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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Once completed, US$1.74 billion project will provide electricity for more than seven million households.

The Karot Hydropower Project: The first BRI development to be backed by the Silk Road Fund.

Construction of the Karot Hydropower Project in Pakistan will be completed in two years, with power generation commencing in April 2021, according to the China Three Gorges Corp (CTGC), the project's Beijing-headquartered development partner. A landmark Belt and Road Initiative (BRI) project, it is the first to be funded by the US$40 billion Silk Road Fund, a China-backed investment body established to support the country's ambitious international infrastructure development and trade facilitation programme.

The $1.74 billion Karot Hydropower Project is the fourth of five cascade hydropower stations planned for the Jhelum River. It will generate 3,174GWh (net) of energy a year, which will be sold to the National Transmission and Despatch Company under a 30-year power-purchase agreement.

The dam will be about 95m high and stretch for 460m across the river, while the reservoir created will extend 27km upstream and the surface powerhouse, consisting of four turbines, will be situated approximately 650m downstream of the dam crest. The project specifications also cover four 316m headrace tunnels, a spillway, three 447m diversion tunnels and coffer dams upstream and downstream of the main dam. Once online, it is estimated that the power generated will be sufficient to run approximately seven million households.

The project is managed by the Karot Power Company (KPCL), a special-purpose vehicle established by Pakistan-based Associated Technologies and China Three Gorges South Asia Investment (CSAIL), with the latter responsible for about 93% of the project's funding.

CSAIL is already a big player in Pakistan's energy sector. It currently has five greenfield investments in Pakistan, all of which are clean-energy projects, including hydro and wind power, with a total installed capacity exceeding 2.6 million kW. According to the company, it accounts for about 9% of the country's current installed electricity capacity.

Financing for the Karot project has been arranged on the basis of 20% equity and 80% debt. In addition to the Silk Road Fund, among the other key financing participants is the International Finance Corporation (IFC), which has provided $100 million. The Export-Import Bank of China – the lead player in the consortium – and the China Development Bank are also scheduled to extend loans to the Karot Power Company.

The participation of the IFC has added to the project's credibility and provided reassurance that it will address a number of environmental concerns. The original project environmental impact assessments were conducted and approved in 2010 and 2011. In its own evaluation of the project, the IFC conducted a further environmental and social-impact assessment report and identified a number of further provisions that needed to be put in place in order to bring the project up to the required standards.

Aftab Alam, Senior Manager of Environment for the project's Social and Safety Department, said the IFC, as a member of the World Bank Group, has done all it can to ensure the project meets all international standards relating to a safe work environment. Quarterly monitoring by third-party consultants is also being carried out in order to assess any potentially negative environmental impact.

Once completed, it is hoped that the project will help to significantly remedy Pakistan's chronic power supply shortage. Located on the Jhelum River in northeastern Pakistan and just 55km from Islamabad, the country's capital, the 720MW project will generate about 3.2 billion kWh of power annually, equivalent to about 10% of the country's total hydropower output in 2017.

In addition to the much-needed increase in power, the project is also expected to pay $23 million in taxes to the government and provide more than 2,200 jobs for local workers during the peak construction period, as well as about 3,500 regular jobs over the long-term.

Geoff de Freitas, Special Correspondent, Islamabad

A 25-year development plan for new 250-square-kilometre city set to include world's tallest building.

Silk City: A mega-Kuwaiti-Chinese development set to transform trade and logistics in the Arabian Gulf.

The first phase of a massive US$130 billion, 25-year Belt and Road Initiative (BRI) project has opened in Kuwait. Last month, the 36-kilometre, $3.6 billion Sheikh Jaber Al Ahmed Al Sabah Causeway began operation, connecting Kuwait's capital to its northern shores, cutting the previous three-hour car journey to just 30 minutes.

The long-term strategic importance of the new route lies in the fact that it creates a key logistics connection to Kuwait's northern area and the five nearby islands, which are collectively being reengineered into a new 250-square-kilometre city. The development, Silk City, is the cornerstone project of the New Kuwait 2035 programme, an initiative designed to help the country diversify its economy beyond its traditional reliance on oil, while creating a huge economic free zone linking the Arabian Gulf to Central Asia and Europe.

There are few illusions, however, as to just how long the development will take to complete, with China and Kuwait having originally partnered to deliver on the project in 2014. In July last year, both parties entered into a strategic partnership followed five months later by the signing of a Memorandum of Understanding in Beijing.

The grand scale of the project encompasses the strategically-sited Kuwaiti port of Mubarak Al Kabir, which is currently under construction on the nearby Al Bubiyan Island. With the $9 billion project scheduled for completion later this year, it is one of the most expensive port developments ever undertaken in the region. Located across the sea from Iraq's densely populated Al Faw peninsula, it is just a short distance from the Iraqi port of Um Qasr, from which – much to the annoyance of the local authorities – it is expected to divert substantial business.

Once complete, the project will also include an international airport, a duty-free trade zone, an Olympic-standard stadium, housing, workplaces, retail outlets and entertainment facilities for about 700,000 people – as well as Burj Mubarak al-Kabir, a one-kilometre-tall skyscraper set to succeed Dubai's Burj Khalifa as the world's tallest structure. According to Sheikh Nasser Sabah Al-Ahmad Al-Sabah, Kuwait's First Deputy Prime Minister and Defence Minister, it is hoped that the development will ultimately attract some $450 billion in overseas investment.

In February this year, Ning Jizhe, Vice Chairman of the Chinese National Development and Reform Commission, led a 35-person delegation to Kuwait. During this visit details of the development's next phase, estimated to cost $86 billion, were discussed. At present, it is envisaged that this phase will focus on construction of the airport, the rail network and the Mubarak Al-Kabeer Port trade zone. Chinese construction firms will be heavily involved in the project, with the delegation including representatives of the China Communications Construction Company and the China Development Bank.

The first stage of construction will also see a tradable goods logistics zone built within Silk City, as well as an industrial hub dedicated to supporting small- and medium-sized enterprises. Plans are also in place to develop a procurement strategy for attracting investment to the Mubarak Al-Kabeer Port under a public-private partnership model.

Jonathan Fulton, Assistant Professor at Abu Dhabi's Zayed University and a recognised expert on both China and the Gulf, sees the project as a prime example of China's ambitions in the Middle East. Expanding on this, he said: "This all fits into the maritime component of the BRI. China is already involved in the Khalifa Port in Abu Dhabi, Duqm Port in Oman, Jizan in Saudi Arabia, Djibouti and Port Said in Egypt.

"A close partnership will also be established with Gwadar Port in the China-Pakistan Economic Corridor, which will enhance the Mubarak Port's integration with greater Eurasia, while providing links to the land-based Silk Road Economic Belt."

Geoff de Freitas, Special Correspondent, Kuwait City