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Global Risks Forecast™

China’s Belt & Road: One initiative, many questions

China’s Belt & Road: One initiative, many questions

Representatives from 57 countries, including 28 heads of state and government leaders, attended the inaugural Belt and Road Forum in Beijing last month. China used the high-profile event to extol the virtues of its One Belt, One Road (OBOR) initiative and articulated a vision of win-win cooperation and mutual benefit. However, the true nature of President Xi Jinping’s signature foreign policy initiative remains an enigma, despite its significance for business. Here, we seek to explain what China is trying to achieve and what that might mean for our clients.

What is OBOR?

Launched in the autumn of 2013, China’s OBOR (also known as the ‘Belt and Road’ or ‘New Silk Road’) initiative is President Xi Jinping’s flagship policy to revitalise ancient trade routes. The ambitious development strategy aims to enhance regional connectivity along a ‘land belt’ linking China with Europe through Central Asia and the Middle East, and a ‘maritime road’ connecting the Middle Kingdom with littoral states in the South China Sea, Indian Ocean and the Mediterranean.

Infrastructure development along various economic corridors and passages is the central plank of the scheme (see Map: Economic corridors and passages under OBOR). China plans to invest hundreds of billions of dollars to create a network of roads, railways, ports, power plants, pipelines, LNG terminals, industrial zones and logistics centres along the proposed routes, which it hopes will collectively grease the wheels of commerce in a Sino-centric economic order.

In his keynote speech at the OBOR forum, Xi confirmed that, while all countries are welcome to participate, the initiative will focus on the Asian, European and African continents. Beijing has circulated a list of 64 countries that are located along the land and sea routes, but these states have not all necessarily endorsed the scheme. Most notably, India remains deeply sceptical of China’s strategic intentions and sent no representatives to the forum in Beijing. Neither will OBOR cooperation necessarily be limited to the ‘OBOR 64’.

In reality, Beijing is likely to work with any willing partners on a broad swathe of projects in support of its vision. Indeed, OBOR is best understood as a branding exercise designed to give shape (and a friendly face) to China’s foreign policy, rather than a detailed policy plan.

Map: Economic corridors and passages under OBOR

Source: Verisk Maplecroft; National Development and Reform Commission; State Oceanic Administration

What does China hope to achieve?

China is hoping to achieve three broad goals through the initiative that include both commercial and geostrategic elements.

Firstly, and perhaps most importantly, China is seeking to strengthen economic links with countries along the Belt and Road through increased trade, investment and financial flows. This will create overseas demand for Chinese industrial outputs and engineering services, support the expansion of exports to under-exploited markets, and help drive economic development in some of China’s least developed western provinces.

Secondly, Beijing wants to strengthen trade and energy security by diversifying commodity import routes, thereby reducing the country’s reliance on seaborne trade that passes through strategic chokepoints. Projects in pursuit of this goal will ideally be commercially viable, but in some cases, China will prioritise geostrategic considerations.

The supply of oil is an illustrative example. As the world’s largest importer of crude oil, China has long been wary of becoming over-reliant on any one oil-producing state. But around 80% of Chinese oil imports transit through the narrow Strait of Malacca (see Figure: China's oil and gas imports). Policymakers in Beijing fear that in the event of war or heightened tensions, a targeted naval blockade would disrupt China’s energy imports and bring the economy to its knees. Alleviating this ‘Malacca Dilemma’ is all the more pressing if one considers that China’s reliance on foreign oil is only set to increase over the next 20 years, as shown in Figure: Origin of China’s oil imports by region. Indeed, the fact that China is not self-sufficient in energy is a key factor driving its high risk rating in our Energy Security Index.

Figure: China’s oil and gas imports by source

Source: Verisk Maplecroft, 2017; Wood Mackenzie, 2017; NCEAS, 2008

Figure: Origin of China’s oil imports by region

Source: Wood Mackenzie

This motivation to diversify commodity import routes can be detected in the most high-profile OBOR scheme to date – the China-Pakistan Economic Corridor (CPEC): a plan worth tens of billions of dollars to link China’s restive Xinjiang province with the Indian Ocean (see Map: Economic corridors and passages under OBOR). The CPEC has been derided as a white elephant in some quarters, and Chinese officials acknowledge in private that it is unlikely to make a commercial return. Nevertheless, sceptics underappreciate the stock that strategic planners in Beijing place on opening up an alternative import route for oil and other commodities via the Chinese-operated port of Gwadar in Balochistan.

Thirdly, Beijing wants to spread its soft power and geopolitical influence, as part of a broader aim to ‘rejuvenate’ the Chinese nation and reclaim China’s historical pre-eminence in Asia. OBOR is designed to distract from a more assertive foreign policy under Xi on issues such as the South China Sea and foster international goodwill through the shrewd calculation that economic influence nearly always translates into diplomatic leverage.

