Cablegate: Jiangsu Pursues Investment-Fueled Growth Despite Central

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FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 8362
INFO RUEHBJ/AMEMBASSY BEIJING 3147
RUEHCN/AMCONSUL CHENGDU 2267
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RHMFISS/DEPT OF ENERGY WASHINGTON DC
RUEHC/DEPT OF LABOR WASHINGTON DC
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RUEATRS/DEPT OF TREASURY WASHINGTON DC
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RUEHML/AMEMBASSY MANILA 0123
RHEHAAA/NSC WASHINGTON DC
RUEHUL/AMEMBASSY SEOUL 0595
RUEHGH/AMCONSUL SHANGHAI 9019
RUEHSH/AMCONSUL SHENYANG 2258
RUEHIN/AIT TAIPEI 2057
RUEHKO/AMEMBASSY TOKYO 0806

UNCLAS SECTION 01 OF 05 SHANGHAI 000444

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DEPT FOR EAP/CM
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STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/KATZ/MAIN
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E.O. 12958: N/A
TAGS: ECON EFIN EINV PGOV PREL CH
SUBJECT: JIANGSU PURSUES INVESTMENT-FUELED GROWTH DESPITE CENTRAL
CONCERNS ABOUT FUTURE RISKS

1. (SBU) Summary: With little regard for Central Government
concerns about investment bubbles or overcapacity, Jiangsu --
East China's largest province -- is tapping a locally funded
government stimulus program and lending to large firms to rack
up impressive growth figures even as net exports remain a drag.
This lopsided dependence on investment means that only limited
progress has been made on sparking domestic consumption as a
major economic driver. Looking forward, the current investment
binge will be difficult to wind down before a rise in industrial
overcapacity and inefficient infrastructure presents new
problems, including more nonperforming loans. End Summary.

==========
Background
==========

2. (SBU) EconOff traveled to Nanjing, the capital of Jiangsu
Province, October 22-23, 2009, to meet with local academics,
government think-tank researchers, and businesspersons to gauge
local economic conditions. As described below, a picture
emerged of province-wide economic growth, but with serious
concerns about the long-term sustainability of this growth.
Note that several contacts raised questions about the accuracy
and consistency of Jiangsu's economic data, which are covered in
septel.

=============================================
Exports are Slowing, Leaving Investment . . .
=============================================

3. (SBU) Overall, the province officially grew 11.7 percent in
January-September, according to statistics released by the
Jiangsu Bureau of Statistics on October 23, a full 5 percentage
points higher than the 7.7 percent national growth recorded in
the same period. With exports still a net drag on economic
growth -- down 22.7 percent in the first three quarters of 2009
compared with the same period last year -- Jiangsu is relying on
investment and consumption. Hu Guoliang, deputy director of the
Economic Research Institute of the Jiangsu Academy of Social
Sciences (JSASS), said that in the first half of the year,
investment accounted for 54.5 percent of GDP growth, consumption
58.9 percent, and net exports -13.4 percent. (Note: In China's
GDP accounting, consumption includes government spending. End
note.)

4. (SBU) Wu Min, chief economist of the Nanjing Municipal
Development and Reform Commission (Nanjing DRC) said the Nanjing
municipal government had set aside RMB60 billion for public
investment stimulus spending, which was intended to draw in
another RMB250 billion in matching funding from enterprises and
banks. (Note: Approximately US$8.8 billion and US$36.6
billion, respectively. End note.) She noted that Nanjing would
not be able to fund large projects such as its subway system
through tax revenues alone, and therefore has four publicly
sponsored investment platforms through which it can borrow
money, including two major ones called the Nanjing
Communications Construction Investment Control Stock (Group)
Co., Ltd. and the Nanjing Urban Construction Investment Holding
(Group) Co., Ltd. Wu said investment by government and industry
was particularly instrumental to the
faster-than-provincial-average growth in northern Jiangsu.

5. (SBU) In addition to government-directed investment, some
interlocutors pointed to market factors driving investment into
Jiangsu's manufacturing base. Prof. Zhao Shudong, head of

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Nanjing University's International Economics Department, noted
Jiangsu continues to attract the greatest foreign direct
investment (FDI) of China's provinces. (Note: In 2008, Jiangsu
took in over US$25 billion in FDI, accounting for over 23
percent of China's total. End note.) Several contacts pointed
to companies consolidating their production in Jiangsu, to take
advantage of lower costs. JSASS researcher Hu pointed out
Jiangsu is similar to Shanghai in terms of public order and
labor quality, but that costs can be 60 percent lower in
Jiangsu, due to lower rents and lower labor costs -- especially
lower salaries for managers. In fact, many of the contacts saw
this as a natural process of manufacturing capacity leaving
Shanghai and flowing into Jiangsu and elsewhere in the Yangtze
River Delta. (Note: See septel for more on how this process
might explain, in part, Jiangsu's higher GDP growth. End note.)

