By Lawrence J. Lau

Economic analysis tells us that voluntary free trade benefits both the exporting and the importing countries. It also tells us that direct investment, which is necessarily long-term in nature, and long-term portfolio investment benefit both the investor and the investee countries. So on this basis, both international trade and long-term cross-border investment should be encouraged and promoted. What new initiatives can be undertaken to enhance the growth of international trade and long-term cross-border investment, and in so doing enhance the growth of the world economy as a whole?

The United States, as the largest trading nation in the world, in terms of goods and services, and China, as the second largest trading nation in the world (the largest in terms of goods alone), can jointly provide leadership in global trade promotion initiatives. Similarly, the U.S. and China, as the two largest countries of origin as well as destination of foreign direct investment can also jointly provide leadership in facilitating cross-border direct investment.

Even though for the economy as a whole every trading country is supposed to have a net gain from international trade, trade does create both “winners” and “losers” inside every country. One vexing problem of long standing for governments worldwide is how to redistribute the gains from international trade among their citizens so that everyone, or almost everyone, receives a net benefit. Unless the “losers” can feel that they have also benefited from international trade, they will oppose the expansion of trade and further opening of the economy. This is a problem that we shall attempt to address in Sections 2 and 3.

The harmonisation of product standards is also a long-standing issue in international trade—if standards can become more harmonised, it will facilitate trade, reduce transaction costs and lower the prices of many imported goods. Another major issue is the redefinition of the rules of origin to take into account the fact that the same product is today processed at or includes components and parts from many different economies so that it cannot be properly considered to have originated solely from the location of the final assembly and packaging. There is a crying need for the revision and simplification of these rules and to base them on the relative value added of different economies to a finished product. The treatment of cyber trade is also becoming a hot issue as it has been increasing by leaps and bounds, both within as well as across economies.

The growing proliferation of free trade areas (FTAs) around the world also raises the concern that the world trade system may once again become fragmented. A mechanism for open accession by countries or regions which are not original signatories to specific free trade agreements will help to avoid the increasing fragmentation of the world trade system. There is also a need to facilitate long-term cross-border investment flows, especially considering the vast differences in saving rates and demographic conditions across different economies. Bilateral or multilateral investment treaties based on the principle of national treatment can be very useful in this regard.

Finally, it may be helpful to the reduction of global carbon emissions by imposing a global tax on imports that depend on the carbon content. The tax rate does not need to be high, but such a tax will send a signal that the entire world will be working together to prevent climate change. All of these issues will be discussed.

This is the time for developing innovative ideas! This is the time to consider the next generation of enhancement of the world trade and investment systems!

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By Lawrence J. Lau

The age of the Renminbi is just beginning. In order to understand the rise of the Renminbi, it is important to realise that the centre of gravity of the World economy, in terms of both GDP and international trade, has been gradually shifting from North America and Western Europe to East Asia, and within East Asia from Japan to China, over the past couple of decades. China has become the second largest economy by GDP as well as the second largest trading nation in the World. The Chinese economy has also been growing and continues to grow at much higher rates than North American and European economies and Japan. China, with a national saving rate in excess of 40%, is a potential large foreign direct and portfolio investor to the rest of the World.

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By Stuart Larkin, Institute of Southeast Asian Studies

Executive Summary

The Asian Infrastructure Investment Bank (AIIB) is one of two new China-led multilateral development banks launched during 2014, along with the US$ 40 billion Silk Road Fund. They join an existing array of institutions for China to export capital and together they signal a quantum step up in the country’s international financial expansion.

The Silk Road Economic Belt and the 21st Century Maritime Silk Road together envisage a comprehensive trans-Eurasian network of economic corridors and maritime trade routes (with the inferred market penetration), with the countries of Eurasia and the maritime Asia Pacific invited to join a “community of shared destiny”.

The AIIB’s purpose is to lead on implementing this “Belt and Road” vision, and become an instrument of “soft power” by providing “public goods” to address the region’s “funding gap” with its infrastructure loans. AIIB’s multilateral structure is for inclusiveness to help alleviate political opposition and fear of China’s rapid rise.

