The Belt and Road backlash

Posted on Jan 8 2019 - 8:06pm by Editor

EUROMONEY

7 January 2019

by ELLIOT WILSON

BRI-backlash-illo-780

It is the first great development project of the 21st century and maybe the greatest of all time. China’s Belt and Road Initiative (BRI) is ambitious, expensive and, in its own way, collaborative.
A project slated to cost anything up to $8 trillion has so far been astonishingly good at corralling financing and galvanizing support from many of the 71 countries along its dual route – an overland ‘belt’ linking China with Europe and a maritime ‘road’ snaking through the Indian Ocean to the Mediterranean.
Sovereigns short of quality infrastructure have borrowed heavily from the likes of Export-Import Bank of China (Chexim) and China Development Bank (CDB), Beijing’s development-banking double-act, while global investment banks work day and night to earn generous fees by channelling funding into anything bearing a ‘BRI’ tag.
Some of these projects are hugely valuable. Take the new Chexim-funded $3.4 billion electric railway set to link the Ethiopian capital Addis Ababa with Djibouti, a coastal state on the Bab-el-Mandeb Strait, a pinch point on the way to the Suez Canal.
Or the dual-purpose deep-sea port and special economic zone under construction on the Black Sea coast at Anaklia. If Beijing had an ideal BRI project in mind, this may be it. If all goes to plan, capital tapped from a mix of CDB, Georgia’s state Partnership Fund and engineering firm Shanghai Zhenhua Heavy Industries, will transform Anaklia from a swamp into a port city able to process 100 million tonnes of cargo a year by 2025.
Other projects are spurious or downright wasteful, or have no connection, however tentative, to the grand scheme. Take the Indonesian theme park with links to US president Donald Trump or the jazz camp in the Chinese city of Chongqing.
“China’s banks are overwhelmed by African countries desperate to borrow as much money as possible to pay for infrastructure, but China needs to learn when to say: ‘No.’ “- Mamadou Ndiaye, West African Monetary Union
Sri Lanka is home to some of the best BRI ideas (such as a new expressway linking Colombo with the central city of Kandy) and many of its worst (Mattala Rajapaksa Airport, a boondoggle that cost $210 million and that now lies empty). Most BRI projects, in truth, lie between these two extremes.
It is easy to lose track when talking about the BRI, so grand, overarching and global has it become. So let’s take a deeper look and ask three key questions of a project that turned five years old in October 2018.
First, what is the BRI really and what does China want to achieve with it? Second, is the initiative going according to plan? And third, is it popular among the countries that lie along its route – the nation states that must embrace the project for it to have any chance of success?
To start with the last question – there are growing signs that the grand project is no longer well-liked. Perhaps the defining moment of the past year came in August 2018 when, shortly after taking office for a second time, Malaysian premier Mahathir Mohamad deferred or cancelled $22 billion-worth of Chinese-funded projects, including the flagship East Coast Rail Link.
He said Malaysia simply could not afford them and accused China of forging “a new version of colonialism”.
Critics line up to accuse Beijing of engineering a ‘debt-trap’ policy: lending too much to fragile states who are desperate for capital but unable to borrow enough from multilateral development banks or in the international capital markets. They point to Hambantota, a $1.3 billion Chinese-funded port in Sri Lanka that was handed wholesale to Beijing in 2017 after the island’s sovereign debts became untenable.
BRI-lending-chart-780
Speaking at the Asia-Pacific Economic Cooperation meeting in Papua New Guinea in November 2018, US vice-president Mike Pence, who has emerged as one of China’s more waspish critics, inverted the project by calling it a “constricting belt” and a “one-way road”, and warned small nations to avoid “opaque” loans that come with strings attached.
“We don’t drown our partners in a sea of debt. We don’t coerce or compromise your independence,” he added pointedly.
Earlier, 27 of the 28 EU ambassadors in Beijing signed a statement that criticized the project for restricting free trade.
China bit back, tweaking its message and embarking on a publicity offensive. Vague talk of “win-win” arrangements were canned and replaced with chatter about the BRI “unifying the dreams of every country and their citizens”.
At a seminar in Beijing to mark its five-year anniversary, the project’s architect, Chinese president Xi Jinping, insisted the initiative was “not a geopolitical or military alliance. It is an open and inclusive process, and not about creating exclusive circles or a ‘China club’.”
Yet this back and forth is inevitable. The US’s great fear is that the BRI succeeds magnificently, leading to a future in which global trade, priced in renminbi, flows easily along Chinese-built rail lines and Chinese-controlled shipping lanes. For its part, Beijing has no choice but to rebut every allegation of over-lending and debt-trapping, in the hope that the tenor of the story will change, allowing it to start winning hearts and minds.
But it is not clear that this will happen. Like it or not, China and its big, globe-trotting development banks have, within an astonishingly short period, got themselves something of a reputation.
“Every one of our operations and agreements relating to BRI has to be open and transparent and credible and sustainable. As a borrowing country, we do not want to fall into a debt trap” – Yuba Raj Khatiwada, Nepal’s finance minister

