Canal fever grips China amid slowing growth

(By Caixin journalists Li Rongqian and Wang Xintong)

China is in the grip of canal fever.

As the government steps up its long-term strategy to turn the country’s inland waterways into a network of interconnected arteries that will boost trade and economic growth, at least five major canal projects costing hundreds of billions of RMB are either being built or planned by provincial governments.

They include the 135-kilometre Pinglu Canal in Southwest China, the first manmade waterway connecting a river to the sea to be built since the founding of the People’s Republic of China in 1949, the 1,988 km Zhejiang-Jiangxi-Guangdong (Zhe-Gan-Yue) north-south canal system — which will be even longer than the Beijing-Hangzhou Grand Canal built 2,000 years ago — and an ambitious project led by the Henan provincial government that reportedly involves connecting waterways between the Yellow River, Huai River, and Yangtze River and provide direct access to the Yangtze River Delta. 

Preparatory work on a major section of the Zhe-Gan-Yue canal, which will link the eastern provinces of Zhejiang and Jiangxi with the southern export powerhouse Guangdong, is pushing ahead. In mid-October, China Design Group Co. Ltd., a Shanghai-listed engineering design firm, announced that it had won a bid to conduct a pre-feasibility study for that section of the waterway, a project the Jiangxi provincial government dubbed the “project of the century” when it was announced in January 2021.

A Caixin analysis of public information about the five waterway projects, and a sixth canal that went into operation in 2023, indicates the total investment could exceed 850 billion RMB (US$117 billion), with funding coming from a range of sources including central government grants and subsidies, the proceeds of special-purpose local government bonds, and low-interest long-term loans from policy banks.

The projects are part of a strategy started almost two decades ago to develop a “high-class” inland waterway transport (IWT) network — mainly waterways rated as navigable for vessels with loading capacity of 1,000 tons (Class 3) to 3,000 tons (Class 1) — as part of an integrated, modern transport and logistics system.

China has the world’s longest navigable inland waterway system at around 128,000 km, with the Yangtze River accounting for around half the total at 64,818 km, government data show. But even today, only some 15,400 km of waterways are suitable for navigation by larger vessels and barges, limiting their usefulness for transport purposes.

For areas unsuitable for navigation by large vessels, improving canal systems greatly aids the shift from road to water transport, Chen Feier, deputy director of the Research Institute of Ports and Shipping at Shanghai Jiao Tong University, told Caixin. Canals have relatively large traffic capacity which enables them to cope well with a sudden increase in demand, she said.

IWT has long been the poor relation of the Chinese transport system, with investment in inland waterways neglected compared with the massive spending on building modern, high-class road and rail networks.

But a big shift began in 2007 when the government published a national plan to develop the country’s inland waterways and ports until 2020. Among the targets were to increase the length of high-class waterways to around 19,000 km from less than 9,000 km in 2006, accounting for 15% of the total length of the country’s inland waterways, up from 7% in 2005, and to connect 25% of cities with a population of over 500,000.

IWT got a further boost starting in 2019 when China published a long-term plan pledging to turn itself into a transportation powerhouse by 2035. The strategy included expanding navigable waterways, modernising infrastructure such as ship locks and dams, promoting sustainability through environmentally friendly vessels powered by clean energy and stricter pollution controls, improving inland port facilities, and linking inland waterways with international shipping routes to better support the Belt and Road Initiative.

In 2021, a flurry of related plans was released, setting ambitious targets such as increasing the length of high-class waterways to 25,000 km by 2035, although the country had, at the end of 2023, only achieved 81% of its 2020 goal of 19,000 km.

Yet despite almost two decades of pledges, development of inland waterways has lagged far behind that of highways and railroads. By the end of 2023, China’s navigable inland waterways had increased by just 1%, or 1,900 km, since 2014, according to data from the Ministry of Transport (MOT). Over the same period, the national highway network had expanded 64%, and the railway network had grown 42%.

In 2023, China invested 764.5 billion RMB in railroads and 2.8 trillion RMB in roads, including nearly 1.6 trillion RMB in highways. In comparison, investment in waterways was just 201.6 billion RMB, MOT data showed.

