Zhihan Yu

Bond Market Infrastructural Investment and Economic Growth

Evidence from China

  • Faculty Advisor

    Robert Coen

Published On

May 2015

Originally Published

NURJ Online 2014-15


As stated in the 1994 World Bank Report, infrastructural development is essential to a nation’s economic well being, as it offers many intangible positive externalities. This type of long-term finance can prepare an economy for sustained growth in the future. Since the global financial crisis in 2008, professionals within China have all simultaneously observed the tremendous growth in the infrastructure sector of China’s economy. It is no coincidence that the annual GDP in the period skyrocketed at a rate of 9.6%. Although this observation may be true on a national level, the author sought to prove that this correlation still existed on a municipal level. Using open data the author collected during his internship at China’s biggest security firm, HongYuan Securities, the author employs statistical tests to conclude that the correlation between economic growth and infrastructure investment exists on municipal levels. Also, the author observes the advantages and pitfalls of the Chinese bond market (especially for infrastructural investment) through his personal experience as an intern in the firm.


Since the turn of the century, China has ascended from the sixth to the second largest economy in the world. Since 2000, China’s gross domestic product (GDP) has grown at an annual average of 10.02%. Many economists came to conclude that China was able to enjoy this rapid economic growth because of its embracement of the market system and participation in world trade, together with its inherent economy of scale. If any one of these three components were absent, China’s economic ascension would have been compromised.

In retrospect, these three factors were the main determinants of this country’s economic dynamism over the past three decades. Indeed, China has experienced consecutive years of trade surpluses since 1995. In fact, from 2004 to 2009, China’s annual trade surplus has increased 10 times. As a result, China earned itself the title “Factory of the World.” The large pool of working hands accommodated the role in the global division of labor and ensured that China would reap the benefits of an economy of scale. Perhaps the most important factor among them was the market-oriented reform initiated, which considerably improved efficiency of resource allocation in the economy. In prospective, there appears a new and lasting driver for China’s economic expansion—it is a vast urbanization unfolding in China, unprecedented in both size and scale and will bring 300-400 million rural people to cities in the next two decades.

As long as competitive spirits begin coordinating economic activities, the financial market develops and becomes a conduit to channel capital toward the vast fund demand for a full-fledged urbanization. Surprisingly enough, China’s infrastructural investment, a main component of domestic aggregate demand since the global financial crisis in 2008, has phenomenally surpassed that in most industrial countries and accelerated city development across the nation. Although many analyzed this new phenomenon from various respects, little has been done to study its linkage with progress of the financial market. As such, the intention of this paper is to fill this void. First of all, this paper will discuss the institutional environment and China’s city development in this century. Then it will explore the nexus between direct finance and city development in China. Finally, it will provide empirical evidence to test for whether or not the financial market has a significant effect on city development.

I. Institutional Background: Infrastructure and Investment

Concepts frequently used

Before continuing further, I would like to clarify a few concepts frequently used. First, how is “development,” especially “city development” defined? Heated debates between economists in the past years have not resulted in one universal definition on economic development. The consensus is that economic development “improve[s] the economic well being of a community through efforts that entail job creation, job retention, tax base enhancements and advancements in quality of life.” The term “city development,” therefore, refers to the improvements in the “economic well being” of city residents. Since an ultimate goal of city development is for authorities to provide tax-based enhancements to its denizens and improve overall quality of life, it is vital for the local government to deliver infrastructural services. Indeed, looking across the world, developed cities such as New York, Tokyo, Hong Kong, and London all have the leading infrastructural basis that supports the bustling of city life.

Then what is infrastructural development? I will use the concept of economic infrastructures given by the World Bank (1994), which contains “public utilities” such as power, telecommunication, sewage treatment, water supply, etc.; “public works” such as roads, highways, and other major works for irrigation; and “other transport sectors” such as airports, railways, subway systems, etc. Furthermore, there is the additional concept of social infrastructure. In contrast to conventional infrastructure, social infrastructure refers not to physical buildings but to abstract systems such as healthcare, education, and social security. This paper, however, will not discuss social infrastructures, as development in this area is relatively intangible and difficult to quantify.

