Saturday, July 22, 2017

The ‘Silk Road’ Verdict

The ‘Silk Road’ Verdict
Why China's massive infrastructure plan won't measure up to economic reality

The idea, at first, sounded good: Plow trillions of dollars into infrastructure projects in the barren wasteland that is most of central Asia, and trade will start to bloom, economies will prosper, and peace will reign. However, most experts believe real world problems will result in the whole idea turning into nothing but a pipe dream.
(VCG/VCG VIA GETTY IMAGES)
(VCG/VCG VIA GETTY IMAGES)
The concept is called the Belt and Road Initiative (BRI), also known as One Belt, One Road, launched by Chinese regime leader Xi Jinping in March 2015. It has two elements: one landlocked route from China to Europe through Asia, called the Silk Road Economic Belt, and one seaborne route going from China to Europe past India and Africa, called the Maritime Silk Road.
Although estimates vary, China has called for up to $5 trillion in infrastructure investments over the next five years in the 65 countries along these routes. Ports in Sri Lanka, railways in Thailand, and massive roads and power plants in Pakistan are just a few examples of the planned investments.
Speaking at the Belt and Road Forum in Beijing in May this year, Xi said: “In pursuing the Belt and Road Initiative, we should focus on the fundamental issue of development, release the growth potential of various countries, and achieve economic integration and interconnected development, and deliver benefits to all.”
His statement sums up the problems with the multitrillion dollar project: It talks about desirable outcomes but is exceedingly vague on the details. This is just like the BRI’s official plans. They call for improving intergovernmental communication, coordinating infrastructure plans, developing soft infrastructure, and strengthening tourism and trade, but the specifics are shaded over.
“There are no concrete action items set out in the Chinese government’s action plan for what has become one of Xi’s most visible policy initiatives. The document contains a number of generic proposals interspersed with platitudes about cooperation and understanding,” research firm Geopolitical Futures states in a July report.
But despite the lack of concrete programs, the vast sums involved show that the BRI has garnered support from many countries. China-led institutions, like the Asian Infrastructure and Investment Bank, have also pledged $269 billion dollars for the project. Even Japanese Prime Minister Shinzo Abe voiced his support at the recent G20 meeting in Hamburg, Germany.
It is completely overhyped. The numbers they published, $4 trillion to $5 trillion, they are completely unrealistic.
— Christopher Balding, professor of economics, Peking University

Objectives Measured Against Reality

China’s objectives, explicit and implicit, need to be measured against reality. On this account, most experts think the project is not economically viable—but it will allow China to gain political influence.
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“It is completely overhyped. The numbers they published, $4 trillion to $5 trillion, they are completely unrealistic,” said Christopher Balding, professor of economics at Peking University.
Economically, it is mostly about investment and exports. “China has surplus capital and excess productive capacity, which is motivating this set of initiatives. With a high savings rate in China and a slowdown in industrial investment at home, they are looking for overseas projects that can be financed and a new outlet for Chinese exports,” said James Nolt, professor of international relations at New York University.
The result is the BRI, which would see China team up with countries along the routes to raise money for building infrastructure to facilitate trade. And Chinese companies would do the construction.
The China Overseas Ports Holding Company has expanded the Gwadar Port in Pakistan and has an operating lease until 2059. This is just the first, small step in connecting the Silk Road Economic Belt with the Maritime Silk Road. Highways, pipelines, power plants, optical connections, and railways are planned for the China–Pakistan Economic Corridor, with a total investment of $62 billion.
Of course, local and international companies are going to bid for these projects as well, but with China providing most of the funds, Chinese state owned enterprises (SOEs) will get most of the contracts.
If Chinese companies got $5 trillion in contracts, this would indeed boost exports, but there are several problems with this notion even in theory.
First, infrastructure projects are very resource intensive, and with few exceptions China simply doesn’t produce commodities. Much of the value-added, therefore, will be absorbed by international commodity producers like Australia (though the Chinese steel industry will certainly get a boost).