The AIIB plays a role in China’s domestic economic restructuring by exporting capital. The country needs to drain its domestic economy of surplus savings to improve returns on investment and raise the efficiency of resource allocation at home.

China’s US$ 4 trillion of foreign exchange reserves can be drawn on to finance infrastructure development for a return superior to those of US Treasury bonds. But the AIIB will also play a role in channelling Renminbi savings overseas by selling its own bonds in the home market as well as developing the offshore Renminbi market by securitizing its project loans.

Effective redress of regional (and global) infrastructure finance markets requires considerable managerial, technical and diplomatic skill. If successful, China will become a major player in global finance.

“China’s “Great Leap Outward”: The AIIB in Context” by Stuart Larkin, first appeared in ISEAS Perspective No.27, 2015. Reproduced here with the kind permission of the publisher, Institute of Southeast Asian Studies, Singapore http://bookshop.iseas.edu.sg

By Fung Business Intelligence Centre

While the Belt provides ample opportunities for sourcing resources and commodities from the West and Central Asia, the emerging South and Southeast Asian countries along the Road are potentially vast consumer markets. It was estimated that countries along the Belt and Road would create an “economic cooperation area” that jointly account for 64.2%, 37.3% and 31.4% of the world’s population, GDP and household consumption respectively. The report also pointed out that in implementing the “One Belt One Road” initiative, business opportunities would be seen in sectors such as infrastructure construction, finance, trade and logistics, distribution and retail.  

Please visit the Fung Business Intelligence Centre website for the full report.

By Zhao Hong, Institute of Southeast Asian Studies

Executive Summary

In 2013, Chinese President Xi Jinping unveiled plans for two massive trade and infrastructure networks connecting East Asia with Europe. While Southeast Asian countries may laud some of Beijing’s initiatives, their view of the long-term trajectory of their economic relations with China is also tinged with caution, for two reasons.

First, as the economic size and power of China have expanded tremendously relative to Southeast Asia since the 1990s, this growing asymmetry alone worries some in the region, and poses an important obstacle to China’s ability to convince ASEAN countries that its intentions are benign.

Second, ASEAN countries may worry that being overly dependent on China economically would allow Beijing to use its dominance to undermine their foreign policy. For example, the Philippines, the second largest Southeast Asian state by population, seems to be excluded from the Maritime Silk Road.

For China, the construction of “One Belt One Road” is the primary strategic objective for the coming years. It cannot be easily separated from the South China Sea question, especially in view of the new round of dispute escalation since April this year. Therefore, it is essential for China to still (or at least significantly reduce) the security concerns of ASEAN countries.

Although there exist some problems between China and ASEAN countries, especially disputes over maritime territory, Beijing sees the development of its relations with ASEAN as a priority in China’s foreign diplomacy. The New Maritime Silk Road and the establishment of the Asian Infrastructure Investment Bank (AIIB) manifest China’s long term commitments to the region, suggesting that the importance of ASEAN in China’s overall diplomacy layout is on the rise.

Indeed, as the largest country among the claimant states in the South China Sea and a major power in Asia Pacific and the world, China should exercise more leadership in facilitating joint development in the South China Sea. This holds prospects for longer term territorial compromises and can become an underpinning factor for peace and stability in the region.

“The Maritime Silk Road and China-Southeast Asia Relations” by Zhao Hong, first appeared in Trends in ISEAS Perspective No.35, 2015. Reproduced here with the kind permission of the publisher, Institute of Southeast Asian Studies, Singapore http://bookshop.iseas.edu.sg

By Zhao Hong, Institute of Southeast Asian Studies

Executive Summary

In 2013, Chinese President Xi Jinping unveiled plans for two massive trade and infrastructure networks connecting East Asia with Europe: the New Silk Road and the 21st Century Maritime Silk Road (“one belt one road”). The plans aim to reinvigorate the ancient Silk Roads with a modern network of high-speed rail, motorways, pipelines and ports stretching across the region.

The idea of the New Silk Road and the New Maritime Silk Road was raised because China’s domestic economy is experiencing structural changes that reflect a “new normal” of slower but better quality growth.

More importantly, it signals a shift in China’s strategic thinking and foreign policy towards prioritizing the relationship with neighbouring countries. Hence, it has many implications for Southeast Asian countries.

