Notice of the State Council for Strengthing Urban Water Supply, Saving and Pollution ControlNovember 7 2000State CouncilCities all over China should start collecting sewage disposal fees according to relevant regulations. Priority should be placed on adjusting the sewage disposal charging to the level of maintaining break-even and making meager profit in order to meet the need sewage treatment facility construction and operation； Value added taxes should be exempted from the sewage disposal fees charged and the depreciation process can be accelerated for equipment purchased for wastewater disposal projects. Opinions of Promoting and Guiding Non-Governmental InvestmentDecember 11 2001State Planning CommissionChange old concepts； gradually broaden investment fields； widen financing channels； implement fair and equitable taxation and fee policies； and establish socialized services systems.Industrial Guidance Category for Foreign InvestmentMarch 4 2002State Planning Commission； State Economic and Trade Commission； Ministry of Foreign Trade and Economic CooperationMunicipal sewage treatment equipment at a capacity of 10,000 ton/day or above, industrial wastewater film treating equipment and other waste water bio-treatment equipment, other garbage burning treating equipment production； construction and management of sewage treatment and MSW disposal plant, hazardous waste disposal plant (garbage burning plants and landfills) and other environmental pollution treatment facilities.Notice of Implementation of Charging System for Living Garbage Treatment and Promotion of Industrialization of Garbage TreatmentJune 7 2003State Planning Commission； Ministry of Finance； Ministry of Construction； SEPAEstablish proper garbage charging standards and scientific calculation and collection methods； strengthen charging management； reform garbage disposal operation mechanism and promote garbage disposal industrialization.Opinion of Promoting Industrialization of Urban Sewage and Garbage TreatmentSeptember 10 2002State Planning Commission； Ministry of Construction； SEPASet definite targets to promote the industrialization of municipal sewage and garbage disposal； Reform the old systems and establish innovated mechanism to create the fundamental conditions for the industrialization process of municipal sewage and garbage disposal with market – orientation and policy support； Strengthen the supervision and control to guarantee the healthy and ordered industrialization development of municipal sewerage treatment and MSW disposal plant.Opinion of Speeding Up Market – Oriented Operation of Municipal Public Utility SectorsDecember 27 2002Ministry of ConstructionOpen up municipal public utility sector market, set up the public utility sector franchising system, change the old government regulation practice, strengthen the leadership in order to steadily promote its market-oriented operation process.

Source: Pei, X.F., et al 2003

Figure 5 shows the UEI sector reform process in China.

Figure5 UEI Sector reform process

Source: Prepared by authors

　　 BOT (Build – Operate – Transfer) and TOT (Transfer – Operate – Transfer) is the most popular PPP options adopted in Chinese cities (Box2. Box3). Box 3 Wenzhou Dong Zhuang Power Generation in by Refuse Incinerator Plant

Wenzhou City has an annual production of 400,000 tons of household garbage, which is still increasing at an annual speed of 8-10%. With the two former landfills of garbage already reaching its full capacity, there is no appropriate place in the city for new landfills. Wenzhou decided to adopt the BOT for building this plant. The gross investment of this project is RMB 90 million yuan, financed by a private enterprise, Wei Ming Environmental Protection Engineering Co., Ltd. This company will build , manage and operate the plant within 25 years (not including the two-year construction period), and return the plant to the government in 25 years without any compensation. This plant is designed with a 320 ton per day of municipal garbage disposal, and an annual electricity generation capacity of 25 million kW. The total investment for the first phase of construction is RM 6.5 million yuan. The daily treatment capacity is about 160 tons generating a total of 9 million kWh of electricity annually, which, deducting the power expenditure of 2 million kWh per annum for operating the project, all goes for sales. Besides, a compensation of RMB 73.8 yuan per ton of garbage disposal was collected from the government. Minus the running cost and the depreciation of equipment, it has netted a significant annual income and its investment return period is predicted to be 12 years.