In October 2018 over lunch at the Ritz-Carlton in Bali with a senior official at the African Development Bank, talk turned to the BRI. The annual IMF-World Bank conference was in full swing around us, but for more than an hour he held court on China’s “dangerous power in Africa: its willingness to lend to anyone who will borrow and to take assets when you cannot repay”.

He pointed to the examples of Angola, Zambia and the Republic of Congo, three countries listed by Moody’s as being among the most indebted to Chinese lenders, and to the fact that 20% of all of Nigeria’s and Ghana’s state revenues are set aside just to meet interest payments on Chinese loans.

“It’s colonizing Africa, just in a different way,” he says. “The Chinese come in, take over economically and financially, and own you. If you can’t repay, they’d rather take over an asset as payment-in-kind, rather than restructure the debt.”

When asked later for their view, a group of Lagos-based investment bankers laughed off fears of rising debts.

“I say to China: ‘Give us all the money you can,’” says one. “We need it.”

But Beijing’s approach has antagonized others.

“It is the responsibility of African countries to know their borrowing limits, but China needs to be a responsible lender,” says Mamadou Ndiaye, chairman of the regional council for public saving at the West African Monetary Union in Côte d’Ivoire. “China’s banks are overwhelmed by African countries desperate to borrow as much money as possible to pay for infrastructure, but China needs to learn when to say: ‘No.’”

Mark Zandi, chief economist of Moody’s Analytics, adds: “China has to be really careful not to overstep. It is threatening to create a lot of resentment in Africa.”

Beating heart

What of Asia? If Africa is an important cog in the BRI – valuable to Beijing as a source of natural resources and a destination for Chinese goods and services – Asia is its beating heart. Morgan Stanley predicts total spending on the BRI will hit $1.3 trillion by 2027, the majority of which will be devoted to projects across the region.

Beijing views Asia through a prism, with some countries and regions seen as more important to the initiative than others. Central Asia is an overland bridge to Europe and the epicentre of the BRI’s belt. South Asia is a mix of both belt and road thanks to its place at the heart of the Indian Ocean. And southeast Asia is a complex mix of poor countries that need infrastructure Beijing wants to build and richer ones full of consumers it wants its firms to target.

But many countries are getting wise to the way China works.

Across south Asia, government officials look at the cautionary tales of Pakistan and Sri Lanka – two countries deeply in debt to China but unable to stop borrowing more – and wonder if that is the right way to go.

Beijing has pledged to finance $60 billion-worth of projects in Pakistan, while Sri Lanka’s total debt to China is reckoned to be $5 billion and rising.

Yuba-Raj-Khatiwada-780

Yuba-Raj-Khatiwada-780 Yuba Raj Khatiwada, Nepal’s finance minister

“China wants to sell more to countries along the belt and road, including smaller states that border their hinterlands: Nepal, Laos, Bhutan,” says Nepal’s finance minister, Yuba Raj Khatiwada. “The BRI is a good idea as it integrates you into a far larger market. But we don’t want to suffer from a debt overhang and we don’t want to lose sight of one of our national priorities, which is to develop our own projects.”

The Himalayan state has been careful, he says, not to get in over its head. He is painfully aware that, having locked in Pakistan and Bangladesh as client states, China is looking to do the same to his country.

So far, Beijing’s overtures to Kathmandu have had mixed results. In August 2018, work started on a new airport near Pokhara, the country’s second largest city, to be built by China CAMC Engineering and funded by a $215 million loan from Chexim. Standard Chartered secured a mandate on the transaction as the official escrow agent.