Why is infrastructure development important?

As indicated earlier, infrastructure does not only include the physical structures. Regardless of whether the structure classifies as a “public utility,” “public work,” or part of the “transportation factor,” they all bring forth externalities. According to Rémy Prud’homme (2004), each infrastructure corresponds to its relating services. Table 1 depicts the implications of infrastructural development.

Table 1. Infrastructure and Related Services.
Source: Rémy Prud’homme, “Infrastructure and Development”

In fact, developing infrastructure provides a means to increase productivity and also reduce production costs. The 1994 World Development Report states that “a 1 percent increase in the stock of infrastructure is associated with a 1 percent increase in gross domestic product (GDP).” It is the result of these services that the quality of labor resources are strengthened, ultimately leading to higher productivities.

Likewise, the services resulting from infrastructures impact development on the enterprise level. When an enterprise enjoys the services brought forth by a newly built infrastructure, it experiences something similar to a technological advancement. The newly introduced service (such as power or transportation) lowers the input costs of some enterprises, leading to a larger market size, and ultimately resulting in economies of scale. This enlargement in market size refers not just to the goods market, but also to the labor market. Large cities are said to have hicigher productivity because with a larger number of jobs and greater number of labor forces, the probability of finding the correct match between employer and employee is greater compared to that of smaller cities. When infrastructure comes into view, its services help bridge the labor demand with labor supply.

Finally, the general public can benefit from infrastructural improvement when its related services enhance quality of life for households. Simple improvements in infrastructure can make a disproportionately large impact on a city’s way of life. Assume a hypothetical isolated city. The only way for the people of the city to leave is by trekking 50 miles on dirt paths. Therefore, it can be easily imagined that the local sectorial economy is likely to have monopolistic characterizations due to geographical isolation. When the government decides to invest in a road that can pass cars, the improvement for this city is not fully reflected in the rise in GDP due to constructing the road, assuming citeras parabus conditions. Opening up to other cities enables individual households to obtain goods from outside the city. The monopoly and monopsonies due to geographic isolation falls apart and the associated deadweight loss is minimized. If a bumpy road were replaced by a highway, these effects would be greater amplified.

In conclusion, infrastructural development can lead to greater improvements in living quality at the household level. These improvements can decrease inefficiency within a confined economy.

II. Constitutional Background: Demand for the Bond Market

One of the most important factors driving this fever of infrastructural investment lies within the Chinese financial sector. Currently, the financial industry is heavily dominated by financial institutions, especially big state banks. Therefore, a mismatch between long-term fund users (i.e. infrastructure investors) and short-term fund suppliers (i.e. commercial banks) is one of several problems in the Chinese financial market. As such, it is highly necessary to deepen the security market to channel funds directly to long-term users. On one hand, enlarged equity market enables firms to tap external funds to strengthen their capitals. On the other, the rise of bond market helps long-term projects to secure long-term financing sources. The capital market itself, in fact, provides companies with greater flexibility in mobilizing financial sources and facilitating development of infrastructural investments in China.

During the Soviet-styled command economy era, development in Chinese city infrastructure was rather stagnant. Since the economic reforms, especially starting in the 1990s, Chinese infrastructural development has accelerated to a new level. There are two features of China’s infrastructure investment. First, total investment in infrastructure increases on a vast scale. For example, the total investment in China’s infrastructure in 1978 is 15.23 billion RMB, and it climbed to 1.147 trillion RMB in 2012, multiplying by a little over 75 times. The growth in infrastructural investment during this period far exceeds the period’s GDP growth. Second, China’s infrastructure development decision is decentralized, giving power to local municipal governments, especially the city authorities. Prior to 1978, the central Chinese government planned and controlled infrastructural investments from its judgment. Since the 1990s, local governments have been granted more autonomy to engage in infrastructural investment to improve both the economic and social investment environment, resulting in an unprecedentedly large scale of city-relating investment, such as roads, subways, and electricity.