Source: the author from the field survey

Box 4 TOT project of Henggang sewerage treatment plant in Longgang District, Shenzhen

　　 Henggang, located in the upstream of Longgang River, is a fast growing town of the Longgang District in the firection of urbanization. At present, its daily sewerage discharge volume has already exceeded 90,000 tons. The construction of Henggang Sewerage Tretament Plant begin in December 2000. The treatment capacity of the first phase of the project was 10,000 tons/day with a total government investment of RMB 129 million. Upon completion, the first pahse of the project passed the inspection and qualification in February 2003.

　　 In order to realize fast return of government investment and activate the cash flow of construction funds, the pattern of TOT was adopted by the Government of Henggang District. The franchise rights for operating the sewerage treatment plant was transferred to Shenzhen Hanyang Investment Holdings Co., Ltd. at RMB 120 million for a period of 20 years. In the contract, it is stipulated that the company must possess at least 30% of the total funds needed. The sewerage disposal toll granted to the company by the government is RMB 1.05 per ton. If the inflation rate exceeds 5%, this charging standard may be adjusted after proper public hearings. Aside from various financial expenses, it is initially forecasted that the annual revenue rate of the company will be 3%. The returned funds will be applied in the construction of new sewerage treatment installations. Therefore, it can be said that this project gas realized win-win for both the enterprise and the government.

Source: Pei, X.F., et al 2003

In China, economic entities other than the public sector include state-owned enterprises, collective enterprises, private enterprises, foreign-funded enterprises, and joint ventures, etc., whose content exceeds the private sector, as frequently mentioned in the global forum. The market economy progressed and its influence by the possession form of a company has decreased. The company progresses ahead of the contractor of the same domain with the following elements: (1) outstanding financial capability； (2) the high capacity of technology, management, and market based operation； (3) a good partner relationship with the government.

(6) Investment organization

The long-term capital market in China is not improved completely yet. The role of investment organization like pension funds and insurance companies is not large. Recently, trust & investment company like China Foreign Economy and Trade Trust & Investment Co., Ltd. is quite activity in urban environmental field. There are lot discussions about the feasibility and concrete model of UEI trust and investment fund. Both public sector and private sector want to learn the know- how and international experience of establishing fund scheme.

(7) International development agencies

International development agencies played important role from 1980`s to 1990`s. There were few UEI facilities in China at that time. The UEI plants aided by international development agencies performed as model project. Japan Bank for International Cooperation (JBIC), World Bank, Asian Development Bank are the major player.

·Japan Bank for International Cooperation

JBIC pledged support for environmental conservation measures as part of sector-specific policies in its Medium-Term Strategy for Overseas Economic Cooperation Operation. Accordingly, JBIC is enhancing and expanding financial provision for the projects that contribute to environmental conservation and improvement in the borrowing countries (environmental projects). Since 1995, JBIC had offered lower interest rates for loans to environmental projects (standard environmental interest rates) than other projects (JBIC 2004). In the former subcategory, water supply and sewerage projects accounted for a large share. The borrowing countries for living environment improvement projects (in the narrow sense) are a diverse set of countries in Asia, Africa and Latin America. Among them, China ranked first with the greatest number of projects (Table 10). Table 10 List of UEI projects for improving the living environment in China (FY1990-FY2001) (¥； million) Project Name Date of L/A Amount of Environmental Project Three Cities Water Supply Project (Tianjin, Hefei, Anshan) 19-Nov-90 8,866 Urban Water Supply Project (Xiamen, Chongqing, Kunming) 4-Oct-91 10,403 Qingdao Development Project (Water Supply and Sewerage) 25-Aug-93 2,513 Xi’an Water Supply Project (1) 25-Aug-93 4,587 Xi’an Water Supply Project (II) 2-Nov-95 2,552 Hohhot Water Supply Project 26-Dec-96 5,446 Beijing No.9 Water Works Expansion Project 26-Dec-96 14,680 Guiyang Water Supply Project 26-Dec-96 5,500 Zhanjiang Water Supply Project 26-Dec-96 5,519 Dalian Water Supply Sistem Rehabilatation Project 12-Sep-97 5,500 Shandong Yantai Water Supply and Water Induced Disaster Management Project 25-Dec-98 6,008 Guangxi Water Supply Project 28-Mar-00 3,641 Kunming Water Supply Project 28-Mar-00 20,903 Chengdu Water Supply Project 28-Mar-00 7,293 Chongqing Water Supply Project 28-Mar-00 6,244 Jiangxi Water Supply Project 28-Mar-00 4,147 Tianjin Wastewater Treatment Project 30-Mar-01 1,480 Dalian water Supply and Wastewater Treatment Project 30-Mar-01 1,591 Changsha Water Supply Project 30-Mar-01 4,850 Yingkou Water Supply Project 30-Mar-01 2,504 Tangshan Water Supply Project 30-Mar-01 2,841 Xi’an Environmental Improvement Project (portion of expanding sewage network) 29-Mar-02 4,577 Anshan Environmental Improvement Project (water supply portion) 29-Mar-02 3,398

