The lim­its of Xi Jin­ping’s grand plan

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

As China’s growth slow­down deep­ens, mak­ing even the gov­ern­ment’s re­duced growth tar­get of 6.5% a year for the rest of this decade look less and less re­al­is­tic, pol­i­cy­mak­ers are in­creas­ingly pin­ning their hopes on Bei­jing’s muchtouted “Belt and Road Ini­tia­tive”.

Not only do they hope that the plan to build new trad­ing net­works across Cen­tral Asia and the In­dian Ocean will boost China’s flag­ging ex­ports, but that the de­mand for com­modi­ties and cap­i­tal goods gen­er­ated by the project will push up prices, res­cu­ing China’s in­debted in­dus­trial sec­tor from de­bil­i­tat­ing pro­ducer price de­fla­tion, which in Oc­to­ber was run­ning at -5.9% year-on-year.

How­ever, while we are cau­tiously op­ti­mistic about the ben­e­fits of the Belt and Road, the of­fi­cial rhetoric em­a­nat­ing from Bei­jing se­verely ex­ag­ger­ates the po­ten­tial im­pact of Pres­i­dent Xi Jin­ping’s grand project.

As we de­tail in the lat­est edi­tion of the China Eco­nomic Quar­terly, the Belt and Road en­vis­ages build­ing roads, railways, pipe­lines and in­dus­trial cor­ri­dors across some 67 coun­tries, all linked to up­graded ports across Asia, the Mid­dle East and East­ern Europe. It will re­quire bil­lions of tons of steel and ce­ment, hun­dreds of thou­sands of work­ers, tens of thou­sands of cranes and dig­gers, and dozens of new dams, power sta­tions and elec­tric­ity grids. This ex­plains why, far from be­ing dis­cour­aged by China’s soft econ­omy, Bei­jing is keen to press ahead.

The Belt and Road is China’s sec­ond big over­seas in­vest­ment push, fol­low­ing the “Go Out” pol­icy launched in 1999. Then, the goal was for Chi­nese state en­ter­prises to ac­quire over­seas en­ergy and min­ing as­sets. This time, the aim is to cre­ate new mar­kets for Chi­nese con­struc­tion firms and cap­i­tal goods mak­ers. Bei­jing por­trays the plan as an in­ter­na­tional project, de­signed to cre­ate eco­nomic link­ages across bor­ders.

But there is a sig­nif­i­cant do­mes­tic com­po­nent: ev­ery prov­ince in China has its own Belt and Road in­vest­ment plan and for lo­cal govern­ments look­ing to stim­u­late flag­ging growth, it makes sense to jump on the band­wagon.

Pol­i­cy­mak­ers talk about the Belt and Road — short for the Silk Road Eco­nomic Belt and 21st Cen­tury Mar­itime Silk Road — as if they were clearly de­fined projects, but they are no such thing. What ac­tu­ally gets built will de­pend on in­di­vid­ual deals struck be­tween Chi­nese firms and their for­eign part­ners. Be­cause Chi­nese pol­icy banks lend to their own, the big­gest ben­e­fi­cia­ries will be Chi­nese state-owned con­struc­tion firms. But projects fi­nanced by the mul­ti­lat­eral Asian In­fra­struc­ture In­vest­ment Bank will be open to com­pet­i­tive bid­ding, so there will also be op­por­tu­ni­ties for for­eign con­struc­tion firms and cap­i­tal goods ex­porters.

Bei­jing has con­jured up vast sums to sup­port the Belt and Road: up to $100 bln for the AIIB, an­other $100 bln for the New Devel­op­ment Bank (for­merly the BRICS Bank), and $40 bln for its Silk Road Fund. Yet we cal­cu­late that the work­ing cap­i­tal of th­ese three new funds will ac­tu­ally be just $40 bln, one-sixth the head­line fig­ure. By the early 2020s, the AIIB and NDB com­bined will lend out at most $20 bln a year. Throw in the $2 bln or so in an­nual eq­uity in­vest­ments from the Silk Road Fund, and the pro­jected an­nual flow from China’s three new finance en­ti­ties will only be a quar­ter of global mul­ti­lat­eral devel­op­ment finance.

The rel­a­tively mod­est scale of the new China-led mul­ti­lat­er­als re­futes US fears that China is build­ing a cred­i­ble al­ter­na­tive to the Bret­ton-Woods sys­tem. For the most part, th­ese in­sti­tu­tions will cre­ate more com­pe­ti­tion by stir­ring other lenders, such as Ja­pan and the Asian Devel­op­ment Bank, into ac­tion. This might dis­com­fit the in­cum­bents, but that com­pe­ti­tion will be wel­comed by bor­row­ers look­ing for cheaper fi­nanc­ing.

In truth, though, a lack of funds is not the root cause of Asia’s in­fra­struc­ture deficit. The real prob­lem is a short­age of bank­able projects. The op­ti­mum level of in­fra­struc­ture in­vest­ment for any coun­try de­pends on its po­ten­tial growth rate, struc­ture of growth, com­mod­ity prices and qual­ity of gov­er­nance. His­tory is lit­tered with ex­am­ples of overop­ti­mistic pro­jec­tions of fu­ture needs. China has plenty of cash, but it may strug­gle to find worth­while projects to in­vest in.

There is much that can go wrong. Plan­ners en­vis­age the Belt and Road cross­ing some of the wildest ter­rain on earth, with in­vest­ments in such volatile states as Syria, Iraq, Afghanistan, Pak­istan, Ye­men, Egypt and Ukraine.

Some projects will bol­ster China’s eco­nomic se­cu­rity or bring much-needed devel­op­ment to im­pov­er­ished ar­eas. Oth­ers will be about lit­tle more than geopo­lit­i­cal bribery, and will re­quire pol­icy banks to throw away money. And as Chi­nese firms have al­ready found to their cost in Africa, Myan­mar and Sri Lanka, such in­vest­ments can back­fire.

Even so, the Belt and Road is a bold strat­egy that must be taken se­ri­ously. It may prove a use­ful long-term stim­u­lus in un­der­de­vel­oped mar­kets that badly need bet­ter in­fra­struc­ture. But the sums in­volved are prob­a­bly nei­ther suf­fi­cient to save Chi­nese in­dus­tries suf­fer­ing from over­ca­pac­ity nor large enough to pull com­mod­ity prices out of the gut­ter.

It is a light in the dark­ness, but the gloom re­mains.

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