In order to finance huge infrastructure investment launched by hundreds of city governments, bond issuance is not only a viable option, but also an irrevocable means to accommodate fund demand. Issuing bonds within China is a complicated process. This paper will briefly overview the process through which HongYuan Securities issues its bonds, as there are many nuances for different companies against the Chinese government backdrop. HongYuan Securities has very strong ties to the central Chinese government, as it is a subsidiary and the only listed firm of the China Investment Company. Over the past five years, HongYuan Securities continually ranked among top ten as the nation’s largest bond underwriters. During this period, HongYuan Securities has received many merits from both media and governmental departments, such as “China’s Best Risk Management Securities Company” and “Exemplar Growth of Chinese Security Company.”

The following figure depicts the general process of how HongYuan Securities issues bonds.

Figure 1. Bond Issue Flowing Chart

As it is depicted in Figure 1, there are five main steps to be completed before HongYuan Securities can issue a bond. In STEP 1, HongYuan Securities needs to work with the issuer to decide upon the total amount, term structure, and the uses of the investment. Then in STEP 2, HongYuan Securities must prepare legal documents needed for the deal. STEP 3 is HongYuan Securities files its reports to the National Development and Reform Commission of China (NDRC) to have them reviewed. After approval at the NDRC, this process proceeds to STEP 4, where HongYuan Securities and the issuer negotiate interest rates of the bond depending on the market and issues the bond. The final step is when the main underwriter, HongYuan Securities, coordinate interest rate payment and principle repayment.

On the surface, this process seems effective and efficient. Yet, what should be noted is the Chinese cultural aspect being woven into the system. First, there exists an implicit government guarantee. Most of the companies that have the ability to issue bonds with HongYuan Securities are among the top companies in China. More importantly, a large majority of these companies are state-owned. A local government may not meet the standards to issue debt from HongYuan, yet its subordinating company can. Hence, when such companies issue bonds, then it is assumed that the local government (ensured by the central government) will bail out should there be a default. Second, because of the sheer number of companies issuing debts in China, not every single bond will be investigated thoroughly. Some companies and brokers will repackage the company—namely reevaluating the value of land the company owns—to create a façade of its financial accounts when it is presented to the NDRC.

Nonetheless, the Chinese bond market for infrastructural investment still holds great potential for future investments and conceivable for China’s imminent development.


The data that are used in the following sections are publically available information compiled during my internship at HongYuan.

All the bonds analyzed in this section have HongYuan Securities as either the main underwriter, co-underwriter, or distributor. In a total of 4875 numbers of bonds that HongYuan participated in, 1472 (30.19%) bonds are specifically labeled as “city investment,” totaling up to 1815.94 billion RMB. These bonds are used to directly finance infrastructural development such as bridges, shopping complexes, and other hardware infrastructure to improve city life and the city’s economic environment.

Figure 2. Distribution of Bond Risk and Issuer Risk of HongYuan Security Bonds.
Source: Wind资讯,

A main function of HongYuan Securities is to help firms to package their bonds to make it more appealing to investors. Figure 2 displays the effects of HongYuan Securities’ role in decreasing bond risk. The trends show that even though most of the issuer risks are centered at AA, half of all the bonds issued have a bond risk of AAA. This disproportionation provides a window to one of the biggest problems in the Chinese financial market, as described earlier as the implicit government guarantee. Another noteworthy point is that there is a significant number of bonds that lack a risk grading. The descriptions of many of these bonds all have ties to the infamous 5-Year-Plans. Since this Plan is conceived by the central government, many say that the risk grading is unnecessary. Overall, this graph is congruent with the notion that bonds with lower risks are favored. This also shows HongYuan Securities’ ability to repackage and present bonds in order to achieve lower levels of risk.

Source: Wind资讯,

Figure 3. Correlation between Bond Risk, Bond Length, and Interest Rates.

