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AfricaSeptember 1 2015

Will China's New Silk Road progress smoothly?

China's One Belt, One Road initiative – building a new Silk Road between western Europe and China's east coast as well as improving the Maritime Silk Road – will be a major game changer for international trade. Stefania Palma assesses its possible impact.
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A smooth journey for the New Silk Road

Three continents, 4.4 billion people and 29% of global gross domestic product (GDP): the One Belt, One Road strategy, put forward by Chinese president Xi Jinping in 2013, could become the largest commercial, political and cultural endeavour in modern history.

Echoing the Silk Road established in China’s Han dynasty that ran from 206 BC to 220 AD, One Belt, One Road includes the New Silk Road Economic Belt linking China with Europe through central and western Asia via land, and the 21st-century Maritime Silk Road, which will link China to south-east Asia, Africa and Europe. 

But if the original Silk Road mainly focused on trade, today’s project is a more complex mirror to China’s economic development and necessities. Today, investment is key at a time when China is upgrading its economic model to fight economic slowdown and digest overcapacity at home.

Outward direct investment (ODI) is ballooning and growing more sophisticated as China learns from occasionally controversial investment practices in Africa. At the same time, China is flexing its geopolitical muscle through new multilateral funding entities, such as the Asian Infrastructure Investment Bank (AIIB), which are backing infrastructure investment along the New Silk Road.

As far as international co-operation is concerned, if the original Silk Road focused on trade relations between its two poles – Europe and China – today’s initiative attributes strategic importance to central Asia and the Middle East, on an economic, political and security level. It is not a coincidence that today’s Silk Road talks with Europe are taking longer to finalise as more strategic interests lie within neighbouring, resource-rich regions such as central Asia.

Contrary to the original Silk Road, the One Belt, One Road strategy is also crucial for China’s domestic agenda: one of its aims in helping develop the poorer western and north-eastern Chinese regions is to reduce intra-province inequality.

How Chinese companies’ outward investment  is diversifying away from energy and mining

Outward investment boom

The One Belt, One Road initiative is reinforcing a new development in China’s economy – the unprecedented growth of Chinese ODI, which is set to outpace foreign direct investment (FDI) in the country for the first time in 2015.

“China has come from a period of very high investment and rapid growth in capital spending, fuelled by the government’s post-2008 stimulus. Now this has slowed decisively over the past year, there is a lot of over-capacity, especially in firms related to construction, transport and upstream industries [such as cement and steel],” says Hannah Levinger, Asia economist at Deutsche Bank. But this year ODI from China is expected to grow to $128bn ($6bn above China’s FDI), according to the National Bureau of Statistics and Ministry of Commerce of China. 

Significantly, China’s ODI is also growing to be more sophisticated. In 2010, more than half of Chinese outward merger and acquisition (M&A) activity was in energy (53%); in 2014 this sector accounted only for 1.3%. Meanwhile, the percentage of ODI in telecommunications media and technology (TMT), real estate, leisure and construction, financial services and the automotive sector almost doubled from 2010 (23%) to 2014 (47%).

This is testament to China’s efforts to upgrade its economic model from an investment-focused to a consumption- and services-driven market. “Chinese companies are investing overseas – not only for foreign resources and markets, but also to bring in products and services to meet the growing domestic demand,” states the EY report 'Riding the Silk Road: China sees outbound investment boom'.

The recipient countries of Chinese ODI have also changed. “Investments abroad initially aimed to access natural resources and implement soft power (mostly in Africa, where [China] had access to commodities). In recent years, Chinese companies are investing more in advanced countries, including [those in] western Europe,” says Ms Levinger.

In the EU, Chinese investment flows more than doubled between 2013 and 2014, reaching €12.1bn. China’s outbound M&A in Germany, its largest EU trading partner, totalled $98m in 2010. By 2014, this figure had grown to almost $2.5bn, according to Dealogic.

This came about through deals such as Fosun International making a binding offer to the shareholders of the Frankfurt-based private bank Hauck & Aufhauser in 2015, in the first outright Chinese acquisition of a German bank. Fosun International, together with Anbang Insurance, is also in the race to purchase Portugal’s Novo Bank – the ‘good bank’ created from the dismantling of Banco Espirito Santo – in what, at €4bn-plus, will be the largest European financial services acquisition by a China-based group.

Chinese outbound M&A deals 2015

Geopolitical muscle

The One Belt, One Road initiative is also very much about much-needed infrastructure investment. The Asian Development Bank (ADB) predicted that Asia’s infrastructure spending will amount to $8300bn between 2010 and 2020.

Infrastructure projects linking the One Belt, One Road project will be funded by a combination of the Chinese government, Chinese development entities such as the China Development Bank and new institutions including: a $40bn Silk Road infrastructure fund, the AIIB – with $100bn in capital and China contributing $29.87bn – and the BRICS New Development Bank (NDB), with a subscribed capital of $50bn and an authorised capital of $100bn. A BRICS monetary fund was meant to be launched on July 31, 2015, but no details have so far been released.