China’s extension of the New Silk Road diplomacy is driven by both economic and political considerations. It is eager to participate in the construction of ports and other related facilities in Southeast Asia and hopes that outward infrastructure investment will help boost production capacity in its iron, steel, aluminum and cement industries for export purposes.

China sees a huge potential in upgrading infrastructure in Southeast Asian countries and is hence supportive of Chinese companies’ participation in such projects. The competition among Chinese provinces for much of this business is likely to launch a new round of investment projects. Some of China’s local governments have been lobbying and organizing activities for preferential policies and financial support from the central government since the Maritime Silk Road initiatives were announced.

Beijing’s new Maritime Silk Road initiative poses an attractive vision of countries working together in pursuit of mutually beneficial cooperation. This initiative appears all the more seductive when it fits with the Master Plan on ASEAN Connectivity and President Jokowi’s vision of maritime power. Nevertheless, there are a number of challenges that China will have to deal with.

Indonesia is the largest country in Southeast Asia and shares many common interests and visions with China in the context of the New Maritime Silk Road initiative. The two countries can strengthen cooperation on transport infrastructure construction as well as on security.

ASEAN countries badly need more infrastructure investment and perceive that multilateral and private sector organizations are not acting fast enough to meet their needs. However, while China has tried to reassure its neighbours that its rapid rise is accompanied by peaceful intentions, there is no guarantee that this will be the case in the long term. There exists a deep-rooted fear among Southeast Asian countries that China has plans that go beyond building roads, laying railways, upgrading ports and boosting trade.

“China’s New Maritime Silk Road: Implications and Opportunities for Southeast Asia” by Zhao Hong, first appeared in Trends in Southeast Asia No. 3, 2015. Reproduced here with the kind permission of the publisher, Institute of Southeast Asian Studies, Singapore http://bookshop.iseas.edu.sg

By E Zhihuan, Chief Economist, Bank of China (Hong Kong)

In light of the recent global economic landscape, the Chinese government launched the Belt and Road Initiative, a national strategy that represents a new form of cooperation. The initiative is expected to turn a new page in international cooperation, create new synergy for the world’s economic growth, and provide Hong Kong with new opportunities for development.

Four innovations of the Belt and Road Initiative

Regarding international cooperation, the initiative presents four key new ideas:

Driven by multiple cooperation mechanisms, the initiative aims to build a community of shared interests through improving infrastructure and connectivity. This innovative concept and type of economic cooperation is significantly different from the traditional ways of regional cooperation.

The initiative focuses on building six major economic corridors, including the New Eurasia Land Bridge, China-Mongolia-Russia and China-Pakistan Economic Corridors, to enhance the flow of capital and talent around the world.

Under the “One Country, One Policy” principle, China has signed Memorandums of Understanding and formulated roadmaps with countries along the Belt and Road, which sets a new example of international cooperation.

Multilateral financial institutions such as Asian Infrastructure Investment Bank and New Development Bank have been established to raise capital for construction projects.

If the Belt and Road Initiative is implemented smoothly, the region will account for half of the world’s GDP in 20 years’ time, becoming the new driver for global economic and wealth growth.

Five opportunities for development under the Belt and Road

In driving the Belt and Road projects, Hong Kong can play to its collective strength and grasp new opportunities:

Hong Kong can serve as a platform for infrastructure investment and management. The Belt and Road will bring about strong growth in infrastructure investment along the route. When choosing partners in infrastructure investment and management, Hong Kong can give priority to countries with close trade ties with China, or countries which are politically stable, having good cross-border cooperation and strong industrial complementarity.

Countries along the Belt and Road are rich in natural resources with huge reserves in oil and natural gas, presenting high utilization potential. The development of industries such as petrochemical, metallurgy, deep processing, mining, mechanical manufacturing and electronics will accelerate, creating business opportunities for Hong Kong enterprises.

Over the next ten years, bilateral trade between China and countries along the route will exceed US$2.6 trillion. Hong Kong can leverage its advantages in trade, bonded trade, offshore trade, re-export and transshipment trade, with a view of facilitating the flow of trade and goods along the Belt and Road.