6. (SBU) Jiangsu government officials and firm managers are
especially focused on investing in new energy technologies in
order to maintain Jiangsu's lead in this sector. This is an
example of Jiangsu's strong science and technology research
base, said Zhao, which has pushed Jiangsu up the value-added
production ladder and allowed it to better survive the crisis
than Guangdong, where factories are more concentrated on
low-value-added processing. As an example, he pointed out
government and corporate leaders have come together to create a
large-scale wind farm in Nantong that will eventually produce
more power than the Three Gorges Dam. Sheng Li, the deputy
general manager of Everbright Bank's Nanjing Branch, which has
operations through Jiangsu, said she sees strong competitiveness
in Jiangsu's solar and wind power production, as well as
electronics such as flat-screen display panels. JSASS's Hu said
Jiangsu is emphasizing development of ocean shipping,
biopharmaceuticals, logistics, agricultural biotechnology, and
clean energy.

==========================================
. . . and Consumption to Drive the Economy
==========================================

7. (SBU) Jiangsu's consumption contribution of 58.9 percent to
provincial GDP growth in the first half is one of the highest
levels reached in the past 20 years. While part of this is
government consumption, the Nanjing interlocutors also pointed
to rising consumption by private households -- in particular,
purchases of real estate. Chen Xinghan, chair of the board of
Chixia Development and president of the Jiangsu Real Estate
Association, said she was surprised by the demand for
residential housing spurred by the Central Government's
incentives introduced at the end of 2008, which included greater
leniency for second home purchases, higher mortgage underwriting
by banks, and adjustment of land prices by local governments.
Chen said more than 50 percent of domestic consumption in
Jiangsu is related to real estate, including 35 percent for new
housing and 10 percent for existing housing. Altogether, she
said, 56 industries depend on real estate for growth. (Note:
The Nanjing Municipal Statistical Bureau reported sales volume
for residential real estate was up 111.8 percent in the first
three quarters. End note.)

8. (SBU) Some other sectors are also showing high growth in
retail sales, say the contacts. Nanjing DRC's Wu pointed out
sales of private vehicles in Nanjing was up over 30 percent in
the first three quarters. Sang Naiquan, an economist at Nanjing
University of Finance and Economics (NUFE), said Jiangsu's
export-dependent electronics industries were taking advantage of

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the Central Government's tax breaks under the "Household
Electronics to the Countryside" program to sell into rural
markets. (Note: Household disposable income grew 10.7 percent
in urban areas and 10.1 percent for rural ones in the first
three quarters, according to Jiangsu official data. End note.)

============================================= ===
Concern That State Interference is Growing . . .
============================================= ===

9. (SBU) Despite the rosy picture painted on GDP growth,
interlocutors expressed some concerns the state sector was
becoming too dominant in Jiangsu's growth pattern. Nanjing
University's Zhao said state-owned enterprises are not as
efficient at using investments. He cited U.S. economist Paul
Krugman, saying that sometimes this money is used to buy
worthless garbage. This was part of the trend of "government
[involvement in the economy] increasing, private [economic
activity] decreasing" (guojin, mintui), said Zhao. At the same
time, Zhao warned against over generalizing, noting, for
instance, that the trend of SOEs taking over private firms
through mergers and acquisitions is only temporary.

10. (SBU) Everbright's Sheng agreed large companies, including
many SOEs, are gaining ground, but did not see the trend
subsiding. China's industry is undergoing consolidation, she
said, and in 2-3 years, the province's large firms will have an
even greater market share, giving them market power. She said
it remains hard to channel funds to small- and medium-size
enterprises (SMEs), despite Central Government policies, since
SME loans have much higher verification and monitoring costs.
SMEs have dropped as a share of Everbright Nanjing's loan book,
because SME lending has held steady while lending to large firms
has grown sharply.

11. (SBU) However, contacts also pointed out that SOEs form
part of Jiangsu's competitiveness. Everbright's Sheng said
Jiangsu has a greater ability to resist economic risk, implying
SOEs can draw on government support in hard times. In addition,
the government is able to implement economic policy more
effectively through SOEs through better control over SOE
investment, she said. Nanjing University economics professor
Shi Xiancheng noted the academic literature is mixed on whether
SOEs can be efficient producers, while colleague Chen Baomin
said Jiangsu's greater government involvement in the economy
leads to better public goods than in Zhejiang.

