By Mahamoud Islam, Senior Economist for Asia, Euler Hermes

Executive Summary

• Born in late 2013, the Belt and Road Initiative (BRI) is a development and cooperation strategy launched by China. It includes 80+ countries mainly from Asia, Europe and Africa and spans an area accounting for nearly 36% of global GDP, 68% of world population, and 41% of global trade.

• We expect merchandise trade flows between China and BRI partners to grow by +USD117bn in 2019 (after an estimated +USD158bn in 2018). This and boost global trade by +0.3pp, would add +0.1pp to global GDP in 2019.

• For China, exports to BRI markets are expected to grow by +USD56bn in 2019 (after +USD76bn in 2018). BRI will support: business internationalization, overcapacity reduction, economic upgrading, RMB internationalization and the reduction of regional imbalances.  Central and Western Chinese provinces will likely be the first direct winners of the project.

• For partner countries, we see the impact being threefold: a boost in capital (already + 410bn Chinese investment to BRI over 2014-18), a boost in external demand (+USD61bn additional exports to China in 2019) and an improvement in competitiveness thanks to lower transaction costs transportation cost and time of travel, e.g.) and better infrastructure. ASEAN and the Eastern European market are best positioned to take advantage of the project.

• However, the BRI will not be a walk in the park. Three challenges remain unaddressed:

  • Financial sustainability, given China’s limited financial resources (total non-financial debt at 253% GDP) and only partial control over the underlying risks in BRI markets (country risk, e.g.). Funding needs are considerable. We estimate that the capital need to fund infrastructure for Asia (excluding China), Europe and Africa combined would amount to USD1.7tn per year.

  • Legal and regulatory risks, given the absence of a uniform regulatory framework among countries with different law regimes (common law, continental law, Islamic law). This creates uncertainty and complexity for trade and cross-border investment.

  • Political risks, as political tensions among BRI members (Saudi-Iran, India-Pakistan), some BRI members with China (India or ASEAN vs China, e.g.), and battles for influence with other superpowers (with the US, EU) hamper partnerships.

Three remaining challenges: Financial Sustainability, Legal risks, Political risks

Yet the implementation of the Belt and Road Initiative will not be a walk in the park. As evidenced above, potential is important in trade and infrastructure financing but realization of this potential entails a leap of faith with the long-term Chinese view that only selected countries, private financiers and companies outside China are ready to take. Hence the toddling start. Financial sustainability, legal and regulatory risks, as well as political defiance, are to be managed for this platform to accelerate trade and growth in China and partner countries.

Challenge #1: Financing Sustainability of the Project

The first issue relates to China’s financial capabilities. China cannot finance BRI alone considering its domestic financial situation (total non-financial sector debt estimated at 253% GDP, BIS estimate) and the amounts at stake. In fact, using the Global Infrastructure Hub forecasting tool from the World Bank, we estimate that the capital needed to fund infrastructure in Asia (excluding China), Europe and Africa combined would amount to USD1.7tn per year until 2040. In that context, partnership with countries willing to finance the project and private capital will probably be needed. The Chinese government already made some moves to lure investors. In 2018, China’s regulators started to allow the issuance of “Belt and Road” bonds in Chinese stock exchanges in order to fund the initiative: the financial instrument is denominated in RMB and local currencies; foreign companies and government agencies of Belt and Road countries can participate. The second issue relates to the financial viability of BRI projects as more BRI-related borrowings could increase the financial vulnerability of already fragile (with heavy public debt) states. Markets such as Pakistan and Sri Lanka are already heavily indebted and being involved in the BRI strains their public finances. Sri Lanka, especially, had to hand over its strategic port of Hambantota to China as it was struggling to pay its debt to Chinese companies.

Challenge #2: Legal and Regulatory Risks

It is worth noting that there is no commonly shared legal regime among BRI countries. Some countries abide by common law (Singapore, Malaysia, Hong Kong), other by continental law (Central Asia) or Islamic law (Middle East). Consequently, businesses have often failed to comply with local regulatory frameworks. To address the legal disputes, China has decided to establish international courts in Beijing, Xi’an, and Shenzhen to tackle issues arising from BRI. While this solution might work for Chinese corporates, it might not fit the interest of corporates in the EU for example.

Challenge #3: Political Risks

First, the BRI spans an area with territories in conflict. This includes hard conflict (e.g. Afghanistan) but also strong political tensions (Saudi-Iran, India-Pakistan). Second, the BRI is unfolding against a backdrop of political tensions of China itself with countries targeted by BRI investments. For example, it wrestles with India on border issues while it faces backlashes in ASEAN countries. Last, China encounters competition with large economic powers such as the US and the EU. It contends with the US in fields ranging from political and economic leadership to military influences especially in Asia. BRI also overlaps with the EU’s Junker plan, rivaling for influence in Emerging Europe.

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