But the government is stepping up its commitment as the economic and environmental benefits of a modern, efficient IWT network become increasingly clear. As well as helping develop the national and local economies, greater use of waterways can cut pollution thus helping the country meet its carbon emission reduction goals, and reduce transport costs for business — government data show that China’s current combined average freight cost for water transport is 0.03 RMB per ton-kilometre, compared with 0.1 RMB for rail and as high as 0.49 RMB for road transport.

Local governments are also eager to invest in waterways.

Pressure to boost infrastructure spending to support GDP growth has led to a renewed push to build canals and upgrade waterways as officials have struggled to find other suitable large-scale investment projects.

Decades of highway construction have left little room to further expand the road network, “prompting localities to shift the focus of investment in transportation infrastructure to waterways,” Zhao Yifei, an associate professor at Shanghai Jiao Tong University, told Caixin.

Investment doesn’t just involve digging the canals, but also building and modernising port infrastructure, cargo terminals and warehousing, and upgrading navigation standards to enable larger vessels with lower unit costs to use the waterways, according to the World Bank’s Independent Evaluation Group.

The IWT sector became even more attractive in 2019 when the central government lowered minimum capital ratio requirements for ports and shipping infrastructure projects to 20% of total investment from 25% in 2019, which means local governments don’t have to stump up as much of the initial investment capital as they would for projects in many other industries.

Better and more modern waterways could also lower transport costs for local businesses wanting to move their goods, especially commodities like coal, to other regions, by making journeys shorter and opening access to larger vessels.

Anhui and Henan provinces, for example, are rich in coal and mineral resources, but the lack of direct waterway access to the wealthier Yangtze River Delta region has made transporting commodities slow and expensive. Vessels currently have to travel hundreds of additional kilometres east along the Huai River and Hongze Lake to the Beijing-Hangzhou Grand Canal and then down to the Yangtze River Delta region. Alternatively, goods have to be moved by rail and road, which are more expensive per unit cost and take longer.

Most of the provincial areas involved in the six canal projects are landlocked. These projects are crucial in helping them connect isolated waterways and overcoming current bottlenecks in shipping. They all hope to boost their regional economies through the development of water transportation, Zhao said.

Developing inland waterways could be an important catalyst to attract further investment and boost local growth.

The construction of modern canals not only involves substantial engineering projects but also encompasses emerging industries related to new productive forces — such as logistics, tourism, and data services — which can be developed along the canals’ banks, said Chen from the Research Institute of Ports and Shipping.

Canals create economic benefits, mainly by reducing the cost of cargo transportation along the canal, promoting material exchanges and trade, and thus further stimulating investment in local industrial and logistics parks, said Zhao. “The creation of economic ecosystems is far more important to regional economic development than the canal itself,” he said, but cautioned that without proper planning and coordinated policies, there’s no guarantee this additional investment will come.

The Pinglu Canal in Guangxi, a mountainous region in southwest China bordering Vietnam, is part of the international land-sea trade corridor project backed by Singapore and the Chinese government to cut shipping times between western China and countries of the Association of Southeast Asian Nations (ASEAN). It will provide a north-south connection between the Pearl River system, which runs across southern China, and the seaport of Qingzhou city on the Gulf of Tonkin, from which ships sail to Vietnam, Malaysia, Singapore, and Indonesia.

Costing an estimated 73 billion RMB, the Pinglu Canal project will use mostly existing rivers and involve the construction of only some 6.5 km of new waterways. When completed in 2026, it will be a Class I waterway, navigable for vessels of up to 5,000 tons loading capacity, and shorten the distance for ships and barges to reach the Gulf of Tonkin by some 560 km by allowing them to avoid a lengthy detour down the Xi and Pearl rivers to Guangzhou.

Although still in its early stages, Henan province’s IWT project could involve investment of as much as 100 billion RMB which will be used to expand the province’s navigable waterways to over 2,000 km, develop new sea-accessible channels and establish six “modern ports,” including in Zhoukou, a major agricultural-producing region and an important transport hub.

