China’s Belt and Road Initiative: Pax Sinica Redux or Economic Black Hole?

Contributed by: Ishwar Chidambaram, CFA, CIPM

“… (We must) hide our capabilities and bide our time, never try to take the lead…”

-Deng Xiaoping, Paramount Leader of the People’s Republic of China (1978-1989)

On May 14, 2017, Deng Xiaoping would have been spinning in his grave at China’s flagrant disregard for his sage dictum, when the heads of state of 29 nations converged on Beijing for the inaugural Belt and Road Forum. The 2-day extravaganza, touted as the biggest diplomatic event of the year, was designed to promote China’s leadership of Eurasia under the Belt and Road initiative, an ambitious plan to realize President Xi Jinping’s strategic vision. This vision calls for constructing a land economic belt to Central Asia and Europe, and a Maritime Silk Route to connect the Pacific Rim with the Indian Ocean and Africa. China has pledged more than $100 billion under this initiative, popularly known as One Belt, One Road (OBOR).

Prominent attendees to the Forum included Russian President Vladimir Putin, Turkish President Erdogan, seven ASEAN leaders, the Prime Ministers of Pakistan and Sri Lanka, and heads of the United Nations, IMF and World Bank. Bucking the rising tide of protectionism in the Western world, 130 nations on 5 continents flocked to the event.  Prima facie, this would appear to affirm China’s position as a beacon of globalization, in an era where the Trump administration has slashed foreign aid and erected trade barriers in the name of “America First”. OBOR might also be expected to consolidate the position and perpetuate the legacy of Chinese President Xi Jinping, arguably the nation’s most powerful leader since the revered Deng Xiaoping. In his speech at the Forum, President Xi announced that total trade between China and other OBOR countries has already surpassed $3 trillion from 2014 to 2016. China’s investments in those nations have exceeded $50 billion, with a target of $4 trillion. It has set up 56 Special Economic Zones in 20 countries, which have collectively generated $1.1 billion in tax revenues and created 180,000 jobs. But the project is not without risks, as outlined below, and has drawn criticism from various quarters.

Critics of the project contend that the entire scheme is poorly conceived and simply an ego trip for the powers that be in Beijing. They point out that China is merely exporting overseas its domestic model of debt-driven development. They contend that this model is unsustainable in the long run, and that any escalation of credit risk could lead to spiralling bad debts, which would severely burden the fragile economies of peripheral nations. In fact, the UN has itself expressed concerns over economic, financial, social and environmental risks of OBOR. A recently concluded UN Economic and Social Commission for Asia and the Pacific Study (UNESCAP) has warned of financial risks in countries in south and central Asia where China’s announced investment value under OBOR is high compared to the relative size of the economy of the recipient country. The $15 billion China-Uzbekistan investment deal signed in late 2013 is roughly equivalent to a quarter of Uzbekistan’s GDP. Similarly, the $37 billion China-Kazakhstan cooperation agreement signed in late 2014 and early 2015 and the $46 billion China-Pakistan agreement in April 2015 each represent over a fifth of GDP level in Kazakhstan and Pakistan, according to the UN study. “External account indicators for some of these economies are relatively weak”, as per the report, which also expresses concerns over upheavals on the social and environmental fronts in the region.

Another concern is ratings firm Moody’s recent downgrade of China’s long-term local and foreign currency issuer ratings by one notch to an A1 rating from AA3. Moody’s cited expectations that the financial strength of the world’s second biggest economy would “erode in future, with economy-wide debt continuing to rise even as potential growth slows”. The downgrade is yet another signal to the international community that all is not well with the Dragon, even as it has embarked upon its expansive OBOR initiative, targeting global dominance. Some Western nations have also expressed reservations about the Forum, as they see it as an attempt to hard sell China’s soft power, with complete Sinification being the ultimate objective. Already there are grim assessments to the effect that weaker economies like Pakistan would be fully subjugated and reduced to an economic colony by China.  Western countries are also bothered by the perceived lack of openness and transparency in awarding contracts. According to one US investment research firm, it is also open to question “how much political sovereignty is sacrificed, and what is the risk to completion of projects in the event of a disorderly slowdown in the domestic Chinese economy”. Nevertheless, this has failed to dent enthusiasm for the Forum.