Source: JBIC 2004

Figure 6 shows commitments to Environmental Projects in the Last Five Years by JBIC. The major reasons for a significant decline in commitments to environmental projects in fiscal 2001is as follow: The aggregate amount of commitments to China, which accounted for a large portion of the overall commitments to environmental projects in the several years up to fiscal 2000, declined in fiscal 2001. On top of that, initiating support for human resources development projects decreased the relative share of environmental projects.

Figure 6 Commitments to Environmental Projects in the Last Five Years (L/A basis)

Source: JBIC 2004

Future Direction of JBIC for aiding UEI are as follows: (i) the provision of safe water and facilities for improving public health is one of the important factors for a desirable living environment. As access to such goods and services are often inadequate or lacking for the poor, their improvement will also play an important role in poverty reduction. Demand for clean water is rising sharply in many developing countries because their populations are increasingly concentrated in urban areas. Thus increased provision of safe water is indispensable to improve the quality of urban life. These considerations will assign a priority on continued efforts to achieve a better living environment with improved water supply； (ii) in implementing water supply projects, it is important from the point of view of environmental conservation to address non-revenue water (loss of water due to leakage and pilferage), advance recycling and curb demand by saving water use. Since increased water supply will inevitably lead to increased sewage, an approach combining both water supply and sewerage must be further pursued. JBIC played very important role.

·　World Bank

The aid agenda for next decade (from 2006 until 2010) in the sewerage treatment field of China focus on the efficiency improvement, institutional arrangement, and technical aspects. Efficiency means assets management and treatment efficiency, secondary connections and system leakage control, optimizing discharge standards, planning in terms of water quality, and low cost solutions. Institutional arrangement means demand management, regulation, benchmarking, pricing reform like full realization of the cost recovery and planning with a long term perspective. Technical aspect means sludge management and water reuse. The WB experts gave the recommendations to facilitate the private participation in water/wastewater sectors at national governmental level including systems for information sharing and benchmarking (to compare utility costs and performance), strengthening the legal base for PPP projects, for the continuum of PPP options, and regardless of foreign and domestic financing, clarifying roles of various ministries and agencies, and allowing pilot projects for full water and sanitation systems, including distribution networks, at local government level including tariff at full cost recovery based on good financial data, fully corporative service provision, including asset ownership, tariff revenues, enterprise accounting, etc, regulatory functions separated from service provision.

International development fund is still as an attractive fund source to local governments due to its low interest, and long-term loan. But it decreases with economic development, in particular in the coastal areas.

(8) Case study of the maturity periods of bank credit, bonds, and other sources of credit

There is an example of financial structure of Beijing Capital Co., Ltd which is one of the major company of UEI field. Table11 Debt loan of Beijing Capital Co., Ltd

Item Interest Period Domestic bank 5.76% 3-5 years Trust loan 4.5% 3-5 years Overseas bank 3.4% 10years

(Source: Pan, WT. 2004)

The competition of different sources of credit (banks, bonds, on-lending) in UEI investment is not formed yet. How to access the lower interest loan becomes as the key of company development strategy.