A Phase 1 project for the Zhoukou port was one of several IWT infrastructure projects granted loans by the China Development Bank in the first seven months of the year amounting to a total of 9.62 billion RMB, state media reported.

Even as local governments plough ahead with their canal projects, some analysts and industry experts have expressed doubts about the financial viability and low returns on some of the investments, and the potential negative impact on the environment.

The finances of many local governments are already strained and they are struggling to tackle mountains of debt built up from years of overinvestment in infrastructure and off-the-books borrowings by their local financing vehicles. The prolonged downturn in the property market and huge expenditure on pandemic control have exacerbated the problem.

But local officials are under pressure to keep spending to support economic growth and with private-sector investment and consumption sluggish, they are turning to the tried-and-tested solution of infrastructure investment. More than half of the Chinese mainland’s 31 provincial-level regions — including Anhui, Henan, Hunan, Jiangxi and Guangxi — missed their GDP growth targets last year and have been struggling to boost their local economies and meet this year’s goals.

There are risks that costly canal investment will increase already excessive local government debt and authorities won’t be able to service or repay the borrowings as projects don’t earn high enough returns, an MOT researcher warned.

Major projects get financial support from the central government and from multilateral lenders such as the World Bank, Asian Development Bank and the Asian Infrastructure Development Bank, which is assessing a US$200 million loan for an inland waterway green port project in Hunan province. Funding is also provided by provincial-level authorities, but there have been significant cuts due to strained local finances and there is a substantial funding gap for waterway construction, a ports and shipping industry insider based in Anhui told Caixin.

Larger canal projects can also use the proceeds of special treasury bonds and policy bank loans, while special purpose vehicles set up by consortia of local state-owned investment funds to manage individual projects can also tap the bond markets and commercial lenders for money.

But even if low-cost financing can keep annualised funding costs at some 2%, below the market rate, generating an annual return of 2% for canal projects is challenging and revenue generated by the projects may not even be enough to cover the financing costs, a researcher at a financial institution told Caixin.

The canals also face sustainability challenges after construction is completed. The upgrading of feeder waterways will significantly increase the workload and funding requirements for canal maintenance, the Anhui-based insider said. The special waterway maintenance funds currently provided by the provincial finance departments will be insufficient and will only be able to meet the maintenance needs of some high-level waterways, the insider said.

Revenue from the canals comes mainly from tolls at locks along the waterway, but this needs to support not only the operating costs of the locks, but also the maintenance and dredging of the artificial waterways, Zhao said.

The Anhui provincial government is already facing this problem with the Jianghuai Canal which went into operation in August 2023, adding a 355-km stretch of shipping lanes to existing waterways and seven new ship locks. The north-south waterway opened up direct access between Asia’s longest river, the Yangtze, and the Huai, a major river in eastern China.

Vessels from ports in Anhui and Henan provinces no longer have travel east to the Beijing-Hangzhou Grand Canal and back down into the Yangtze, shortening journeys by between 200 and 600 km, state media reported. The province’s transport department has estimated it will reduce freight costs by more than 6 billion RMB a year and cut carbon emissions by nearly 1.8 million tons a year.

But so far, income from vessels transiting through the canal is insufficient to cover even its daily operational costs, Caixin has learned. Raising tolls on ships passing through the locks is controversial. Excessively high fees will weaken the competitiveness of inland water transportation and dampen demand, several sources familiar with the matter told Caixin. But if lock charges are lowered or waived, the canals will have to rely more on government subsidies to keep running, which may also not be a long-term solution, they said.

The other danger is that with the bursting of the property bubble, slowing economic growth, and the shift to renewable energy, domestic demand for the types of bulk commodities shipped through the inland waterway system such as coal, gravel and cement, may have started to decline, taking a toll on inland shipping.

“The boom in real estate construction has passed, and the demand for inland waterway transport has greatly diminished,” the MOT researcher told Caixin.

This article was first published by Caixin Global as “In Depth: Canal Fever Grips China Amid Slowing Growth”. Caixin Global is one of the most respected sources for macroeconomic, financial and business news and information about China.

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