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China's BRI: 2nd forum to stir an old debate

  • The 2nd Belt and Road Initiative (BRI) Forum is due to be held in Beijing on 25-27 April.

  • We do not expect to hear anything sufficiently specific from the forum that immediately moves markets.

  • We anticipate responses from the Chinese leadership on some of the oft-mentioned BRI criticisms.

China's BRI: 2nd forum to stir an old debate
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

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Christopher Dielmann CFA
Christopher Dielmann CFA

Director, Macroeconomic & Sovereign Research

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Tellimer Research
22 April 2019
Published byTellimer Research

The 2nd Belt and Road Initiative (BRI) Forum is due to be held in Beijing on 25-27 April 2019. 

We do not expect to hear anything sufficiently specific from the forum that immediately moves markets. But we anticipate responses from the Chinese leadership on some of the following oft-mentioned BRI criticisms and concerns from the US, geopolitical allies of the US, multilateral agencies such as the IMF and mainstream (Western) media:

(1) Debt-financing burden resulting from BRI for recipient countries – we expect the Chinese to argue that BRI-related financing is small compared to the overall external financing burden for most recipient countries. (In the strictest sense this would be accurate, but when all China-related finance – of which BRI is merely one component – is consolidated, then there are countries such as Ecuador, Pakistan and Sri Lanka, where "China Inc" is a very significant creditor, arguably large enough to have an influence on the treatment of others in a default scenario).

(2) Lack of financial transparency in BRI agreements – we expect the Chinese to argue that this detail is disclosed at the individual project level as more detailed planning is undertaken (this is likely not the sort of quantified, consolidated liability data required by institutional investors in a recipient country).

(3) Lack of open, competitive bidding for construction contracts related to BRI projects – we expect a significant change in emphasis at this forum will be the encouragement to third-party sovereigns and private sector enterprises to participate in BRI projects (of course, this is not the same as open, competitive bidding, particularly if other sovereigns involve their own state-owned enterprises in BRI). 

We may hear a reiteration of the rebuttal of homegrown Chinese criticism over the allocation of resources to international investment given tighter liquidity domestically. We may also get an update from the Chinese leadership on the state of trade negotiations with the US (beyond its previous messaging on how BRI champions the ideal of globalisation).

Since the inaugural forum in May 2017 and since its inception in 2014, BRI has become bigger in geographic scope and attracted more criticism from the US-centric geopolitical, financial and mainstream media community.

We highlight the following changes in BRI over the last two years.

(1) The scope of BRI has grown:

  • Before the 2017 forum there were 36 countries signed up with BRI cooperation agreements; there are now 126 countries and 29 multilateral organisations.
  • Italy became the first G-7 country to sign BRI agreements, in March 2019; a move that drew open criticism from the US and other EU leaders.
  • Leaders of 29 countries attended the 2017 forum. This time, the attendance of 37 are confirmed. For most attending governments, except for the US, the average seniority of the representatives is expected to be higher. 1,500 delegates attended in 2017; 5,000 are expected this time.
  • About US$33bn of outbound Chinese foreign direct investment related to BRI projects was deployed in the two years, 2015 and 2016, compared to cUS$30bn in 2017 and 2018. FDI related to BRI remains c13% of total outbound Chinese FDI. (We do not have consolidated data on the size of debt finance related to BRI provided by Chinese banks).

(2) Sri Lanka precedent: default and, effectively, a debt to equity swap

In July 2017, Sri Lanka signed a 99-year lease with Chinese firms for the Hambantota port as part of a resolution (such as a 32-year tax break and 70% shareholding for the Chinese firms and an initial US$300mn cash receipt from them) for debt arrears. Most coverage of the risks of BRI for recipient countries highlight this project as evidence of the "Chinese debt trap" that underlies BRI.

In contrast, our interpretation is that this is an example of Chinese capital exacerbating the prior deficiency in Sri Lanka's political economy. The "white elephant" Hambantota port was constructed during the crony-capitalist era of the Rajapaksa government. In other words, BRI did not transform Sri Lanka, it accelerated it down the imperfect path it was already heading.

(3) Pakistan precedent: disclosure and BRI's co-existence with IMF assistance

In July 2017, the IMF, in its Article IV report, mentioned that Pakistan's external vulnerabilities had increased as a result of current account and external repayment obligations associated with CPEC (the China Pakistan Economic Corridor, part of BRI). In July 2018, US Secretary of State Pompeo publicly warned that the US would not support IMF assistance for Pakistan if funds were used merely to pay off debts related to CPEC. We understand that disclosures on CPEC-related commitments required by the IMF, as a part of ongoing discussions for a loan, have been provided by the Pakistan authorities and that this specific issue is no longer an obstacle to concluding negotiations. 