But a month after that the government scrapped plans to build a $1.6 billion hydroelectric dam on the Seti River in the far west of the country, deeming it too costly.

The project was slated to be built by China Three Gorges Corporation, which would have owned 75% of the completed dam, and funded by Chexim, using a mix of ODA-like concessional loans bearing an interest rate of 2% and commercial loans at a rate of 7%.

Khatiwada refused to comment on the cancellation but pointed to the importance of ensuring every domestic BRI project was fastidiously assessed and costed from the outset.

“Every one of our operations and agreements relating to BRI has to be open and transparent and credible and sustainable,” he says. “As a borrowing country, we do not want to fall into a debt trap. We have learned lessons from Sri Lanka and Pakistan, and [because of this] we are moving forward cautiously, and we ask our friendly neighbour China that their processes and procedures be more credible.”

There is nothing wrong with debt by itself. What is wrong is that many projects are not economically efficient – George Kobulia, Georgia’s minister of economy and sustainable development

For a respectable and gently spoken public official, these are strong words, carefully chosen. He points to the importance of making all projects “fully transparent” and “accountable to parliament and anti-corruption agencies”. Of being able to refuse to “simply agree to any loan [packaged in] opaque ways”. And making sure every new project leaves him with “enough fiscal space still to borrow”.

The minister’s subtext is clear: that too many BRI projects in the region fail to meet some or even all of these commonplace and ethical requirements.

Downstream, beyond the foothills of the Himalayas, lies Bangladesh, a country in a similar situation. Like Nepal, it was largely overlooked by Beijing during the early years of the BRI. Neither has much in the way of natural resources, nor is either, from a Chinese viewpoint, particularly well located. Nepal is landlocked, while Bangladesh lacks a land border with China.

But over the last 18 months Beijing has belatedly turned its gaze in Bangladesh’s direction, keen to lend to and invest in an impoverished country with a swelling population and poor infrastructure. Work is already under way on a $1.7 billion road and rail tunnel set to link Chittagong with a new Chinese economic zone on the other side of the Karnaphuli river.

The project will be majority funded by Chexim, which is providing $1 billion in 20-year loans at a rate of 2%, and built by China Communications Construction Company (CCCC), which is also putting together a vast new $13 billion financial and economic zone off the Sri Lankan coast in Colombo. Many of Beijing’s big banks and corporates are integral to the BRI, but none seem to appear on more projects than the funder Chexim and the builder CCCC.

But not all has gone to plan. In January 2018, Dhaka banned China Harbour Engineering, another BRI mainstay, from future contracts after, it said, the company tried to bribe an official at the roads ministry by stuffing $100,000 into a box of tea.

The firm was slated to build a $2.8 billion expressway in the southern city of Cox’s Bazar, a 750-acre industrial park and a highway linking Dhaka with Sylhet in the northeast.

“We’ve blacklisted [China Harbour],” said Bangladesh’s finance minister Abul Maal Abdul Muhith at the time. “It won’t be able to work [here] anymore.”

More money

When a BRI project runs into trouble, China often finds a solution. More money usually helps. Such was the case in November 2018, when the president of Sierra Leone, Julius Maada Bio, halted plans to build a new $400 million airport funded by China Development Bank.

Bio called it an unaffordable project that would have “deeply indebted” his country and dismissed all Chinese infrastructure as “a sham”. Yet a few days later he appeared on Chinese state television to make clear that not only was the loan back on the table but that he planned to borrow more from CDB to finance a $1 billion bridge.

This makes Muhith’s stubbornness over China Harbour all the more surprising and, in its way, heartening.

“They got a big highway deal but the party that got the project bribed us, and the project was cancelled,” he tells Euromoney. It helps of course that not only was CCCC standing by to take its place but that the state firm is also China Harbour’s parent.

This allowed China to save face and Bangladesh to keep a much-needed project ticking over. For its part, CCCC’s reputation is hardly whiter than white. It was blacklisted by the World Bank in 2009 for allegedly fraudulent business practices relating to a highway contract in the Philippines and it has run into trouble in Australia, Malaysia, Kenya and Canada.