These new institutions are giving a stronger voice to emerging economies which, despite their economic clout, feel under-represented in institutions such as the US-heavy World Bank, the Europe-heavy International Monetary Fund (IMF) and the Japan-heavy ADB. 

If these new institutions commit to issuing loans in renminbi, they could also help the yuan qualify as a global reserve currency (meaning entering the IMF’s special drawing rights basket). Achieving this status is as much about a significant amount of global trade being executed in renminbi as it is about making the currency ‘freely usable’, meaning a considerable amount of global settlements are done in yuan. The NDB for one stated that its first loan, to be announced in April 2016, will be issued in renminbi.

Lessons from Africa

But for Chinese investment to be welcome, it will have to have a more sophisticated and co-operative approach than has sometimes been the case in Africa, according to many analysts.

“To be honest, some of the manufacturing standards in Africa initially were not as high as in other markets. But now manufacturing involves higher quality products and combinations of local and Chinese resources,” says Keith Pogson, senior partner and global assurance leader, financial services for Asia-Pacific at EY. “[China’s new] approach… is politically smart and not as blunt as the approach in Africa. China is starting to learn that projects need a mix of domestic and Chinese resources.” 

Involving local labour will be a way to ensure a good relationship between Chinese investors and the host country. “We have started to see this in hotels in the Caribbean, manufacturing in Africa, commodities in South America,” says Mr Pogson.

An example of a country wary of China’s investment track record is Sri Lanka. Former president Mahinda Rajapksa built strong relations with Beijing, but the current president, Maithripala Sirisena, has made it a point to diversify foreign relations. He also suspended the construction firm China Communications Company’s (CCC's) Colombo Port City project on the basis of its lacking the correct permits and approvals.

In a statement, CCC said: "The company will be taking all necessary steps to provide these requested documents as instructed by the Ministry of Ports, Shipping and Aviation to abide by the notification received... CCC will continue to comply with the laws of the country, and follow the necessary guidelines issued by the government for a mega development project of this nature." 

One Belt One Road: quick facts 

  • Population 4.4 billion
  • Share of global GDP 29%
  • China’s planned investment $900bn
  • Capital of dedicated funding entities up to $300bn
  • Asia’s infrastructure funding gap (2010-2020) $8300bn

Sources: China embassy in UK, Asian Development Bank, China Daily

Ms Levinger says: “One has to keep in mind that such large investments in infrastructure are often long term and lumpy in nature, and may entail political risks.”

For the One Belt, One Road project to run smoothly, it will also be crucial for there to be proper benefits for the countries that lie between China and the EU, according to Ayumi Konishi, director-general of the ADB’s east Asia department. “When people talk about ‘economic linkages’… nobody wants to be in the middle, where there is just a pass-through. These countries want to know ‘what’s in it for us?’ We have to make sure that ‘economic linkages’… benefit everybody. It is not an easy task,” he says.

The most strategic region 'in the middle' is central Asia, where there are already concerns about China’s presence in extractive industries, according to an official based in the region. “Dealing with energy investment might be more delicate due to old ‘pipeline politics’,” adds Mr Pogson.

“The Chinese government is not always great at getting the message across outside of its own borders. It has a political model that is not appealing to the outside world,” adds Kerry Brown, director of the China Studies Centre at the University of Sydney.

Central Asian questions

And yet, central Asia and China have a lot to gain from each other, say analysts. They both offer access to large, populous economies. China is interested in central Asia’s natural resources and foodstuffs. Meanwhile, the Silk Road Fund has committed at least $16bn to central Asian infrastructure development.

“I think central Asian economies will be the winners in this initiative – they will be exposed to trade they didn’t have access to before,” says Mr Pogson.

However, China and central Asia’s embryonic diplomatic ties could lead to hiccups in negotiations, according to Mr Brown. “The real problem is skin deep. There is not a lot of trust or cultural overlap. This new initiative could highlight historic, cultural and psychological differences. China cannot easily talk about security with central Asia, [for instance], which has always been a problematic area, even to Imperial China. The One Belt, One Road [initiative] is quite a nice, abstract way of pretending there is unity that probably is not as deep as it wants to be shown,” he says.

Kazakhstan focus

As the largest economy in central Asia, Kazakhstan is becoming a key trade and investment partner for China. In March 2015, Kazakhstan and China signed 33 deals worth $23.6bn. China-Kazakhstan trade and investment totalled $24.1bn in 2013.

“Two years ago, I went to visit the Chinese consulate [in Kazakhstan] to talk about trade flows and how the European Bank for Reconstruction and Development [EBRD] can be part of that. It was very closed at the time. There is a much more open attitude today,” says Janet Heckman, the EBRD director for Kazakhstan. 