The Belt and Road initiative encourages Chinese enterprises to invest along the Silk and Road. Last year, related direct investment reached US$14.8 billion. Hong Kong enterprises can provide professional services such as financing, consultancy, accounting and engineering to Chinese enterprises. As such, enterprises from both sides can capitalize on their own advantages and collaborate on the success of the investment projects.

There will be advantages and opportunities for Hong Kong’s financial sector. Hong Kong can accelerate the establishment of an integrated financial platform serving the six major economic corridors and draw up an integrated financial solution. With a pool of talent from around the world, Hong Kong should strive to become a major overseas operational centre of organizations such as the Asian Infrastructure Investment Bank and a leading international financing platform. As the world’s largest offshore renminbi centre, Hong Kong can offer a range of renminbi financial products and asset allocation tools to the Belt and Road, thereby further enhancing its function as an offshore market.

While capitalizing on opportunities, businesses should not ignore the potential risks. To enhance their core competitiveness, they have to effectively manage the political and economic risks under the Belt and Road Initiative.

This article was firstly published in the HKGCC magazine “The Bulletin” August 2016 issue. Please click to read the full article.

By PwC

PwC B&R Watch: Review of capital project and deal activity in the countries that fall under the Belt & Road Initiative (B&R). The review finds that over US$490bn of projects and deals were announced in 2016 across seven core infrastructure sectors (Utilities, Transport, Telecoms, Social, Construction, Energy and Environment). A third of all these were in China, with the remainder spread across the rest of the B&R region.

• PwC B&R Watch finds a positive picture in 2016, with an increase in the volume and the average dollar value of infrastructure projects.

• In China, the average project size increased by 14% - largely driven by public expenditure on infrastructure as a central pillar of economic policy.

• M&A activity points to a decline in volume and dollar value, reflecting a flight to quality and renewed focus on project economics.

The review uncovers striking growth in the size of capital projects across the B&R region. The value of the average project was 47% higher than in 2015.

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By Michal Makocki, European Union Institute for Security Studies (EUISS)

(Mr. Makocki served as Consul for Economic Affairs at the Consulate General of Poland in Hong Kong in 2007-2008.)

The EU and its eastern partners have found themselves among the focal points of China’s ambitious economic project, the Belt and Road Initiative (BRI), which aims to revive economic, cultural and political exchanges along the ancient Silk Road. Given their geographical location at the crossroads of Eurasian routes, eastern Europe and the Caucasus are expecting to benefit from substantial infrastructure investments and new commercial opportunities. For the EU, China’s endeavour to establish new economic corridors in the region covered by the block’s Eastern Partnership (EaP) policy, poses both opportunities and challenges.

The BRI could potentially support the EaP’s goals by generating wealth in the region and helping to diversify its economy. However, to a substantial degree it is also up to the EU to make sure that the economic promise that BRI carries is actually delivered on and that the high hopes some of the eastern partners have in Chinese investments are justified. Indeed, this aspect is stipulated in the June 2016 EU China strategy, which stresses that ‘it is in the EU’s interest to work with China to ensure that any Chinese involvement in the EU’s eastern and southern neighbourhoods helps reinforce rules-based governance and regional security.’ It is therefore pertinent to look at eastern Europe’s relations with China and explore the best policy solutions to achieve synergy between European and Chinese projects in the region.

On the Road

Not surprisingly, given the ever stronger economic links with China, the BRI was met with   a rather warm welcome from the EU’s eastern partners. For certain EaP countries, China is already one of the most important economic partners. This is, for example, the case with Ukraine, which has become one of the main suppliers of grain to China. In Belarus, China has created an industrial park and promised infrastructure financing as part of the BRI during the last visit by President Xi Jinping in May 2015. China has also joined the European Bank for Reconstruction and Development (EBRD) to tap into investment opportunities in eastern Europe.

China’s promise that the BRI will generate large-scale investments in eastern European infrastructure is seen by many as a panacea to sluggish domestic economic development and a way to bridge the massive infrastructure gap between the region and the EU. Additionally, several eastern European governments hope that BRI infrastructure will extend their trade reach and thus diversify the markets for their own products.

