The fate of Suzhou as a city has long been tied to transportation networks. The completion of the Grand Canal in the Sui Dynasty (581-618) helped transform the city into a commercial and cultural center, and life in Suzhou was defined by the smaller canals that crossed and encircled it.
A 21st-century equivalent of those canals is now taking form under Suzhou’s streets. Over the next five years, the city has budgeted nearly US$15 billion to build and operate an underground metro system. It will will go into service next year, and there are plans to construct four lines by 2020.
Ms Chen, an administrator at Suzhou University, is cautiously optimistic about the project. "I think it is a combination of good and bad," she said. "It will ease citizens’ lives, but I don’t know whether this metro plan is meant for convenience, or if it’s just a politician’s project."
She worries about the impact of construction on daily life, and wonders if the city needs more than a couple of lines.
If such concerns exist in Suzhou’s municipal government, or at the National Development and Reform Commission (NDRC) in Beijing, they are kept well hidden. China is embarking upon an urban railway construction boom that will more than triple the length of its urban train networks over the next five years.
With first-tier cities Beijing, Shanghai and Guangzhou as models, the transportation networks in China’s cities will be transformed, with far-reaching implications for city planners, businesses and especially residents. And in spurring the development of urban centers, subways and other forms of urban rail, including light and elevated rail, will encourage an urbanization trend that will spur demand for raw materials and heavy industry for years to come.
Out of the shadows
For all the changes that will be sparked by the development of urban rail, it has long been overshadowed by national rail and projects such as the high-speed lines that promise to cut travel times between Beijing and Shanghai to five hours or less. A look at last year’s annual report for China South Locomotive and Rolling Stock (CSR; 601766.SH, 1766.HK), one of two firms producing rolling stock for China’s railways, explains why: Rapid transit vehicles made up just 9.6% of the company’s business in 2009, compared with 30.9% for locomotives. However, the rapid transit figure represented a jump of more than 70% from the previous year.
"In 2009 the multiple units and the rapid transit vehicles’ percentages were somewhat smaller, because they haven’t deployed much, but that percentage will grow very fast over the next few years," said Jack Xu, an analyst at Sinopac Securities in Shanghai. Multiple units – self-propelled train units, frequently powered by electricity – are commonly used in rapid transit.
The NDRC threw metros into high gear in mid-May with the announcement that spending on subway expansions would increase over five years to more than US$146 billion from a previously announced US$88 billion. This would take China’s total subway network to 3,000 kilometers, up from 940 km at present. At present, Beijing has given permission to 25 cities – including Suzhou – to build metro systems.
Even this newly strengthened backing won’t satisfy national demand. Far more municipal governments than have received approval are keen to develop subways, and Beijing has been careful to manage growth. Cities must apply to the central government to build metro systems, and a green light is not guaranteed.
"Since urban railways require tremendous investment, cities need to fulfill some requirements set by the central government before building," said Wang Mengshu, a rail expert at the Chinese Academy of Engineering. Requirements include a minimum population of two million, a "reasonable" rail network plan, GDP above US$14.6 billion, tax income of more than US$14.6 million and the use of at least 70% domestically developed technology within the metro system.
Ridership is also a consideration: Wuxi, in Jiangsu province, had long planned a metro system, but its forecasts did not meet State Council-set minimum hourly passenger rates. Approval was eventually granted, and the city began construction on the Wuxi Metro Line 1 in November 2009. Dongguan also had its metro plans delayed after its early feasibility studies were rejected by the central government. Having finally received approval, the Guangdong city expects to complete its first subway line in 2015.
Manmohan Parkash, principal transport specialist at the Asian Development Bank, said that there are typically two kinds of investment in developing metro systems. The first comes from large cities – with roads snarled by traffic – that hope to integrate urban rail into an existing transport infrastructure.
"The rapid urbanization that has taken place in the country has left these cities largely unplanned. The motorization rate has really been increasing significantly," said Parkash. He raises the example of Xi’an, where city walls present a monumental challenge to efficient traffic flow.
The second form of investment comes from cities that are introducing metro systems as part of a larger plan to expand and develop new city centers. Implementing this kind of urban rail is helped by the relative ease of acquiring undeveloped land and of planning interchanges with other modes of transport such as roads.
