(Yicai) Nov. 9 -- China’s cabinet has approved a significant change to public-private partnerships, strictly limiting their scope and the way the projects are carried out so as not to stoke further local government debt risk.

PPPs should focus on user-paid projects, and they should be done using a franchise model, according to a document drawn up by the Ministry of Finance and the National Development and Reform Commission and published yesterday on the central government’s website.

These projects must have a clear fee structure, and their operational revenue should cover construction and operating costs, without adding to the financial responsibilities of local governments, it said.

Governments can provide certain investment support and operating subsidies to PPP projects under the premise of strict control of debt risks, but they are not permitted to subsidize building costs, according to the document.

This is the biggest change to the PPP model since it was introduced in 2014, and it is expected to result in a substantial reduction in the number of eligible projects, industry experts told Yicai. Previously in China, there were three return mechanisms for these projects -- government payment, feasibility gap subsidies, and user payment -- with more than 90 percent using the first two methods.

The new mechanism will help to support the healthy development of China's PPP market as it can prevent local governments from investing blindly without considering their financial resources, which leads to implicit debt risks, intergenerational inequity, and a lack of sustainability, said Wang Shouqing, chief expert at Tsinghua University's research center for investment and financing policy. It will also ease excessive reliance by financial institution on government credit, Wang added.

Implicit debts are the liabilities of local governments financing vehicles that are not included on the books of local authorities. Since the start of this year, the gap between fiscal income and expenditure has widened in some regions, leading to multiple defaults by LGFVs. Resolving local government debts has become a priority for the central government. 

China has been strengthening its regulation of the PPP model since 2017 to prevent excessive investment, with the number of projects falling annually. Some 10,346 PPP projects were registered with the finance ministry as of the end of last year, with total investment exceeding CNY16 trillion (USD2.2 trillion).

Editors: Dou Shicong, Martin Kadiev