Eastern European expectations concerning the economic potential of the BRI are partly warranted by developments on the ground. In the last year, the land-based container traffic between Europe and China has increased to more than 30,000 containers, an impressive achievement given that four years earlier few (if any) cargo trains operated on this route. And additional Chinese economic engagement and infrastructure projects in Central Asia mean that traffic is to likely increase further.

Further to the south, China’s project is stimulating local investments in support the creation of new freight corridors such as the Trans-Caspian route, which connects Europe with Kazakhstan and China through the Caucasus and the Caspian Sea. This route already allowed trains operated by Kiev to bypass Russia’s transit ban on Ukrainian goods by shipping cargo through the Black Sea, Georgia, and Azerbaijan. Georgia is also betting on increased commercial opportunities and signed up to a Free Trade Agreement with China in the latter half of 2016.

Quality and reality

These early achievements suggest that the BRI might have the potential to open up new economic markets and to create greater wealth and stability across Eurasia. The EU is in a good position to help eastern Europe fully tap into the BRI’s economic potential. The EU can play an advisory role, showing in what areas and ways the BRI creates the greatest possible added value to national economic development and supports the jointly-agreed goals of the EaP. But China’s promises – and their related implications – need to be carefully analysed.

Eastern Europe’s rather positive perceptions of Chinese financing do not necessarily match with the reality of China’s practices. An evaluation of the existing evidence of Chinese investments along the ‘New Silk Road’ suggests that recipient countries and the EU can expect a number of shortcomings. Examples from other regions suggest that it is unlikely that Chinese investments will prove to be a silver bullet for fixing EaP countries’ lack of adequate infrastructure, nor will they help to advance overall, sustainable economic development.

First, the availability of Chinese financing might be working against the governance standards envisaged by the EU with regard to the eastern partners, as the latter may feel less inclined to comply with complex EU rules if presented with an alternative source of funding. China’s objective has been to promote its own model of infrastructure construction which starkly contravenes EU rules on public procurement and state aid. As such, Chinese projects may also work against the EU’s rules and norms, to which EaP countries have signed up to through Association Agreements. BRI-related financing – and the accompanying aversion by Chinese firms to transparency – might also fuel corruption and prop up regional oligarchs who view government predation as a business opportunity.

Second, Chinese investors have a tendency to shift the burden of risks associated with infrastructure investments entirely to the receiving country. Unlike the EU’s financing instruments, for example, Chinese funding rarely involves grants. Instead, Chinese banks extend financing on the basis of sovereign guarantees from the recipient countries. This, in turn, might negatively affect fiscal stability, thereby also reducing the likelihood of recipient countries being able to acquire more funding from other international players, such as the World Bank. A relevant example, albeit from a different region, is China’s BRI-related financing of a motorway in Montenegro. The country suffered a lowering of its credit rating by agencies Moody’s and Standard and Poor’s due to fears that the Chinese loan for the construction of the motorway could ultimately undermine fiscal stability. Another consequence was the withdrawal of the World Bank’s $50 million budget support fund due to the concerns over the same loan. This example draws attention to the fact that Chinese financing can lead to competition over domestic resources and capacities and may crowd out the EaP and other multilateral instruments. Accordingly, China’s model of conducting infrastructure deals may imperil key macroeconomic reforms agreed under the EaP and undermine macro-financial assistance programmes.

Another serious downside of Chinese BRI-related financing is that it (sometimes) has a tendency not to bring real value for money. As this infrastructure financing is often tied to the provision of equipment or services by Chinese contractors, governments are unable to select the best financial offer through open public procurement tenders. For example, Chinese loans extended to Ukraine under the previous regime of President Yanukovych had to be renegotiated due to concerns over their terms and conditions.

Some Chinese companies also have a patchy record of compliance with environmental or social standards. One of the best known examples in the region was the inability of Chinese engineering company COVEC to build a highway in Poland that was in full compliance with EU environmental guidelines, with the company demanding additional exemptions from labour, social and taxation laws for Chinese labour and machinery involved in the project.

