Belt and Road Initiative: what are the challenges for China and its partners? (Note)

Usefulness of the article: Hailed as the most important infrastructure project in history, the Belt and Road Initiative is often compared to a^21st-century Marshall Plan. The significant rebalancing that this initiative would bring about in global trade, as well as the increased risk of over-indebtedness that it could cause in many partner countries, raises questions about its long-term viability, especially at a time when the prospect of a sharp slowdown in the Chinese economy is causing growing concern.

Summary:

• The Belt and Road Initiative, or New Silk Road, is a major project initiated by China, aimed at increasing connectivity and cooperation in the Eurasian region, mainly through ambitious infrastructure and trade agreements.
• For China, it is primarily a response to significant industrial overcapacity and a way to extend its geopolitical influence.
• For partner countries, which often suffer from a lack of infrastructure, the prospects for growth and inclusion are significant, but tempered by significant risks of debt unsustainability.
• Similarly, political, security, social, and environmental risks (including political instability, corruption, and terrorism) raise questions about the initiative’s viability in the absence of complementary reforms aimed at improving institutions and the political framework.

Announced in the fall of 2013 by President Xi Jinping, the Belt and Road Initiative (hereinafter BRI) is a regional infrastructure network project initiated by China and covering most of the Eurasian continent. Bringing together land, sea, energy, and communications infrastructure projects across six « corridors, » this ambitious initiative is part of the overall « Chinese Dream » policy pursued by Xi Jinping since he came to power in 2012, which aims to increase China’s international standing.

At a time when Chinese growth is slowing, the central idea behind this initiative is therefore to increase trade links with the rest of the Eurasian continent and thus find new outlets for Chinese industry, which is suffering from structural overcapacity.

Beyond promoting infrastructure projects, the BRI’s overall goal is to increase connectivity and cooperation with member countries, in particular by encouraging greater financial integration and reducing trade barriers.

A substantial budget for a broad initiative

The difficulty in assessing the scope of this initiative lies in its lack of clarity. Indeed, the boundaries of the BRI have not been defined, and numerous projects are associated with it, to the extent that the initiative is increasingly linked to the Chinese Communist Party’s general policy, and even to China’s international development philosophy. The BRI was thus enshrined in the Chinese Communist Party’s Constitution at its^19th National Congress in October 2017. The budget allocated to the BRI is difficult to estimate, but most studies mention a range of between USD 800 and 900 billion for projects currently underway or under consideration.

Geographically, the BRI consists of two main components:

• The « Belt » part corresponds to the development of six land corridors (road and rail) mainly to Southeast Asia, the Middle East, and Europe.
• The « Road » component involves the development of maritime routes and port activities around the Indian Ocean and as far as Europe via the Red Sea.

Also known as the « New Silk Road, » this initiative also has the symbolic significance of redeveloping the historic Silk Road, which monopolized trade between Asia and Europe until the 15th century. Bringing together 68 countries representing 65% of the world’s population and 40% of global GDP, the BRI’s main objective is to address a significant infrastructure deficit in the regions concerned. As described bythe Asian Development Bank, infrastructure needs (energy, transport, telecommunications, water, and sanitation) for the Asia-Pacific region will amount to $1.7 trillion per year by 2030 if the region is to maintain its current growth rate. Many Central Asian countries do not have the financial resources or industrial capacity to invest in the necessary improvements to their infrastructure. In addition, only a limited portion of the financing provided by current development institutions (primarily theAsian Development Bank) is devoted to infrastructure.

To address this, several financial institutions have been set up to provide financial support for project development, the two main ones being the New Silk Road Fund (NSRF) and the Asian Infrastructure Investment Bank (AIIB). Mainly financed by the Chinese sovereign wealth fund China Investment Corp. and the two public banks, the Export-Import Bank of China and China Development Bank, the NSRF (a development fund with capital of USD 40 billion) differs in structure from the AIIB, a multilateral organization developed by 57 countries, including 37 in Asia, with capital of USD 100 billion. Both institutions aim to finance infrastructure projects in countries participating in the BRI, through loans (AIIB) and equity investments (NSRF). Similarly, a policy of facilitating the regulation of Chinese companies’ investments abroad has led to a significant increase in Chinese investment in the Asian region.

What are the effects for the countries concerned?

