By Alicia Garcia-Herrero, Chief Economist for Asia Pacific at NATIXIS; Adjunct Professor, Department of Economics, The Hong Kong University of Science and Technology
Jianwei Xu, Beijing Normal University

1. Introduction

It has been three years since China launched its grand plan of the Belt and Road Initiative (BRI). Although Chinese government has put great efforts to push for the plan, not only inserting related topics in most of its diplomatic events, but also promoting more funded projects in the area, domestic and international concerns regarding the feasibility of the plan have never diminished. Against the back drop, an economic overview of the BRI becomes very important to understand the feasibility of the plan.

To this end, we will discuss the economic progress of the BRI from the trade, investment and financial perspectives, respectively. Trade is most accessible field for China to breakthrough as it can be instantly affected by short-term policies such as removing tariff or non-tariff barriers. If China has established a closer relationship with the BRI area, trade between the two should move upward in a short period. Our findings also confirm the rapid progress in trade, though the development was not equally distributed in the area, with the ASEAN, Middle East, South Asia and Russia constitute the largest trade share with China. Our analysis on the BRI’s spillover effect on the US and the EU reveals that the BRI plan poses actually very little substitution effect but under some scenarios even positive impact on the EU-China trade. We especially assess the impacts on the EU, which sits at the other end of the BRI area, and find that better connectedness within the BRI area will bring higher economic benefits to the EU than free trade agreements.

Compared with trade, investment needs longer time spans to deliver fruits, especially when most of the BRI area is still classified as risky destination and long-term investment takes time to push forward. Needless to say, the BRI area is attractive for nearly every international participant. Our analysis indicates that the progress in investment has been so far discouraging. Although the overall level of China’s oversea investment in the area has been picking up in recent years, the relative share compared with the other destinations actually declined. Chinese oversea investment focuses on the developed world, especially Europe. This can partly be explained by the higher risk associated with many countries in the BRI area. But it is too early to be pessimistic about the plan. It is possible for the trend to reverse in the future. With the rising protectionist atmosphere in the EU and the US, as well as pressure from Chinese regulators to discourage investing in non-productive fields in the developed economies, China is likely to divert more investment to the BRI area, which needs close watch.

Finance is the most difficult part. Although China has set up the Asian Infrastructure Investment Bank (AIIB), the Silk Road Funds, etc., to support the plan, it is far from enough. Various estimates indicate that there is still a big gap to fully fulfil the needs for finance in the BRI area. In fact, the EU has long been an important credit supplier in the BRI area. To better facilitate the grand plan, China must seek international cooperation, especially with the EU.

Admittedly, it is also too hasty to extend our assessment as the final one because it is only three years since the start of the plan, while most of these projects may take a long time to realize their benefits. But our mid-term assessments at least show that it is not easy for China to deal with such a broad area with countries of very different development structures, cultural and political systems. To enhance the efficiency of the BRI, China may consider taking a strategic attitude to implement the plan: first focus on certain low-risk countries, such as the ASEAN countries and Russia, and then extend it to more if their economic conditions have improved.

Last but not the least, the prospect of the BRI hinges not only on the BRI area itself, but how China’s relationships with the US and the EU evolve. If the US started to befriend China and two territories can agree to put aside their conflicts, China may have more incentive to push stronger for the BRI in the area. Otherwise, the development of the BRI will less likely to be a priority for china. The EU also plays a pivotal role in the plan, as some of its members are directly included as BRI countries and the others stay at the other end of the area. If China could gain more confidence from its cooperation with the EU, and the EU is willing to join efforts in finance and investment, the development of the BRI will undoubtedly accelerate…

3. Unbalanced improvement in China’s trade with the BRI area

The Belt and Road countries, despite their dispersion in terms of politics and culture, have become an increasingly important trading partners for China, especially destinations for Chinese exports. Back to 2000, the OBOR countries only constitutes 13% of China’s exports and 19% of China’s imports, but both shares have reached up to 27% and 23% by 2015, with an apparent bigger winner being exports.