Impossible to Finance

Then there is the question of financing these investments. The countries where the investments are going to take place, like Pakistan and Cambodia, don’t have the money to spend trillions and also can’t raise it in international financial markets. This leaves China to come up with a way to get the hard currency financing to achieve its economic goals.
At the beginning of the BRI, China still had almost $4 trillion in foreign exchange reserves, and it was looking to diversify. These have dropped to $3 trillion in 2017, a threshold the central planners in Beijing have made clear they will not cross.
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“They have to tap international bond markets for that money, or they have to exhaust their foreign exchange reserves and even then go out and borrow. Even by global bond market standards, a $5 trillion bond sales program spread out over a couple of years is an enormous number. They are not going to shoulder that type of repayment risk and they are not going to deplete their reserves,” said Balding.
Research by investment bank Natixis estimates that such a borrowing binge would increase Chinese external debt from 12 percent to 50 percent of GDP. This would expose the country to exchange rate risks and put it in the same vulnerable position that the Asian tiger economies were in during the financial crisis of 1998.
Loans from China denominated in yuan from Chinese banks are not an option for two reasons. This “poses its own risks to the overly stretched balance sheets of Chinese banks. In fact, their doubtful loans have done nothing but increase during the last few years, which is eating up the banks’ room to lend further,” especially for risky projects, wrote Natixis Chief Economist for the Asia Pacific Alicia García-Herrero, in a blog post.
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In addition, recipient countries could only pay back a loan in yuan by selling goods and services to China, thus procuring the Chinese currency. This would be directly counterproductive to the goal of promoting exports from China with construction contracts and eventually through improved trade infrastructure.
“How is Pakistan to repay a yuan loan? They are going to generate a trade surplus in yuan. So China has to run a trade deficit with all the countries it lends to. Even if they don’t do that, Pakistan is going to have to generate some type of trade surplus with another country to have enough capital to pay back China,” said Balding.
Given that most of the infrastructure will be built to facilitate trade with China, this is highly unlikely. So in the end, China will be left to vendor finance these projects. The only way to achieve its economic objectives will be hard currency loans that are completely repaid, with interest—which China currently has no clear means of financing.

Bad Risks

All of the economic indicators regarding the most prominent BRI projects point against this repayment scenario.
There is a reason countries like Cambodia, Laos, Thailand, Pakistan, and Mongolia don’t have good infrastructure. They have a generally poor macroeconomic framework, underdeveloped institutions, and a high degree of corruption. Building roads and railways will not change that.
Additionally, “Central Asia, a patchwork of states whose borders were drawn to make the countries more easily controlled from Moscow during the Soviet era, is hardly a promising market for Chinese goods,” states the Geopolitical Futures report.
“People talk about [the BRI] as if China is giving away money. In almost every case, it’s the Chinese credit card company giving a credit card to a despotic dictator, like in Sri Lanka or Venezuela. None of that has ended well,” said Balding.
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The nature of the value proposition of the BRI leads to the worst countries needing the most infrastructure and the most financing. Economically stable and healthy countries like Malaysia and Vietnam need less investment than troubled states like the Kyrgyz Republic and civil war-torn Ukraine. These countries have an economic health ranking of 44 and 38.2, respectively, compared to Malaysia’s 66.8, according to a ranking by Oxford Economics.
“Where financial development is relatively weak and governments are heavily indebted, BRI financing will be crucial,” states the report by Oxford Economics. It is precisely these places that offer the lowest chance of repayment.
“While a new airport or railway can be built in just a few years, amassing the human and institutional capital needed for them to operate efficiently and contribute to economic and social progress is a slower process,” states a report by research firm TS Lombard.