The main goal of the BRI remains the promotion of trade between its participating members. As Ruta and Boffa point out, trade between BRI members and with the rest of the world has already increased significantly over the last thirty years. Driven mainly by intermediate goods, this increase masks a significant disparity between dynamic regions (East Asia and Europe) and regions that remain poorly integrated (MENA and Central Asia). This increased integration is also reflected in value chains, with value-added production becoming more dispersed among partner countries. However, BRI export products are still largely dependent on value added from non-BRI countries, as is the case, for example, in the leading electronics sector, where the same report shows that half of the value added of BRI countries comes from abroad, with two-thirds of that coming from countries outside the BRI. The advantage that the BRI could bring in terms of reducing trade costs could therefore be particularly significant for intermediate goods, as these cross borders between production sites several times, which would lead to multiplied productivity gains.

Beyond the trade gains it would generate (Djankov, Freund, and Pham show that each additional day a product spends waiting to be shipped reduces trade flows by 1%), reducing transit times could also improve the connectivity of territories isolated from global trade flows, through increased regional trade and investment. The benefits for the local populations of these countries (particularly in terms of poverty reduction) could therefore be significant.

As Baniya, Rocha, and Ruta show using a gravitational model and an analysis of comparative advantages, the BRI’s infrastructure alone would lead to a 4.1% increase in trade flows between member countries (simulation before and after the implementation of infrastructure). Including trade reforms (lower customs tariffs and other technical barriers to trade, a common regulatory framework for intellectual property, etc.), this effect would be tripled. Finally, the gains would be most significant for countries benefiting most from the new infrastructure (Myanmar, Laos, and Thailand in particular) and countries most integrated into global value chains (countries producing goods requiring rapid delivery, such as Bangladesh and Kenya).

A « safety valve » in a context of « new normal »?

The Belt and Road Initiative should also be analyzed within the context of the structural slowdown that China has been undergoing for several years. Reflecting China’s interest in achieving slower but more stable (« higher quality ») long-term growth through more mature economic structures, this « new normal » is also found in other strategic plans such as « Made in China 2025, » announced in 2015 with the aim of advancing Chinese industry in the value chain through massive investments in high value-added sectors such as information technology, robotics, green energy, etc.

The massive debt situation of Chinese companies (155.1% of GDP in H1 2018 according to the BIS) and shadow banking[1] poses a major risk to the country’s economy, prompting the government to implement economic policies aimed at reducing financial vulnerabilities.

The situation of overcapacity in many Chinese industries (primarily steel, cement, aluminum, and green energy) ten years after the $4 trillion stimulus plan implemented after the financial crisis requires the development of new export markets in this context of tightening credit and weak domestic demand. As the Lowy Institute points out, the aim of relocating Chinese production sites to BRI member countries would be a response to this problem of overcapacity, as well as enabling the development of Chinese industry and economic growth in partner countries through the technology transfers that these relocations would entail.

Similarly, in the context of conflictual and protectionist risks to trade between China and the United States, the search for new outlets via the New Silk Road appears essential to safeguarding Chinese exports.

Thus, the combination of bilateral trade agreements and infrastructure financing aims to develop increased external demand for Chinese products, thereby enabling China to protect itself against a decline in domestic demand or the protectionist policies of its trading partners.

How viable is the project?

The first question concerns the security aspects of the project. A large part of the BRI’s land corridor crosses Central Asian countries with significant security challenges (particularly terrorist risks) as well as the Chinese region of Xinjiang, where political and social stability remains difficult. Even if the Chinese government is counting on the economic growth generated by the BRI to better integrate these regions, the security risks involved raise questions about the project’s viability. More general geopolitical risks must also be taken into account (risk of currency inconvertibility, transfer blockages, risks of nationalization, expropriation, or political or social instability) in countries where political risk is often high. The example of the Myitsone Dam in Myanmar, whose $3.6 billion construction project financed by China was blocked by the military government—and has still not resumed—is a good illustration of this risk. Similarly, the risk of public discontent with Chinese companies (employment of Chinese workers to the detriment of local populations, sale of land to Chinese investors, etc.) further accentuates the risks to the overall viability of the BRI.

The very financing of the BRI also raises questions. With USD 900 billion worth of projects (under development or under consideration) mainly financed by public or commercial banks, the rating agency Fitch fears that the political motivations behind the selection of projects and the massive entry into unpredictable markets will lead to problems in the allocation of resources and a massive increase in non-performing loans. Similarly, the potential impact that loans could have on the economies of countries with often low sovereign ratings also raises questions about the sustainability of the BIS for the countries receiving its financing. The low level of foreign reserves to finance projects often denominated in renminbi, as well as the sometimes massive debt, are therefore the most significant risk factors.

