China Suddenly Has Trouble Building Things Infrastructure is the key to turning around flagging investment—but that may be trickier than it looks By Nathaniel Taplin Updated Aug. 27, 2018 4:51 a.m. ET Beijing wants to shore up growth without inundating the economy with cheap credit. To see how hard that will be, take a look at China’s roads and railways. China is the 800-pound gorilla of global infrastructure. Its building prowess has permeated popular culture, as in the disaster movie “2012” where China constructs giant ships to help humankind escape rising seas. Recently, however, China’s infrastructure build has all but ground to a halt. Chinese local governments, which account for the bulk of such investment, have to date funded it in two main ways. The most popular method has been to set up so-called local-government financing vehicles, or LGFVs. These off-balance sheet entities mushroomed after the financial crisis, when local governments—which back then were still not allowed to issue their own debt—were called upon to invest billions to stimulate the economy. A worker checks his phone at a construction site wall depicting Beijing’s central business district, Sept. 19, 2017. PHOTO: ANDY WONG/ASSOCIATED PRESS The central government last year started to crack down on such opaque borrowing, alarmed at its vast scale—and potential for corruption. In the past four months, a net $19 billion has flowed out of LGFV bonds. These days Beijing prefers that local governments borrow on-the-books, through the now legal municipal bond market. The problem is that lower-rated and smaller cities are mostly shut out, even though they do most actual capital spending. As a result, investment has kept slowing even though China’s net muni bond issuance in July was three times higher than it was in March. Infrastructure investment excluding power and heat was up just 5.7% in the first seven months of 2018 compared with a year earlier, down from 19% growth in 2017. A state-owned investment company in China’s far west has just punted on its debt, raising the prospect of more LGFV defaults and a much worse selloff in the corporate bond market, further damaging investment. Eventually, all the cash big cities and provinces are raising through muni bonds will start filtering down. Meanwhile, the investment drought will likely worsen, raising pressure on Beijing to ease credit conditions further—making the incipient rally in the yuan hard to sustain. That also means China’s debt-to-GDP ratio, which fell marginally in 2017, could start rising again next year. Odds still remain good that this round of stimulus will be smallish, particularly since the crucial real-estate market is still doing well. But China’s leaders haven’t figured out how to crack down on local governments’ dubious infrastructure spending during good times without severely damaging growth—or how to loosen the reins during bad times without creating lots more bad debt. Unless they can square that circle, it bodes ill for the nation’s long-term prospects.