As the world’s largest producer of uranium, Kazakhstan is China’s most important supplier of this material. To achieve its nuclear power generation objectives, China will need between 500,000 and 1 million tonnes of uranium by 2050. In 2050, China could require as much uranium annually as the entire world does today, say Hui Zhang and Yunsheng Bai, senior researchers at Harvard University.

In the oil and gas sector, China accounts for 24% of oil and gas investment in Kazakhstan. “In particular, it allows gas from Turkmenistan to transit in pipelines via Kazakhstan,” says Ms Heckman. What is more, two years ago China National Petroleum Corporation won the 8.33% stake in Kazakhstan’s Kashagan Caspian offshore project for roughly $5bn, which was originally meant for India’s Oil and Natural Gas Corporation. “I suspect it was due to bilateral relations with China,” says Ms Heckman.

Chinese companies are also involved in Kazakh infrastructure projects. One of the five pre-qualified consortia to build the $1bn ring road around Almaty, the Big Almaty Ring Motor Road, is a Chinese company.

Meanwhile, food security remains a big issue for China, and the government will also be interested in Kazakhstan’s immense agriculture potential, according to Ms Heckman. “In the north [of Kazakhstan], with wheat and grain, and in the south, with edible oil, cotton, fruit and vegetables, I expect to see more Chinese investment in agri-business,” she says.

Conversely, Kazakhstan is also investing in China’s ports, according to Ms Heckman. The transport links set up in Kazakhstan will also be used to connect China to the Middle East.

Middle Eastern foray

Another key issue will be what happens to Iran following moves to lessen the sanctions imposed on the country by many Western powers. If its economy opens up after this year’s crucial nuclear deal, Iran could play a role in the One Belt, One Road strategy. “Iran was key in the first Silk Road… and it would want to play a very active role [today]. There are trains connecting it to Kazakhstan and the new Caspian routes connecting through Iran and transiting down to ports such as Bandar Abbas,” says Ms Heckman.

More than half of China’s imported oil comes from the Middle East, and China has big commitments in Iran, Egypt and Saudi Arabia, says Mr Brown. “But it is very desperate to not get dragged into the politics of the region,” he adds.

Pakistan could also become a vital juncture connecting China to the Middle East. If realised, the proposed $46bn China-Pakistan Economic Corridor will become China’s largest commitment to a foreign country’s economic development. 

The plan constitutes a 3200-kilometre commercial route between north-west China and Gwadar, a warm-water port in Pakistan looking out to the Middle East, which will be run by the Chinese. The corridor also has enormous potential to tackle pervasive energy sector problems, says Ms Levinger.

EU in progress

If Sino-central Asian One Belt, One Road projects are evolving quickly, the same thing cannot be said for Europe – the key destination of the original trade route. The only official talks taking place between the EU and China are in relation to the EU-China Investment Agreement, which aims to liberalise investment and provide a simpler and more secure legal investment framework, according to the European Commission.

Market participants say it is early days for official talks on the One Belt, One Road project. “I suspect that agreements will be finalised first with China’s neighbours and then will move towards the EU,” says one Asia-based official.

However, at the June 2015 EU-China summit, the parties released a joint statement saying they might establish a China-EU co-investment vehicle on the back of the One Belt, One Road project. In the statement, both parties agreed to improve transport links and help develop areas between China and the EU with a new ‘connectivity platform’. Considering that the AIIB boasts 17 EU members, One Belt, One Road initiatives involving the EU and China might not be far off, say analysts. The European Commission was not available for comment.

China's domestic development

Aside from international co-operation, the One Belt, One Road initiative is very much a domestic Chinese development story too. Historically, coastal provinces have rushed ahead, whereas western areas and north-eastern regions have lagged behind. 

But the One Belt, One Road project involves 18 provinces in China, where cities could become railway hubs or see their port infrastructure improve. Even local banks are looking to be involved in this project.

“Many less developed provinces such as Xinjiang autonomous region, Yunnan province, Guangxi autonomous region and Inner Mongolia autonomous region are now fully integrating regional co-operation in their development strategies. They’ve been wanting to see the development of regional co-operation and enhanced support of the central government in this regard,” says the ADB’s Mr Konishi.

In Xinjiang, there are long-standing tensions between its Muslim, Turkic-speaking ethnic group – the Uighurs – and Beijing. But consolidating commercial ties between Xinjiang and Kazakhstan could help calm the waters. “As you increase trade and production and start to open up, one would hope that it will improve economic circumstances of dwellers in China’s border areas,” says Ms Heckman.

The One Belt, One Road initiative represents the most ambitious example of international co-operation of modern times, with enormous development potential within and outside China’s borders. It is still early days, but if commercial ties are carried out fairly and in a balanced way, the New Silk Road represents the single biggest challenge to the post-World War Two geopolitical and economic world order.

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