Finally, the BIS’s focus on infrastructure investment also raises questions about the lack of consideration given to the institutional reforms needed to carry out the projects. Indeed, as pointed out in a World Bank analysis, Central Asian countries often rank low in the Doing Business rankings on the business environment, raising questions about the profitability of future projects in the absence of complementary reforms aimed at improving institutions and the political framework. Similarly, the lack of consideration of the environmental impact of IBRD projects, as highlighted in another World Bank report, could lead to additional costs, particularly for energy and transport projects.

A vehicle for China’s expansion?

Although economic characteristics remain at the heart of the BRI’s concerns, it can also be analyzed from a geostrategic perspective. Within China itself, the integration of the western regions of Xinjiang and Yunnan through increased trade via the BRI is key to the country’s political stability, particularly with regard to the Uighur population, which could be better integrated through the economic opportunities offered by the BRI. Similarly, as this article by BSI Economics shows, China’s desire to reduce its dependence on maritime supply routes, whose security is essentially ensured by the US military presence, also explains its massive investment in port infrastructure in the Asian region.

Externally, too, the BRI tends to be seen as a vehicle for China to extend its global influence, particularly in the United States, which tends to view the development of the AIIB and the NSRF as a means of competing with the Bretton Woods institutions, namely the World Bank and the IMF. Increasing the use of the renminbi in trade, investment, and other financial activities is also a goal for China through the BRI, with the inclusion of this currency in the IMF’s global reserve currency basket in 2015 symbolizing a promising first step in this regard.

President Obama’s « pivot » to Asia policy has adapted to China’s rise in power by increasing US involvement in the region (diplomatic, military, economic), This has been taken up by the Trump administration with its policy of  » a free and open Indo-Pacific region, » which includes an infrastructure development project alternative to the BRI in partnership with Japan, India, and Australia. The frequent comparison between the BRI and the Marshall Plan clearly illustrates the prevailing mistrust of this project, which is seen primarily as politically motivated by China to gain a dominant position at the regional and global level.

It can also be conjectured that the BRI is a way for China to export its economic model. China has developed using a growth model based on investment in infrastructure, based on the idea that devoting a significant portion of the budget to long-term assets (transportation, energy, social infrastructure) would increase long-term economic performance (technological innovation, greater social inclusion, etc.) and create an environment conducive to private sector development. The World Pensions Council contrasts the rapid development of China and other Asian economies based on this model (Singapore, South Korea, etc.) with Latin American economies based on the Washington Consensus, where many obstacles to development linked to a lack of infrastructure remain.

China’s potential ability to influence the finances of the countries receiving its investments is also a cause for concern, and has even led to the development of the term  » debt trap diplomacy. » Indeed, the lack of transparency regarding the terms and even the amounts of loans granted by China raises questions about its intention to extract economic and/or political concessions when the debtor country is unable to honor its debt—especially when the financing is asset-based. The example of the Sri Lankan port of Magampura Mahinda Rajapaksa, whose cost of $361 million was 85% financed by The Export-Import Bank of China at an annual interest rate of 6.3%, is characteristic of this concern.

When Sri Lanka found itself unable to finance its debt following the commercial failure of the port, it was leased to China on a 99-year lease, reinforcing Indian and Western concerns that it would become a Chinese naval outpost in the Indian Ocean. Sri Lanka is not the only example of a Chinese-financed « white elephant » project in a heavily indebted country; the Center for Global Development has identified several countries where the risks of current debt unsustainability and increased dependence on Chinese debt were exacerbated and could lead to a significant risk of default as a result of BRI projects. The case of African countries is also questionable, with data from the China-Africa Research Initiative showing that loans provided by China to all African countries rose from $130 million in 2000 to $30 billion in 2016. However, the same report shows that Chinese loans are not (yet) the main cause of these countries’ over-indebtedness.

Conclusion

A key component of Xi Jinping’s foreign policy, the Belt and Road Initiative is intended as a means of promoting China’s rise on the international stage, built in particular on a regional community sharing the same interests and destiny.

Economically, the BRI is part of China’s desire to achieve a « new normal »—a healthier economic structure—and to address its industrial overcapacity issues through new markets.

For partner countries, most of which suffer from a significant infrastructure deficit, the resulting gains in trade and investment could have widely beneficial effects in terms of growth and inclusion. However, the risks of vulnerability linked to dependence on Chinese debt, as well as political, security, social, and environmental risks (including political instability, corruption, and terrorism) raise questions about the initiative’s viability in the absence of complementary reforms aimed at improving institutions and the political framework.

Feared by Western countries as a vehicle for China to extend its global influence, the BRI could go down in history as a gigantic « white elephant » in the event of massive, unproductive and economically irrational investments in financially and politically fragile countries.