July 2017
China’s Belt and Road Initiative
Ambitious scope beset by regional challenges
China’s Belt and Road Initiative (BRI), formerly referred to as One Belt, One Road (OBOR) represents an economic development funding plan worth, at its most ambitious target, US$4 trillion in foreign direct investment (FDI) along two regional trade routes. Representing the consolidation of strategic objectives for Beijing, the BRI remains beset by uncertainty over the scope and timeframe of China’s commitment and hesitancy from key regional partners. Questions linger over commercial viability from industry and regulatory compliance and credit risk relating to project financing.

Scope and outcomes

First proposed by Xi Jinping in 2013 and initially getting off to a slow start, the BRI saw nearly US$500 billion worth of related projects and M&A deals announced in 2016 alone. The initiative focussed on physical asset development across two trade routes. The “Belt” refers to the westward overland route linking China to Central Asia, Russia and Western Europe along the ancient Silk Road trade route. The “Road” relates to the maritime channel navigating from South East Asia through India and the Persian Gulf to Southern Europe. The BRI aims to engage over 65 countries and reach a total population of 4.4 billion, representing over a 30 percent share of the global economy across three continents. The plan dwarfs the size and scope of past initiatives such as America’s Marshall Plan to rebuild Europe after the Second World War. Existing projects greenlit include new rail lines from Europe to China, ports in Pakistan and Sri Lanka and high speed rail links with Laos and Thailand.

BRI will employ a combination of intragovernmental free trade agreements, state-owned bank sponsored underwriting and direct FDI. The initiative will support the internationalisation of China’s competitive advantages in the industrial, manufacturing and infrastructure sectors. Infrastructure development will comprise railways, roads, highways, ports and pipelines, supporting industrial and manufacturing capacity investment in industries including energy, chemicals, aerospace, telecoms and textiles. Involvement by firms from every Chinese province will be backstopped by support from China’s Export and Import Bank, Ministry of Commerce and sovereign wealth fund. While most of BRI is expected to be funded in US dollars, the project will provide opportunities to promote the internationalisation of RMB, building upon the IMF’s 2016 inclusion of the RMB in the Special Drawing Rights (SDR) basket of currencies.

China’s outward foreign direct investment through the BRI is the culmination of multiple geopolitical, diplomatic and economic objectives. Large scale public-private partnership will enable the reorientation of China’s foreign exchange and capital reserves from low interest US government bonds to higher yielding infrastructure projects. Investment partnerships with businesses across every province in China will facilitate the take up of industrial production overcapacity as the economy transitions from investment driven manufacturing to a consumption led, service and higher value goods based economy. A non-discriminatory investment focus that eschews traditional alliance structures will aim to facilitate intra-regional cooperation and dependence between nations. China will also be looking to build the profile of the Asia Infrastructure Investment Bank (AIIB) as a competitor to the World Bank and Asian Development Bank through co-sponsorship of BRI projects.

Challenges and the financial sector

Concerns linger relating to China’s commitment and the hesitancy of regional partner involvement. Whereas overall outbound FDI reported a 40 percent jump in 2016 prompting regulators to clamp down on capital outflow, FDI directed at BRI markets has slowed, with decline accelerating into early 2017. Non-financial FDI to key BRI countries similarly accounted for less than 10 percent of total outbound FDI in the previous year. Loans from the China Development Bank (CDB) to BRI markets similarly peaked in 2014 at 41 percent, falling to 33 percent by the end of 2016. Measures towards solidifying regional partnerships remain fraught. India has expressed concerns over regional sovereignty and territorial integrity relating to development in Pakistan-Occupied Kashmir. Sri Lanka and Myanmar leaders have meanwhile sought to renegotiate projects approved by predecessor leadership.
  Financial institutions have similarly expressed trepidation relating to regulatory challenges and commercial viability and the complexity of operating in frontier markets. Global banks including HSBC, Standard Chartered and Citi remain attracted by opportunities for financing, bond issuance, advisory and partnership with Chinese leadership. Uncertainty remains relating to tax, financial planning and particularly compliance as it relates to infrastructure projects such as rail and oil pipelines that may flow through sanctioned regions. The bulk of finance business is further expected to flow to Chinese state owned commercial banks supported by domestic agencies and governmental ministries. Financiers have additionally expressed reluctance to originate and hold long dated and complex exposure without some form of credit enhancement and insurance, given regulatory constraints on concentration and counterparty risk. Impending Basel IV standards will further raise risk weighting on foreign secured loans imposing a contingent liability of loan repricing.

Regional trade and the role of business

Measures to ease financing concerns from China through to the Middle East, Africa and South East Asia resulting from BRI investment should be welcomed. East & Partners Global Supply Chain report indicates China tops the measure of most challenging region to fund inside a corporate supply chain, nominated by over 40 percent of top 100 revenue ranked corporates across eight global markets. Africa and South East Asia are comparatively ranked third and fourth after Latin America, nominated by around 20 and 10 percent of businesses respectively. This however, serves primarily to emphasise the predominance of China as a key export market and the capacity for infrastructure investment to support greater globalisation of trade throughout the Silk Road and BRI maritime route. According to recent East research on enterprises in the Asia region, China is nominated as a key export market by over 75 percent of institutional businesses as compared to India (42.3 percent), the Middle East (6.6 percent) and the wider African continent at 2.3 percent.

Chinese leadership is further seeking to leverage the technical expertise of industrial multinationals who have expressed greater interest than Western governments. GE is looking to build upon existing contracts with Chinese construction and engineering firms through orders for natural gas turbines and power equipment in the BRI region worth US$7 billion over the next 18 months. Manufacturing conglomerate Honeywell is similarly orienting to build upon existing business in supplying natural gas processing equipment in Central Asia. Western governments in contrast, have broadly treated the initiative with scepticism both with the expectation of favouritism for Chinese firms, and reluctance in granting China economic and political leverage in the wider region. However, to the extent that infrastructure development and the establishment of thriving capital markets helps to facilitate new export destinations and supply chain networks for businesses from the Institutional segment through to SME, investment in the region should be welcomed.

An initiative to be embraced

Realisation of the full scope of the BRI will depend on China’s capacity to solidify regional engagement through memoranda of understanding and striking milestone contracts with a diverse partnership of public and private stakeholders. Western governments and financial intermediaries would be well served by gaining a greater clarity of the industries and enterprises with the interest and capacity to engage on the BRI and the economic, geopolitical and regulatory impediments to be overcome.

To the extent that China can export its investment driven model of productivity, gross domestic product and income growth to the wider Central Asian, Middle East and Africa region, the Belt and Road Initiative should be an undertaking that is encouraged globally.

To speak to East & Partners about additional trade finance research, or about exploring opportunities within China’s Belt and Road Initiative, email us here.

To read previous Research Notes published by East & Partners, click here.
Challenging regions to fund inside global supply chains

Source: East & Partners Global Supply Chain Report
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