Peering into history, commerce along the ancient Silk Road was pivotal to the emergence and flourishing of the ancient civilizations in East Asia. The Chinese, in particular, were the greatest beneficiaries of that free trade, which led directly to the establishment of the first Pax Sinica (Chinese peace), when China maintained the dominant influence in Asia due to the combined might of its soft and hard power. In its current avatar, the Belt and Road initiative is widely regarded as China’s tour de force, heralding its emergence as a superpower on the world stage and shifting the planet’s economic centre of gravity towards Eurasia. It envisages extensive investments (as much as $ 1 trillion by some estimates) in infrastructure, such as roads, railways, airports, seaports, transnational electric grids, oil pipelines and fibre optic lines of communication. If successful, it would represent the culmination of China’s ascendance, and transform the face of Eurasia beyond recognition.  

The initiative showcases China’s global ambition on an epic scale. The motivations behind this proposal are ubiquitous, with economics being chief among them. China needs to find and develop the untapped markets in its hinterland to export its excess capacity in cement, steel and industrial materials. The Dragon has a burgeoning war chest of over $3 trillion in foreign exchange reserves, most of which is parked in low-interest-yielding US Treasury securities, and which need to be redeployed to more profitable alternatives. Another imperative is to quell the unrest in China’s troubled western provinces of Tibet and Xinjiang, by strengthening the fragile economies of Central Asia, thereby creating a more stable environment. And last, but not least, the Maritime Silk Route could possibly bolster China’s territorial claims in the South China Sea, a region long coveted by Beijing.

The Initiative has already begun to attract significant financing. In 2015, The People’s Bank of China transferred over $80 billion to three state-owned banks mandated to provide funds for OBOR projects. A new Silk Road Fund worth almost $40 billion was promoted by China’s sovereign wealth fund. The most significant milestone was the inception of the Asian Infrastructure Investment Bank (AIIB) by the Chinese government, with $100 billion in initial capital. Like a freight train pulling away from the station, the OBOR project is slowly gathering momentum. Now China’s omnipotent state resources are mobilising, with over two-thirds of China’s provinces incorporating OBOR in their development objectives.

Despite these efforts at coherence, the initiative is beset with teething troubles, especially in South and East Asia, with disputes over a railway line through Thailand and clamour for renegotiating projects in Sri Lanka and Myanmar. There is also a profound dearth of feasible projects for the enormous sums of money allocated. Moreover, OBOR lacks a strong central leadership, with its present leader- Mr. Zhang Gaoli- perceived to be out of favour in Beijing. Even more critically, there exists a vast cacophony of internally competing bureaucratic voices within China- the ministry of commerce, the foreign ministry, the planning commission and China’s provinces, to name but a few- each competing for their share of the lucrative OBOR pie. These will need to be reconciled for the OBOR orchestra to hit all the right notes and play a fluent symphony. Whether it results in a second Pax Sinica or collapses into an economic black hole-only time will tell; but one thing is certain: win or lose, the Dragon means business. Every chain is only as strong as its weakest link, however, and the Belt and Road Initiative is no exception.

IC

 

About IAIP

India Association of Investment Professionals (IAIP), which is established April 2005 and located in Mumbai, is an association of local investment professionals. As one of the 136 CFA Institute member societies, IAIP connects members to a global network of investment professionals. Consisting of portfolio managers, security analysts, investment advisors, and other financial professionals, IAIP promotes ethical and professional standards within the investment industry, facilitates the exchange of information and opinions among people within the local investment community and beyond, and works to further the public’s understanding of the CFA designation and investment industry.
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