Government diktat
Both forms of investment, like almost all investment in rail in China, are directed by government, both central and local. Most of the money comes from local governments’ tax revenue, according to Wang at the Chinese Academy of Engineering, which helps to explain Beijing’s minimum tax income requirement. Unlike in other countries, infrastructure bonds and municipal bonds – both forms of financing that remain relatively immature in China – are not used.
This is in part, Wang says, because such projects are considered a form of social welfare, but also because the ventures simply aren’t designed to make money. The low fares on China’s metros reflect heavy government subsidies.
"Municipalities are subsidizing transportation … there’s no way they can get their capital investment back," said Yam Kong, the director and general manager of construction firm HCCG (China), who has consulted on projects for firms including China Railway Construction (601186.SH, 1186.HK). "The best they can achieve is to balance their running costs with the fare box."
Cities may be running subways at a loss, but the likes of CSR and its counterpart China North Locomotive (CNR) are certainly benefiting from state-directed rapid transit largesse. Many other companies also hold out hopes for a share of the investment money – but for foreign players, restrictions stand in the way.
The precise restrictions are laid out in China’s Guidance Catalogue for Foreign Investment, which lists rail as an area in which foreign investment is encouraged, rather than permitted, restricted or prohibited. However, urban underground railways – like national high-speed lines – allow foreign investment only if there is a controlling Chinese interest. Foreign investors must therefore be content with playing a minority role in a sector that Beijing considers strategic. This is especially true in construction of the rail networks themselves.
"There are issues of expropriation and nationalization of land," said Stuart Valentine, a partner at Mallesons Stephen Jaques in Hong Kong. "And although that’s been done with private projects, such as roads in China, it becomes a very difficult, sensitive issue. It’s the sort of thing that’s seen as better for government-owned corporations to do than private ones."
Less difficult – if still subject to investment restrictions – are opportunities in supplying equipment such as rail carriages and signaling equipment. Midas Holdings (5EN.SIN), a manufacturer of aluminum alloy extrusion parts for the passenger rail sector is one foreign firm with involvement in China’s metros. In 2006, it established a joint venture with CSR Nanjing Puzhen Rolling Stock Works (NPRT) – a subsidiary of CSR – and a state-owned capital corporation to build trains, bogies and parts. Nanjing SR Puzhen Rail Transport has since been awarded projects including, in April, a US$69.4 million contract to provide train sets for Suzhou’s Line 1.
"We are optimistic that our aluminum alloy division will be a direct beneficiary of these massive government initiatives. We are also positive on the outlook for our associate, NPRT," Midas told CHINA ECONOMIC REVIEW in a written response to questions.
The outlook also appears positive for other foreign transport giants like Alstom (ALO.Euronext), Bombardier (BBD.A.TSX, BBD.B.TSX), Siemens (SI.NYSE, SIE.FWB) and GE (GE.NYSE), which have all come to China in the hope of cashing in on the metro spending spree. Alstom Transport, one of the most active foreign firms in China’s rail industry, produces signaling equipment, components and rolling stock through five separate joint ventures. Currently, the company’s metro cars operate in Beijing, Shanghai and Nanjing.
Risk factors
While the profits may be tempting, there are risks for foreign firms seeking involvement. As in many high-tech industries, intellectual property (IP) and technology transfer are major issues. Earlier this year, Yoshiyuki Kasai, the chairman of Central Japan Railway (JR Central; 9022.TYO) hit out at China’s high-speed rail industry for IP theft, which he cited as the reason JR Central has avoided bidding on projects in China. Subways may lack the glamor of high-speed rail technology, but IP protection remains a problem.
"It’s something that’s very, very sensitive to manufacturers of these sorts of equipment, whether they’re European or North American," said Valentine at Mallesons. "There’s big bucks involved … and China’s reputation in terms of protecting intellectual property is improving, but it’s still not good."
Another area of contention for foreign firms – and separate from investment restrictions – are rules on government procurement issued by the Ministry of Science and Technology (MoST). Tied into concerns over IP, procurement rules effectively barred overseas companies from some rail projects. A notice on the MoST’s website in April suggested a softening of the rules to allow foreign bids on certain government contracts, but some observers are skeptical.
"The legislation that’s been issued is certainly worrying," said Valentine. "It’s not clear how exactly that’s going to be implemented, because it does not seem consistent with China’s commitments under the WTO. But having said that, China did not sign the government procurement protocol to the WTO."