EU member states also need to monitor potential shifts in political allegiance among eastern partners. Chinese pragmatism has proven to be a double-edged sword: while Beijing helped Ukraine circumvent Russian transit bans, other Chinese state-owned enterprises (SOEs) were allegedly interested in building a bridge between the annexed Crimea peninsula and the Russian mainland. Moreover, Chinese investments in separatist or breakaway territories in the region may further fuel conflicts, and China’s rapprochement with Moscow may limit its potential to play a positive role in the neighbourhood.

China has already demonstrated that it will respect Russia’s perceived sphere of influence. For example, due to Russian sensitivities, China did not allow Moldova (and possibly other EaP countries) to join the 16+1 mechanism when it was created. Similarly, in May 2014 Russia forced China to formally acknowledge Russia’s role in the post-soviet space and agree to consider the ‘interests of Russia during the formulation and implementation of Silk Road projects’. This agreement was further extended through the officialising of cooperation between the Silk Road and the Eurasian Economic Union, agreed in May 2015 in Moscow. While recent press reports have discussed the possibility of Ukraine joining the 16+1 mechanism, no formal talks on accession have actually been held.

Chinese projects will also have security implications, including the assessment of hybrid threats to the region: because of its political rapprochement with Russia, China may be amenable to Russian pressure. The safest (and politically sensitive) option would be to allow Chinese SOEs to develop non-strategic portions of infrastructure connectivity to China, while supporting the strategically vital ones through EU or domestic funds. This would protect the sovereignty of EaP countries – a key goal of the EU’s partnership initiative.

Engaging China

Looking beyond the economic potential, China’s growing investment role in the EaP countries poses a number of potential challenges from an EU point of view. This makes a structured response to Chinese BRI projects, as called for by the recent EU Strategy on China, even more desirable.

First of all, any response should be guided by the principle of assisting eastern European partners in obtaining the best possible conditions from Chinese counterparts while respecting the mutual commitments to the EaP. Through the EaP, the EU and the region have already established a comprehensive policy framework which can incorporate China. The region’s engagement with Beijing should thus ideally be embedded within European Neighbourhood Policy (ENP) Action Plans or Association Agendas, which every partner country has individually negotiated with the EU. Under the transport component of the EaP, a list of priority infrastructure projects for the regional transport network has already been agreed upon. The best approach could be to identify a pipeline in the list of priority corridors and projects to be undertaken by China, and offer to co-finance or co-implement the initiative. Such an approach would also take into account China’s willingness to tap into existent regional plans or networks.

However, Chinese participation does not have to be limited to the list of priority projects. Additional proposals could be agreed jointly, as long as they fit with the wider regional transport strategy, are linked to TEN-T networks, and comply with EaP principles. Silk Road-related projects embedded in EaP Action Plans and following ENP principles will likely be of higher value than those agreed bilaterally (where China would be able to push projects according to its own priorities). More specifically, the EU could propose co-financing Chinese projects which promise the greatest possible economic added value and which align with EaP goals. For example, EU support could be given to those projects which aim to diversify energy sources and decrease energy dependence on hydrocarbons from Russia, build connections to the EU market or increase intraregional links between EaP countries.

If the fiscal stability of partner countries is a priority, China could be encouraged to participate in the construction of the region’s infrastructure through investments rather than project lending. By investing in the projects, rather than just lending money, China would be forced to take on its corresponding share of risk. That would subsequently act as a guarantee that the Chinese expect projects to be commercially viable. Such an approach will also help make sure that China brings actual development to the recipient countries rather than build ‘white elephants’ or support vanity projects. By embedding Chinese projects in national development strategies, such an approach will share the profits from Chinese projects more equally and beyond political elites. This, in turn, will bring more economic stability rather than exacerbate the socioeconomic fault lines within the region.

The EU may also have to acknowledge its limited leverage when it comes to influencing Chinese corporate behaviour (although it can help shape the environment in which Chinese companies operate). It is local frameworks and structural conditions, rather than the EU’s direct engagement, that will put BRI projects on a sustainable footing. Past records of Chinese undertakings suggest that countries with higher standards of governance are in a better position to properly assess the true costs and benefits of any Chinese deals. Improvements in the rule of law and the business environment will therefore allow EaP countries to get better value for money and address key deficiencies in China’s model of infrastructure construction.

