China: OBOR and the Pursuit of Superpower Status
posted by Karim Pakravan on February 27, 2018 - 3:06pm
The recent removal of term limits for the presidency from the Chinese Constitution represents a further tightening of President Xi JiPing’s grip on power. While he was not up for reelection until 2019, term limits were an obstacle to his grandiose plans for establishing China as a major economic, military and political superpower over the next few years or even decades. While the rise of China as a global power was inevitable, it has been facilitated by the vacuum left by the rapid decline of the U.S. global position under President Trump.
A key element of China’s global strategy is the “One-Bridge/One Road” (OBOR) initiative, launched in 2013. OBOR, aka “Silk Road” or “Belt and Road” is a massive long-term transportation/energy infrastructure project centered on Chinese finance and Chinese state-owned enterprises (SOEs). The project follows approximately the historical trade routes of the ancient Silk Road. The project is designed to integrate the markets of Europe, Asia, the Middle East and Africa with the Chinese economy. The boost in trade and investment should benefit China in a number of ways: the lowering of transportation costs and opening of new markets; stimulating a Chinese economy plagued by overcapacity and slowing growth; and promoting the economic development of the western Chinese underdeveloped hinterland.
The OBOR project was launched in 2013 by China. Since then, 65 countries from Germany to Indonesia and Kenya have joined the project. The rationale of revitalizing the Silk Road in part lies in lowering transportation costs between China and Western Europe. A large container ship voyage from China to Europe around Africa covers 24,000 kilometers. The same voyage by rail will cover 11,000 kilometers. Furthermore, Asia will need $22.6 trillion in infrastructure by 2030 (approximately $1.7 trillion per year). Finally, from the Chinese point of view, the control over trade routes and warm water ports will confer massive strategic advantages.
While the numbers are vague and subject to hype, OBOR is well under way. Financing comes from three major Chinese-sponsored sources. First, the Silk road Fund, launched in 2015 with $40 billion in capital. Second, the multilateral Asian Infrastructure Investment Bank (AIIB), with $100 billion in capital. And third, the multilateral New Development Bank, with $50 billion in capital. Complementing the official and multilateral sources are the China Development Bank and the China Export-Import Bank. Finally, the Chinese banking system is funding investments by the Chinese SOEs. The AIIB had approved $1.7 billion in infrastructure loans to the OBOR countries by 2016. The Chinese banks had extended about $130 billion in loans to Chinese SOEs involved in OBOR projects. (Fifty Chinese SOEs are reported to have invested in 1,700 OBOR projects). The Chinese government committed another $113 billion in funds at the May 2017 OBOR meeting. According to available data, projects that will be ultimately cost $900 billion are under way. The flagship projects are a $46 billion transportation infrastructure investment in the China-Pakistan Corridor (which incidentally will give access to the Arabian Sea Pakistani port of Gwader, at the entrance of the Persian Gulf), a 3,000 km high-speed rail line between China and Singapore, and gas pipeline across central Asia. The main rail connections to Europe are under completion, as are ancillary lines connecting China to Iran. These developments have led to a 5X increase in trade volume transported by rail between Europe and China from 2013 to 2016, to over 300 million tons.
OBOR is also attracting the interest of global financial banks and financial markets. While the major global banks are leaving the financing of infrastructure to Chinese sources, they are interested in providing ancillary banking services (foreign exchange, cash management, trade finance and hedging) to OBOR projects. As an example, Standard Chartered has invested in 20 OBOR projects. There is now an OBOR-linked ETF, the KraneShares MSCI, tied to the MSCI Global China Infrastructure Exposure Index.
The numbers are impressive, but at the same time, these projects entail significant downsides.
The first problem is the imbalance among the level of socio-economic and political development of the OBOR countries. Many countries, especially the “Stans” (former SSRs), as well as Pakistan cannot even qualify as emerging markets, as they are characterized by high levels of poverty, a massive deficit in governance, as well as corrupt and unstable regimes. The injection of massive amounts of cash into these fragile countries in a short amount of time can only amplify these problems. Furthermore, many of the recipient countries do not have the operational ability to build and/or run these projects. Finally, weak environmental standards, displacement of populations and sometimes heavy-handed actions by Chinese companies have been a source of resentment and social turmoil.
The second problem is the degree of exposure of the Chinese financial institutions to the OBOR projects. Many projects were started at a time of high commodity prices. As commodity prices collapsed in 2016 and 2017, many projects have faltered. Furthermore, financially weak governments have taken on massive levels of debt, which they will be unable to service. China has historically shown little financial flexibility in this regard. The example of the Sri Lankan port of Hambantota is illustrative. The $2 billion project ran into economic difficulties, forcing the government to hand an 80% stake to the Chinese government in exchange for $1.1 billion in debt relief, in the face of considerable political opposition. Thus, we can expect significant pressures on both bilateral and multilateral Chinese financial institutions in the form of massive write –offs.
While China may be willing to wave off these risks and bear the financial burden of surging non-performing loans in the short term in its pursuit of global power, it will also face in the burdens and costs of becoming an imperial power. That could be a steep learning curve.