Small Scope

Given the constraints in viable economic projects as well as available financing, the scope of the BRI will likely remain small, while China can still focus on its political objective to exert greater influence over the participating countries.
“What this leaves us with is a much more modest program of $15 billion to $30 billion a year,” commensurate with the $269 billion already pledged by the China-led institutions, Balding said. “I don’t want to say that it’s irrelevant, but it is irrelevant. The United States is spending $300 billion in direct investment every year overseas.”
One of the initiatives that makes sense but needs little infrastructure and investment is protecting ships from pirates. “The cooperation with Singapore to keep the sea-lanes safe is promising, and that would have happened either way,” said Nolt.
While Chinese propaganda is touting that the BRI will revive the spirit of the ancient Silk Road through central Asia to Europe, it may have missed the boat on that one.
Given advances in shipping technology, it is far easier and cheaper to transport goods by ship rather than by land. That’s why most of China’s and the world’s trade (80 percent) is done by sea.
In the end, keeping out pirates and building a few ports in Pakistan and East Africa is a worthwhile endeavor—but it’s one that falls far short of building trillions worth of landlocked infrastructure.
“The Silk Road was a constantly evolving marketplace that moved goods across a vast continent where they could be exchanged for other goods. And unlike today, Eurasia was the center of world civilization, home to the most important economies,” states the Geopolitical Futures report.
Today, the most important economy, also for China, is the United States, and it is best reached by sea through the Pacific Ocean, far away from the Maritime Silk Road and the One Belt.

CHINESE INFRASTRUCTURE PROJECTS IN ASIA

BOATS AT THE GWADAR PORT IN PAKISTAN ON THE ARABIAN SEA. China Overseas Ports Holding Company is leasing the port until 2059 and has already started expanding it. China has been looking to secure sea trading lanes along the so-called Maritime Silk Road, and the Pakistani port is an important piece in the puzzle. (J. PATRICK FISCHER/CC BY-SA)
BOATS AT THE GWADAR PORT IN PAKISTAN ON THE ARABIAN SEA. China Overseas Ports Holding Company is leasing the port until 2059 and has already started expanding it. China has been looking to secure sea trading lanes along the so-called Maritime Silk Road, and the Pakistani port is an important piece in the puzzle. (J. PATRICK FISCHER/CC BY-SA)

A SKY TRAIN IN BANGKOK ON MARCH 20, 2013. Thailand will borrow a total of $69.5 billion to fund high-speed railways and other transportation mega projects, with most of the money coming from China and Chinese companies providing the construction. Thailand's railways will form part of the Kunming– Singapore railway system. However, Thailand will repay the loans with rice and rubber exports, thus running a trade surplus with China and going against the objective to generate export growth. (NICOLAS ASFOURI/AFP/GETTY IMAGES)
A SKY TRAIN IN BANGKOK ON MARCH 20, 2013. Thailand will borrow a total of $69.5 billion to fund high-speed railways and other transportation mega projects, with most of the money coming from China and Chinese companies providing the construction. Thailand’s railways will form part of the Kunming– Singapore railway system. However, Thailand will repay the loans with rice and rubber exports, thus running a trade surplus with China and going against the objective to generate export growth. (NICOLAS ASFOURI/AFP/GETTY IMAGES)

THE BANKS OF THE IRRAWADDY RIVER IN BURMA ON OCT. 2, 2015. Although not officially part of the Belt and Road Initiative, the $3.6 billion Myitsone Dam project is an example of a Chinese infrastructure project in a very poor country that hasn't gone as planned. Construction has been suspended for six years, as both countries could not agree on how to proceed. (YE AUNG THU/AFP/GETTY IMAGES)
THE BANKS OF THE IRRAWADDY RIVER IN BURMA ON OCT. 2, 2015. Although not officially part of the Belt and Road Initiative, the $3.6 billion Myitsone Dam project is an example of a Chinese infrastructure project in a very poor country that hasn’t gone as planned. Construction has been suspended for six years, as both countries could not agree on how to proceed. (YE AUNG THU/AFP/GETTY IMAGES)