=============================================
. . . Which Could Lead to Overinvestment . . .
=============================================

12. (SBU) With market signals for investment distorted by the
large economic stimulus flows, investment in Jiangsu is less
likely to scale back in the face of emerging signs of
overcapacity in some industries, agreed all the Nanjing
interlocutors. Many raised the real estate industry in this
context. NUFE's Sang said, for instance, the Central Government
wants to control the real estate market, but local governments
are eager for some inflation in this market, as it supports
their income from land sales. Local governments are following
this course even though it reduces the buying power of ordinary
households and thereby increases social tensions, said Sang.
Chixia's Chen said that the rapid increases in real estate
prices are propelled in part by the government's loose monetary
policy, which has channeled funding to businesses that have

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nowhere to invest the money but in real estate and the stock
market. Chen also warned that local governments could become
too reliant on the real estate sector, although she was more
sanguine that housing purchase incentives would be allowed to
expire at the end of 2009, helping dampen demand in 2010.

13. (SBU) The Nanjing contacts said that while overinvestment
could lead to deflation in final goods prices, it could also
lead to inflation in key inputs and upstream commodities.
NUFE's Sang said the government must chose the proper balance
between stimulus-led economic growth and managing inflation
expectations. He warned that the highest inflation ordinary
households can support is 20 percent -- which is the high point
reached during the period of economic reforms. Inflation causes
instability because it essentially takes from poor savers and
gives to rich owners of capital. Nanjing DRC's Wu Min also put
inflation at the top of her list of concerns in the coming year.

=========================================
. . . And Future Financial System Strains
=========================================

14. (SBU) Some contacts offered warnings about problems with
record bank lending in China this year, which has been directed
by the government to support its stimulus program. (Note: As
of September, bank lending in China had risen 149 percent over
the same period the previous year. End note.)
Nanjing University's Zhao said bluntly, "China has paid a large
price for the financial crisis, and not all the impacts have yet
emerged." He worried that the financial cost could become more
pronounced as China enters into a period of rapid population
aging and loses some economic growth momentum.

15. (SBU) NUFE's Sang said the short-term risk with the lending
surge is that liquidity flowed into speculation, but that the
real problem is medium- and long-term loans. While the National
Development and Reform Commission (NDRC) has dispatched people
to monitor the projects, said Sang, local government management
of projects will play a key role in generating an appropriate
return on investment. Everbright's Sheng said her bank has
already exceeded the China Banking Regulatory Commission's
guideline of setting aside 150 percent of nonperforming loans as
a provision for possible future losses -- Everbright Nanjing is
currently provisioning at 190 percent.

============================================= ========
But Jiangsu Still Hoping to "Win" the Investment Race
============================================= ========

16. (SBU) Despite these potential problems, one of the most
frequently heard comments was that Jiangsu should continue
aggressively to develop its industries -- even those among
industries declared by the NDRC to have overcapacity -- because
increased market share would position it better for the coming
industry shakeouts. (Note: On October 15, the NDRC named
steel, cement, plate glass, coal-chemicals, polycrystalline
silicon, and windpower equipment as the focus of its crackdown
on overcapacity industries. It also warned of obvious
overcapacity in aluminum, shipbuilding, and soybean pressing
industries. End note.)

17. (SBU) Everbright's Sheng said that Jiangsu wind and solar
power equipment companies were planning to increase their
capacity to widen their current low-cost advantage; already,
China's top eight solar panel companies are based in Jiangsu,

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she noted. JSASS's Hu said that the current overcapacity in
wind and solar power results from a demand shortfall, since
final goods prices remain high. Increased production scale will
bring down prices, and stimulate demand, he said. Nanjing DRC's
Wu said that wind and solar power equipment manufacturing
capacity on which investment has already started should be
completed. She pointed to a possible motivation for local
governments to continue investing in the sector, saying, "It is
impossible to get rid of projects that are already in place."

18. (SBU) Underlying many of these statements was a sense that
Jiangsu -- and in particular its capital, Nanjing -- should not
play second fiddle in the region, and should be left alone by
the Central Government to develop the local economy. JSASS's Hu
said that Shanghai wants to be the "dragonhead" in the Yangtze
River Delta, with Jiangsu and Zhejiang as the wings. However,
Jiangsu's economy is bigger than Shanghai's, so why should it
take the supporting role? Hu and NUFE's Sang noted that Nanjing
Municipality serves as a natural center for an economic region
that stretches into Anhui.

=======
Comment
=======

19. (SBU) Despite the Central Government this fall launching
efforts to reel back local government investment, the lack of
incentive in Jiangsu to comply is obvious. All signs point to
officials across the province vigorously protecting local growth
sources, including both real estate as well as industries with
officially designated overcapacity.

20. (SBU) At the same time, aside from the possible bubble
reinflating in the residential real estate sector, there is
little evidence that Jiangsu officials are encouraging private
consumption. In fact, disposable household income growth
continues to lag provincial GDP growth, with the result that
household consumption -- if measured separately from government
consumption, with which it is lumped together in the Chinese GDP
accounting system -- is most likely falling as an overall share.
CAMP

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