Other opportunities for participation remain limited, and there are few exceptions. Hong Kong’s MTR Corporation (0066.HK) is the notable outlier: In 2004, the company signed an agreement for a public-private partnership (PPP) with Beijing Infrastructure Investment and Beijing Capital Group to invest in, build and operate the Beijing Metro’s Line 4. MTR is also investing about US$880 million to build the second phase of Shenzhen Metro’s Line 2. So far, however, there are few signs of other companies following in MTR’s tracks.
The property effect
The impact of new urban rail will be felt by much more than the firms involved in developing it: Property developers are also major beneficiaries as metro lines encourage the growth of formerly remote suburbs. This is true even though without direct involvement in the metro planning process, developers may face some uncertainty in timing their investments to maximize metro-related benefits.
"[In Shanghai], the master plan has been in place for some time and that gives some certainty for developers in terms of assessing the value of and the development potential of land that they might acquire through the auction process," said Michael Klibaner, head of research for China at property consultancy Jones Lang LaSalle (JLL).
The overall effect on new development can be significant. A recent JLL report highlights the example of Sanlin, an area south of the site of the Shanghai World Expo in Pudong, which benefited from more than US$950 million in development projects starting in 2007 as it became accessible by Shanghai Metro Lines 6 and 8. New apartments in what was once a remote and undesirable area now sell for above-average prices.
In Suzhou, listings for apartments in a recently opened residential development called Jinfeng International trumpet the building’s location near an upcoming subway stop; one real estate website includes Jinfeng International on a list of properties with investment values expected to increase as a result of the new metro line. And it’s not just residential property: Commercial and retail space will feel the effects, too.
"They are all impacted, and they’re all impacted directly," said Klibaner.
By increasing accessibility of more urban and suburban areas, metro development is fundamentally encouraging a trend toward urbanization that consultancy McKinsey expects will lead to an urban population in China of one billion by 2030. This is not a new trend, but the rapidity of the process has prompted Beijing to increase not just its spending on metro rail, but on urban infrastructure overall.
Boon for commodities
In Mid-May, the Ministry of Housing and Urban-Rural Development (MHURD) said that China will invest up to US$1 trillion in urban infrastructure, including rail, other transportation and public facilities, as part of the 12th Five-Year Plan. Together with private fixed-asset investment, the government money will drive continued demand for raw materials such as steel and cement; mining giant Rio Tinto (RTP.NYSE, RIO.LSE, RIO.ASX) has forecast that urbanization and industrialization will double China’s steel demand by 2020.
As more metro systems are implemented, they will contribute a larger share of this demand, and will continue to spur changes to and investment in China’s cities. In that sense, metro systems could have a relatively larger economic effect than the high-speed lines that the Ministry of Railways said account for nearly 60% of investment in new rail projects. (Metro systems are not included in national railway investment figures.)
Playing the system
There are legitimate concerns regarding the impact of all this investment; Chen, the Suzhou University administrator, is not alone in finding metro construction disruptive, or in fearing that metros are, for many cities, simply vanity projects.
Then there are situations, as in Guangzhou, where Wang at the Chinese Academy of Engineers says the local government, lacking central government approval for an urban metro system, built one in a rural area. "Once there is a metro around, developers will usually come and invest in real estate projects near it," said Wang.
This does little to inspire faith in Beijing’s ability to control investment in new metro systems across the country. By feeding government coffers through land sales to developers, such loopholes also have the potential to encourage governments to develop systems for profit rather than public utility – and to contribute to overcapacity in property.
But Parkash at the ADB says concerns may be overblown. "I have seen the Chinese system at the level of these provincial development reform commissions or planning commissions, and they tend to make informed choices. They do ask sensible questions," he said.
"From the political side, yes, it always has the glamor … but China does have the systems in place to look through feasibility studies objectively to see whether [metros] are a viable option," Parkash said.
For Suzhou, the central and local governments have spoken: A metro system is being built, and the city will be changed. As more cities follow Suzhou into developing urban rail, such changes will inevitably spread across the country. The challenge now for China – and the focus of next month’s special report – will be how to ensure those changes are supported by the country’s heavy industry and already-strained logistical networks.