When talk turns to over-borrowing from China by regional sovereigns and of the mounting fiscal challenges facing Pakistan and Sri Lanka, Muhith smiles and nods.

“Yes, we have some big projects with China,” he says. “But we also make a very significant calculation with our debt burden before we do anything with China.”

A theme is beginning to emerge. States bordering China and located on the belt and road are drawn ineluctably into its orbit. As a group they lack good infrastructure and, often, good governance.

They are typically illiquid while China is hugely liquid. And they often struggle to tap international capital markets or multilaterals for cash.

Bangladesh’s Muhith is not alone in complaining that Bangladesh’s ability to “borrow hard-currency loans [or secure] concessional loans has long been too limited”.

These states often feel there is no choice but to turn to Beijing for financial aid.

This is the quandary facing another fragile state in Asia’s frozen north. Mongolia’s relationship with China is deeply conflicted.

A century ago its itinerant herders wound up deeply in debt to traders from Shanxi province who lent them silver and demanded repayment in livestock. As the Qing empire crumbled, Ulaan Baatar burned its Chinese debt certificates and turned to the Russian tsar for support.

China is a huge country, billions of people, trillions of dollars in foreign reserves, the second-largest economy in the world. We are a small kid and they are the bully in the playground – Lkhagvasuren Byadran, Bank of Mongolia

All Mongolians grow up keenly aware of the pain of financial subjugation and are determined never again to be in hock to any nation state, particularly China. But Beijing is persistent and Mongolia is at a disadvantage. Its finances are in a perilous state. Only a $5.5 billion IMF-led bailout finalized in 2017, including funding from Japan, Korea, the World Bank and the Asian Development Bank, kept it afloat.

China, which accounts for 80% of imports, is desperate to secure onshore operating licences for its commercial banks and to fund big-ticket local projects. Sometimes Ulaan Baatar caves in. In 2016, when the pre-bailout economy was at its nadir, Chexim lent $1 billion to build a hydropower plant and a highway between the capital and the airport. The two central banks also signed a $2 billion debt swap during this period – still Mongolia’s largest single source of foreign financing.

But spend time in Ulaan Baatar and you quickly sense a deep wariness about China and its intentions with the BRI.

“As a neighbouring country, we have a good relationship with China, a friendly partnership,” says Lkhagvasuren Byadran, deputy governor of the Bank of Mongolia. “But if there is a loan that is going to be a burden to us, it’s not our wish [to take it]. We ask them: ‘Is it your wish to burden us?’ And they say: ‘No, no, no.’ They always tell us: ‘We can support you’.

“But we don’t want to increase our debt to China,” he adds. “Under the terms of the bilateral debt swap, we owe China Rmb12 billion ($1.75 billion), which matures in 2020, and we are preparing for that. The point of that swap was to increase trade between the two sides, but the previous government used its resources [poorly].

“Look, there is a risk here for us,” he says. “China is a huge country, billions of people, trillions of dollars in foreign reserves, the second-largest economy in the world. We are a small kid and they are the bully in the playground.”

Many voices from different, disparate countries, all with the same message: be wary of the BRI. It makes golden promises, but it has a dark heart.

Rewriting rules

So what, really, is the BRI and what does China want to do with it? Neither has a simple answer, in part because Beijing has never defined the project, nor clarified its objectives and ambitions. That was left for others to do – multilaterals, investment banks, fretful Western officials and the many sovereigns that lie along its sprawling route.

Jonathan Hillman, director of the Reconnecting Asia project at the Center for Strategic and International Studies in Washington, describes the BRI as: “A vehicle for China to write new rules, establish institutions that reflect Chinese interests, and reshape ‘soft’ infrastructure.”

Jason Elder, a partner at the global law firm Mayer Brown, sees the project as: “Part of the same story arc that includes the Chinese establishing the renminbi as a reserve currency. I see the belt and road as a continuation of trying to increase China’s power within the financial community: our banks matter, our currency matters, we have some weight.”

There is much evidence to suggest that, for all the fluff and abstraction surrounding the BRI in its first days, we still are in the very early stages of a preconceived, concerted and scrupulously planned attempt by China to rewrite the rules and norms of global trade and finance, in its interests.