At what cost?

Estimates as to the value of China’s planned investments vary wildly depending on the criteria used to define an 'OBOR project', but a ball-park figure would be around the US$1 trillion mark. Yet, there is clearly a shortfall from the astronomical sums promised by Beijing and the (still considerable) financial resources currently deployed: China Global Investment Tracker (CGIT) data indicates USD240 billion-worth of Chinese investments and construction contracts in 'OBOR 64' countries since the scheme’s launch. The main vehicles for financing OBOR are China’s state-owned policy banks, its sovereign wealth and Silk Road funds, and the Beijing-backed Asian Infrastructure Investment Bank.

In some cases, Chinese financing is made available in return for an equity stake in a specific project – the Yamal LNG development in Russia is a good example of how this model works. However, the typical model is for China to provide loans to finance a venture, with Chinese SOEs in pole – if not sole – position to win the associated construction contracts. The terms of these loans are often opaque and are not necessarily always concessional.

Indeed, some finance deals are thought to be secured against untapped natural resources or include sweeteners such as the right to commercially develop surrounding land, particularly where default risks are high or the project economics unattractive. While such lending terms reduce the overall financial risks borne by the Chinese state, they can be a source of contention within host countries, as has been the case with a high-speed railway in Thailand for example.

Individual debt write-downs from states unable to pay back OBOR loans will, in some cases, hit China in the pocket and potentially exacerbate stresses in the Chinese financial sector. However, such a scenario may also increase Beijing’s diplomatic leverage with beholden governments.

What obstacles do OBOR projects face?

Map: Political risks in countries along the Belt and Road

Source: Verisk Maplecroft, 2017

Investing in projects across a swathe of countries in Asia, Europe and Africa throws up an array of diverse risks, which will vary depending on the project or location. According to a recent survey conducted by the Centre for China and Globalisation, a Beijing-based think-tank, Chinese companies are particularly wary of political risks, with political unrest, policy changes and government expropriation topping the list. As shown in Map: Political risks in countries along the Belt and Road, this concern is well founded. Various geopolitical, economic, social and environmental risks will also present significant obstacles to individual ventures.

Figure: OBOR Risk Landscape overlays some of Verisk Maplecroft’s propriety risk data with Chinese investments and infrastructure contracts in selected 'OBOR 64' countries since the scheme’s launch. While this data point is imperfect (it assumes all investments and contracts in ‘OBOR states’ are ‘OBOR projects’), it provides a signpost of China’s economic engagement and a snapshot of the risk landscape. The figure shows that Beijing has generally done business with states that have relatively stable governments and cordial diplomatic relations with China. Nevertheless, sizeable cumulative investments and contracts with countries such as Iraq (USD4.6 billion) or India (USD5.4 billion) highlight the high risk of government instability or militarised inter-state tensions respectively delaying or derailing some projects.

Moreover, Figure: OBOR Risk Landscape II shows that many investments or contracts have been with countries where projects risk being disrupted by civil unrest or challenging regulatory environments. For instance, violent protests earlier this year thwarted a USD1.1-billion debt-for-equity deal for a Chinese SOE to take over the Hambantota deep-sea port in Sri Lanka on a 99-year lease. Meanwhile, the Jakarta-Bandung high-speed railway in Indonesia has been beset by permitting delays and difficulties acquiring the necessary land.

Figure: OBOR Risk Landscape

Source: Belt and Road Portal; Verisk Maplecroft; China Global Investment Tracker

Figure: OBOR Risk Landscape II

Source: Belt and Road Portal; Verisk Maplecroft; China Global Investment Tracker

What does it all mean for our clients?

While the impacts and opportunities associated with OBOR will of course vary depending on sector, geographical focus and risk appetite, it is nevertheless worth highlighting two broad points.

Understanding China’s OBOR initiative is a prerequisite for any investors looking to position their operations or portfolio to maximise benefit or minimise loss. A flurry of infrastructure projects and ancillary developments will present opportunities across a range of sectors – including energy, metals and mining, insurance, transport and financial services – for those companies able to navigate the risks associated with doing business in what are mostly emerging or frontier markets. While Chinese SOEs will undoubtedly be the largest beneficiary of the scheme, there is plenty of scope for international companies to partner with, or be subcontracted by Chinese firms, in projects along the routes.

As the world largest energy consumer, China’s bid to improve its energy security will have a significant impact on how oil and gas crisscross the globe over the coming decades. Efforts to diversify import routes were evident before the launch of OBOR. Nevertheless, strong policy support and funding from Beijing under the auspices of the initiative will see this diversification trend accelerate, despite the potential for individual setbacks at the project level. International energy companies would do well to appreciate this policy driver when seeking to align corporate strategies with China’s grand vision.

Hugo Brennan, Politics Analyst, Asia

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