There is an oft-repeated concern about a lack of transparency on financing commitments and government guarantees associated with BRI agreements. The example of Pakistan, where many of the projects in CPEC have moved from a memorandum of understanding, through financial close, to actual construction, show that a good portion of this detail is available. Indeed, at the project level, much of it was always accessible on Pakistan government and electricity regulator websites. (What is not so transparent is the aggregate and maturity profile of all Chinese funding, including, for example, bilateral loans to the central bank).

(4) Malaysia precedent: renegotiation

Similar to Sirisena in his successful presidential election campaign in Sri Lanka in January 2015, Mahatir successfully used the issue of "unfair" China projects signed by incumbent PM Razzaq, among other issues, to lead the winning coalition in Malaysia's parliamentary election in May 2018. After initially suspending the East Coast Rail Link (one of the largest single projects in BRI) – and for many months it appeared that the project may have been cancelled altogether – the Mahatir-led government announced that a renegotiated version of the project had been agreed with Chinese authorities in April 2019. The reduction in project cost (to US$10.6bn) is in the range of 15% to 33% (depending on whether the current or previous government's figures for total project cost and scope, before renegotiation, are used).

In our view, this example demonstrates that, on the one hand, there is scope for renegotiation in order to preserve political support for BRI in recipient countries but that, on the other, the insertion of cancellation fees into the original contract may limit the scope of that negotiation. 

(5) US relations: more friction between two global geopolitical powers 

The Trump presidency was merely a few months old at the time of the 2017 BRI forum. Since then, relations between the US and China have publicly deteriorated with, for example, reciprocal trade tariffs (the "trade war"), greater scrutiny over technology intellectual property and security (Huawei), open criticism of BRI (Italy) and an infrastructure funding response (Indo-Pacific initiative).

We argue that BRI and reactions to it need to be considered in the widest geopolitical context. Financing sourced from both sides of the global geopolitical divide have strings attached and it is naive to label one as inherently more "rules-based" or "good", and the other as inherently more "ad hoc" and "bad".

(6) India relations: more friction between two regional geopolitical powers 

High-level representatives from India did not attend the 2017 forum and, we understand, are not expected this time. Since the 2017 BRI forum, geopolitical competition has persisted between these two in the South Asia region, as demonstrated by the following examples: troops from India and China have engaged in a stand-off in territory disputed by Bhutan and China at Doklam (June-August 2017); India was openly supportive of a presidential candidate in the Maldives, Solih, who defeated the China-aligned incumbent, Yameen (September 2018); China continued to oppose India's application to join the Nuclear Suppliers Group (July 2018); and China used its UN Security Council veto to block the designation of Masood Azhar (JeM) as a terrorist (March 2019).

Similar to relations with the US, at a regional-level, we expect friction on matters of defence and foreign policy to persist between China and India. Because BRI is a part of foreign policy, reactions to it from the Indian side will be coloured by this.

(7) BRI incorporated into China's Constitution:

In November 2017, the promotion of BRI was included in the Communist Party of China's Constitution. This legally embeds BRI in Chinese foreign and economic policy beyond the era of Xi Jinping. Furthermore, in the near term, it likely enables greater influence of the central government on the implementation of BRI (as opposed to provincial government).

For recipient countries, with their political economy already pointing in a positive direction, this is a helpful change, in our view.

Our views on BRI's generic implications for frontier and emerging markets remain unchanged: 

(1) The capital made available via BRI does not transform the development trajectory of a recipient country but accelerates it (i.e. a well-functioning political economy should benefit from BRI, just as a poorly functioning one likely suffers). 

(2) BRI projects focused on infrastructure are likely much more useful for the broader economy than historic investments from China (or Western sources) in resource extraction. 

(3) BRI investments, like most investments under a sovereign umbrella, are embedded in a geopolitical context and the recipient countries are likely to be exposed to a risk of geopolitical reaction from China's global rivals (e.g. the US, Japan, South Korea, India in particular, and the EU, Australia and Canada to a lesser degree).

See our previously published reports on BRI:

China's BRI: not a Marshall Plan or an East India Company, January 2019

BRI in Italy: China knocks on Europe's front door, March 2019

Summary of BRI-related investment implications 

Five investment implications of BRI
(1)Chinese capital accelerates a recipient country down its existing path – it does not transform that country;
(2)Chinese capital is not always ‘bad’, ‘Western’ capital is not always ‘good’ and the two are not mutually exclusive;
(3)Chinese logistics investments are likely more useful for the recipient country than natural resource investments;
(4)Chinese middle-class growth drives the shift of its low-cost jobs to cheaper locations and grows discretionary consumption (e.g. tourism and real estate purchases) in FM-EM;
(5)Chinese M&A is positive in the short term, but its entry will disrupt sleepy incumbents.
Two investment risks related to BRI
(1)As with all capital-intensive projects, BRI increases the financing burden of recipient countries and, in a debt default scenario, it is unclear how China would be treated relative to other creditors;
(2)The response of the US (and its allies) to Chinese engagement may be destabilising for the recipient country.

Source: Tellimer


BRI growth since 2014

Source: China Ministry of Commerce, yidaiyilu.gov.cn