All this means there is a serious demand for the EU’s experience in creating high quality regulatory environments. EU support will be crucial to strengthen environmental and social regulations, thereby boosting the capacity of EaP partners to conduct environmental and social impact assessments of any infrastructure projects, including Chinese ones. For example, the EU could use European Neighbourhood Instrument (ENI) grants to allow for an appraisal of a project’s feasibility and development according to shared European rules and principles. Finally, assistance could also be offered to engage international law firms or consultancies for advice over deals with Chinese SOEs.

Michal Makocki is an Associate Analyst at the EUISS and a former Senior Visiting Academic Fellow at Mercator Institute for China Studies in Berlin.

This article was originally published by the EUISS in February 2017 and is reproduced here with the permission of the Institute.

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HKGCC magazine "The Bulletin"

The Mainland’s Belt and Road initiative seeks to promote regional economic growth through economic and trade cooperation among over 60 countries and regions along the Silk Route Economic Belt and 21st Century Maritime Silk Road. Of the initiative’s five major goals, policy coordination, facilities connectivity, trade and investment facilitation, financial integration and people-to-people bonds; facilities connectivity mainly in the form of infrastructure development has emerged as a top priority.

Hong Kong’s role in the Belt and Road Initiative

As the Belt and Road Initiative covers over 60 countries, this implies complex corporate treasury operations that include such elements as cash flow management, foreign exchange, cross-border payments, risks and liability control. Therefore, a regional corporate treasury centre (CTC) would be required to centralize all treasury functions so that multinational corporations can enhance operational efficiency, reduce foreign exchange exposure and risk, as well as achieve economies of scale in treasury operations.

Hong Kong is already a premier CTC in Asia. Hong Kong’s advantage lies in its well-developed financial infrastructure including but not limited to its deep and liquid foreign exchange and money markets, absence of capital restrictions, stable and free exchange rates, and concentration of the world’s leading banks. Furthermore, Hong Kong possesses a simple and competitive tax regime, a common law system, an excellent pool of well-educated labour force and business professionals, as well as world- class transport and telecommunications infrastructure. More importantly, its proximity to Mainland China and its position as a premier offshore renminbi centre makes Hong Kong a preferred location for fulfilling Belt and Road projects. For all these reasons, Hong Kong is the first choice by far in Asia for many corporations, especially Chinese firms, to raise funds.

Singapore, which also shares many of Hong Kong’s attributes, is another leading regional CTC in Asia. Compared to Hong Kong, Singapore is more attractive to corporates whose main business is in Southeast Asia and India. The city also offers a favourable tax rate of 8% for CTCs, as well as a number of incentive schemes for global treasury businesses. In addition, Singapore has a distinct advantage over Hong Kong in terms of the 80 Double Tax Agreements (DTAs) it has signed. This is in contrast with the less than 40 DTAs entered into thus far by Hong Kong.

Geographic proximity is considered an important determining factor for treasury operations to function effectively. To this end, London is less ideal despite its standing as an international CTC due to its distance from the Belt and Road countries.

In comparison, Hong Kong is an ideal CTC location for Chinese companies that are expanding globally (including those participating in Belt and Road projects). It is also the preferred location for MNCs’ corporate treasury operations, which are increasingly trading in renminbi.

As mentioned above, external financing will be needed to bridge the immense funding gap for Belt and Road projects. Debt financing or debt securitisation can be considered a useful means to provide funding for these projects. In contrast to equity funding, this option allows governments to retain control over public projects while providing long-term investors with guaranteed returns.

This method of financing also has the advantage of supporting another key objective of the Belt and Road Initiative, which is to promote the internationalization of the renminbi. A sizable and market-determined renminbi-denominated debt market is essential to encourage non-resident corporates and investors to hold and use renminbi. The absence of large and liquid capital markets (debt, equities, derivative and money markets) offshore has hindered the global expansion of the renminbi. There is an urgent need for the Mainland to either establish a sizable debt market offshore or open up its onshore debt market as soon as possible. How- ever, as the latter remains heavily regulated and is dominated by public debt, this is unlikely to meet investors’  demands in the foreseeable future.