China has plans to set up international courts in Shenzhen and Xi’an, the heart of the original Silk Road, to oversee BRI-related commercial disputes. Beijing insists the courts will follow international rules, but critics fear they will favour Chinese parties over foreign firms.

And if Beijing continues to lend boisterously and at times excessively to fragile countries, it will surely only be a matter of time before they need to be bailed out. Will China allow nations assimilated into the BRI and deeply indebted to mainland banks to be investigated, analyzed and bailed out by the IMF?

It is surely only a matter of time before Beijing sets up its own multilateral: a China Monetary Fund with the goal of bailing out troubled sovereigns and embedding them in China’s currency, banking system, and corporate and political world view.

This sense of long-term and joined-up thinking can be seen at Aibo, a Beijing-based finishing school for international officials run by the commerce ministry.

Dilip Samarasinghe, a director at the Sri Lankan Board of Investment, spent a fortnight at the vast campus in the company of a personal Chinese minder with the anglicized name of Sherlock and civil servants from 20 countries including Afghanistan, Iran, Bangladesh, Nepal, Kenya, Romania and the Seychelles.

“We learned about China, its trade policies and legal systems, the history of the belt and road, how they deal with international trade issues,” he says. “A group of Francophone speakers were there from Africa, learning how to reform their central bank, and another group from the Port of Djibouti, learning how to operate the port more efficiently and effectively.”

China has invested heavily in Djibouti, building a $590 million army base not far from a US military compound, buying a stake in the Port of Djibouti and beginning work on a $3.5 billion free-trade zone part-owned by China Merchants Group and Dalian Port Authority.

Next decade

What does the future hold for the BRI? Will it be one where goods and services are priced in renminbi and transported super-efficiently along Chinese-controlled shipping lanes, highways, communications grids and rail lines?

Or a world that has grown to resent Beijing for tricking it into debt and building infrastructure it did not need and cannot afford? A future in which China, rather than making friends and influencing people, has frightened them away.

Much will depend on how it acts over the next decade. The first five years of the BRI have been manic. Chinese loans have, wholly or partially, funded the construction or expansion of 35 ports from Australia to Greece, according to the Johns Hopkins China-Africa Research Initiative.

Data from the American Enterprise Institute and the Heritage Foundation’s China Global Investment Tracker put total spending on 3,116 BRI projects between 2014 and 2017 at $340 billion.

But is the project running out of steam – and out of friends? A March 2018 study by the Center for Global Development found that 23 of the 68 countries hosting BRI projects were at heightened risk of debt distress simply due to being part of the project.

It pointed to eight more states, including Pakistan, Djibouti, Montenegro, the Maldives, Mongolia and Tajikistan, that owed more than half their debt to China and were at “serious risk” of being unable to meet their obligations. Across Africa and Asia, sovereigns that once approved BRI projects without a murmur are scrutinizing them ever more carefully and, in some cases, repackaging or scrapping them entirely. Senior officials have grown wary – and in some cases weary – of Beijing’s often pushy ways.

While some projects are genuinely valuable, too many are poorly planned and financially worthless.

George-Kobulia-780

George-Kobulia-780 George Kobulia, Georgia’s minister of economy and sustainable development

Georgia’s minister of economy and sustainable development, George Kobulia, reckons the problem is: “Not about the debt, [but] about the efficiency of the projects. There is nothing wrong with debt by itself. What is wrong is that many projects are not economically efficient.”

Even China’s Xi admitted as much in September 2018, warning against the funding of gratuitous “vanity projects”. But China’s grand plan to build the world could leave a legacy that few, even in Beijing, could have predicted five years ago. In October 2018, the US Senate passed a law creating the International Development Finance Corporation, a new federal agency that aims to invest up to $60 billion in Asian and African projects, competing directly with the BRI.

Japan and Korea are also ramping up concessional lending to projects across Asia, while the Indo-Japanese Asia-Africa Growth Corridor aims to combat China’s growing influence in Africa and the Indian Ocean. The upshot, surely, will be big powers competing with one another or working in harmony to channel huge pools of low-cost capital into much-needed projects in the developing world. For fragile sovereigns and investment banks the world over, it’s a dream come true.

https://www.euromoney.com/article/b1cldq6cmyslms/the-belt-and-road-backlash

About the Author