Undoubtedly, given the broad dispersion in the stage of development as well as politics and culture, China’s trade with the Belt and Road area also varies across the region. ASEAN, Middle East, South Asia and Russia are China’s largest four trading partners in the region. The other countries are small in terms of economic magnitude, accounting for only three percent of China’s total trade…

4. Investment

One important aspect of China’s ambitious BRI plan is to invest more projects in this developing area to gain capital benefits as its domestic capital return has declined dramatically. Since the announcement of the BRI in 2014, China has accelerated its project negotiation with the BRI area relative to the other countries. China’s signed contract value was only 43780 USD million on April 2014, accounting for 38 percent of China’s total oversea signed contracts, but the accumulated contract value since then has climbed up to 781110 USD million in July 2017, which constitute nearly 50% of the total accumulated signed contract value.

However, it is too early to say that real progress has been made for investment in the OBOR area. Although signed contract value increased dramatically, the accumulated completed contract in the region increased at a relatively slower pace, with its share over the total completed contract only slightly increased from 45% to 46%. This may reflect the fact that most of the existing signed contracts are either ongoing or not started yet. Chart X further shows that the proportion of the accumulated oversea nonfinancial direct investment in the BRI area has actually decreased since 2014 from 15% to 11%. As such, the implementation of the BRI projects seems still lack efficiency…

5. How to finance BRI? Headwinds ahead

The implementation of the BRI includes a number of grand infrastructure plans. But this is easier said than done. The Asian Development Bank (ADB) recently increased its already very high estimates of the amount of infrastructure needed in the region to 26 USD trillion in the next 15 years, or 1.7 USD trillion per annum. The great thing about the China driven Belt and Road initiative is that it aims to address that pressing need, especially in transport and energy infrastructure. The a-priori is that the financing will be there thanks to China’s massive financial resources.

Such a-priori was probably well taken when China was flooded with capital inflows and reserves had nearly reached USD 4 trillion and needed to be diversified. In the same vein, Chinese banks were then improving their asset quality, because the economy was booming and bank credit was growing at double digits. However, the situation today is very different. China’s economy has slowed down and banks’ balance sheets are saddled with doubtful loans, which keeps on being refinanced and does not leave much room for the massive lendings needed to finance the Belt and Road initiative. This is particularly important as Chinese banks have been the main lenders so far (China Development Bank in particular with estimated figures hovering around USD 100 billion and Bank of China has already announced its commitment to lend USD 20 billion). Multilateral organizations geared towards this objective certainly do not have such a financial muscle. Even the Asian Infrastructure Investment Bank (AIIB), born for this purpose, has so far only invested USD 1.7 billion on Belt and Road projects. As if this were not enough, China has lost nearly USD 1 trillion in foreign reserves due to massive capital outflows. Although USD 3 trillion of reserves could still look ample, the Chinese authorities seem to have set that level as a floor below which reserves should not fall so that confidence is restored. This obviously reduces the leeway for Belt and Road projects to be financed by China, at least in hard currency.

Against this background, we review different financing options for Xi’s Grand Plan and their implications. The first and least likely one, is for China to continue such huge projects unilaterally. This is particularly difficult if hard-currency financing is needed, for the reasons mentioned above. China could still opt for lending in RMB, at least partially, with the side-benefit of pushing RMB internationalization. However, even this is becoming more difficult…

6. Conclusion

This paper makes a mid-term assessment for China’s BRI from the perspective of trade, investment and finance, respectively. We find that trade has made significant progress in the BRI area in the past three years, but the development was not equally distributed in the area. The progress in investment has been so far more discouraging. Although the absolute level of China’s oversea investment in the area has been picking up in recent years, the relative share compared with the other regions actually declined. The financial aspect of the BRI is also uncertain. China has injected its own funds through various institutions, but various estimates indicate that there is still a big gap to fully fulfil the needs for finance in the BRI area, which requires more international cooperation.

All in all, China’s progress in the BRI is still on the way. The future of the BRI may continue to go in a very unbalanced direction, especially towards ASEAN and Russia. The actual investment in this area is also expected to increase and upgrade with more technology, but this hinges not only on the BRI area itself, but how China’s relationships with the US and the EU evolve. More importantly, China cannot finance the BRI by itself and needs to cooperate with the EU and US for the development of the BRI.

This article was first published by HKUST Institute for Emerging Market Studies. Please click to read the full article.