This is where Hong Kong can play a role. Hong Kong possesses a developed financial infrastructure for both debt securitisation and project financing. Hong Kong also has a diversified investor and issuer base, with foreign currency debts accounting for up to almost half of the local market. Although Singapore shares similar characteristics, Hong Kong has the edge due to a bigger pool of offshore RMB bonds.

In addition, Hong Kong’s vast and diverse investor base includes 201 authorized institutions, 158 insurance and reinsurance companies, and 594 Hong Kong- domiciled SFC approved funds. It is perhaps noteworthy that in 2014, more than 70% of the combined fund management businesses with some US$2.3 trillion in assets were sourced from overseas investors.

Hong Kong is also considered a major offshore RMB debt centre for infrastructure investments, including both structured debts and infrastructure bonds, com- pared to around 20 other offshore RMB clearing centres around the world, including Singapore and London. By the end of 2015, the total value of outstanding Dim Sum bonds in Hong Kong amounted to around 368 bi lion RMB, which far outpaced that of its second-placed rival, Singapore, which accounted for some 50 billion RMB (Q2 of 2015). There is also strong local appetite for diversified and longer-term investment vehicles such as debt, given that the offshore renminbi loan-to-deposit ratio in Hong Kong is still very low at 29.4% in 2015 (versus the overall loan ratio of around 70%). Moreover, continuous improvement of the offshore renminbi market infrastructure in Hong Kong will help attract global investors to trade debt in Hong Kong.

Recommendations

The Hong Kong SAR Government should lobby the AIIB to set up its treasury centre in Hong Kong. This would give rise to a cluster effect by encouraging other enterprises that possess or are planning to set up a CTC to choose Hong Kong for their operations as transactions would be more cost-effective when conducted in one place.

Although the Hong Kong SAR Government has introduced a 50% cut on corporate tax rate on prof- its (i.e. 8.25%) of eligible CTCs that are established in Hong Kong, this is contingent on such CTCs being standalone corporate entities or those satisfying the safe harbour rule under the current regime. It is recommended that this requirement be removed so that multinationals do not have to alter their corporate structure to enjoy the tax benefit. To do otherwise would undermine the benefit of and objective behind the tax concession.

Furthermore, the Hong Kong SAR Government should enter into more regional DTAs to enhance its competitiveness versus Singapore. Presently, some 47 countries have signed a DTA with Singapore but not Hong Kong. Many of these countries are located along the Belt and Road. A special unit under the Office of Financial Secretary should be set up to lead and oversee the negotiation process, with the aim of expediting the expansion of Hong Kong’s DTA network.

Debt financing centre

In light of the vast potential in debt financing of Belt and Road projects, Hong Kong is being presented with an invaluable opportunity to build up an enviable debt market that is comparable in size to that of the U.K. The Hong Kong SAR Government should, in conjunction with the private sector, proactively lobby the AIIB, NDB BRICS and SRF to issue foreign currency bonds, Dim Sum bonds and infrastructure bonds in Hong Kong. The role of the Infrastructure Financing Facilitation Office under the Hong Kong Monetary Authority should be expanded to include the function of a marketing agency for attracting more of such activities to Hong Kong.

The Hong Kong SAR Government should consider providing tax incentives (such as the deductibility of interest income on corporate tax) for companies to hold debt. This includes the extension of a tax exemption on interest income and profits derived from debt instruments issued by governments and multilateral agencies in all types of currencies. Currently, under the Qualifying Debt Instrument (QDI) scheme, interest income and trading profits arising from certain debt instruments are exempted from profits tax in Hong Kong according to Sections 14A and 26A of the Inland Revenue Ordinance (Cap 112). This includes RMB-denominated bonds issued by the Central People’s  Government  of  the  People’s  Republic  of  China in Hong Kong, Exchange Fund Bills and Notes, Hong Kong Government Bonds and Hong Kong dollar- denominated multilateral agency debt instruments. In addition, the Government can also consider exempting profits tax on interest income and trading profits from debt securities issued by specific funds for infrastructure projects.

This article was firstly published in the HKGCC magazine “The Bulletin” September 2016 issue. Please click to read the full report.