Figure 3 investigates the risk structure of the bonds studied, depicting the relationship between interest rates and bond duration when the risk structure is held constant. This series of graphs shows that longer bond length and higher risk rating leads to lower interest rates. The total monetary value of bonds issued for AAA bonds tallies up to 2689.223 billion RMB, with an average bond length of 6.62 years and average interest rate of 5.18%. The averages for other risk levels are presented in Table 2.

Table 2. Risk Structure and Average Bond Length, Average Interest Rate

Source: Wind资讯,

Figure 4. Total Investment and City Scale.

Figure 4 illustrates that the total investment in cities with higher populations is much greater than that of smaller cities. This is an important indicator of city development. When a municipal government invests to improve infrastructure, it increases the living qualities of those in the city. Hence mega-cities with populations over 30 million should enjoy more infrastructural investments to achieve a similar improvement in life quality compared to that of small cities.

More importantly, Figure 4 also illustrates a positive relationship between annual nominal GDP and total investment. The pie on the right splits GDP into the five categories in terms of nominal values described in the Appendix, and the total investment amount in terms of monetary value is plotted in the bar graph. Cities with a stronger economic foundation—larger GDP—will have a greater number of investments. Based on Figure 3, it is clear that larger cities with higher GDP have greater numbers of infrastructural investments from HongYuan Securities.

Source: Wind资讯,

Figure 5. Regressed OLS Test of Investment and GDP.

Finally, Figure 5 presents results of city GDP regressed by investment financed by bonds underwritten by HongYuan. The total observation is 73 cities in the period of 2005 to 2014. The empirical outcome shows that there exists a positive relationship between a 5-year-GDP sum and the 5-year total investment through HongYuan Securities of each city. Statistically speaking, every one hundred million RMB of investment will raise city’s annual GDP by 1.514 million RMB. The R2 value indicates that the regression can explain 69% of the observed data, and the t-statistic value of 12.556 suggests that this relationship is statistically significant for a confidence level of 95%. Since this is a simple regression, a causal relationship needs to be further investigated and verified.

IV. Concluding Remarks

Infrastructure investment in China has been a major driving force to the nation’s development in the past decade. At the local level, on the one hand, infrastructure investment provides better public goods for the society, accelerates economic growth for municipalities, and improves living standards for households. At the national level, on the other hand, infrastructure investment brings forth the potentials originally latent in China’s market and increases efficiencies in many industries across the board. Such large-scale investment could not occur without the help of the financial market. As shown through the data collected from HongYuan Securities, the relationship between city GDP and total investment is positive and statistically significant, indicating that investment consists of a main cause of economic growth in the sample Chinese cities. Nevertheless, this result does not fully include the full scope of benefits accrued from infrastructural investment, as many of them may lag behind and appear in years coming. In this regard, one can safely assume that the merits associated with infrastructure investment are greater than most common investments.

The analysis also reveals some flaws in the expanding yet primitive Chinese financial market. As discussed earlier, there exist many deals where information is asymmetric or incomplete. Figure 1 is a clear indicator that the bonds issued may have similar risk ratings regardless of their actual risk level: firms with AA rating may issue bonds rated with AAA. This phenomenon is quite common in the Chinese bond issuances, which stems largely from the implicit guarantee from the central government. As long as subordinate companies of local governments issue bonds, investors commonly assume the debts are fully backed by the central government, thereby raising the risk rating for the bonds issued.

Overall, the Chinese financial market is very supportive to infrastructural investment in recent years. Yet, there exists the latent risk within the industry. Relevant policies should advocate transparency by making regulatory measures more stringent. In this respect, no underwriters would dare to seek extreme measures to repackage and falsify information during risk evaluation. More importantly, the central government should delineate their relationship with issuers to investors to eliminate the implicit guarantee assumption. When the asymmetry of information within the market decreases, risk will also decrease to favor a healthy development of the financial market.


Zhihan Yu