"One Belt, One Road" May Be China's 'One Chance' To Save Collapsing Economy

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In April, Chinese President Xi Jinping marked a historic visit to neighboring Pakistan. China, via Beijing’s “One Belt, One Road” initiative, will invest some $50 billion in Pakistani infrastructure, including power plants, roads, railways, and, perhaps most importantly, the Iran-Pakistan natural gas pipeline. The vast sum represents 53% more than the US has given Islamabad over the past 13 years combined. China is also set to invest an equally large sum in Brazil and is even considering the construction a railroad over the Andes, which would connect Brazil to China via the Pacific and ports in Peru. 

On Sunday, Hungary became the first European country to sign a Silk Road MOU. Reuters has more:

Hungary has become the first European country to sign a cooperation agreement for China's new "Silk Road" initiative to develop trade and transport infrastructure across Asia and beyond, China's foreign ministry said late on Saturday.

 

China welcomes more European countries to look East, and strengthen cooperation with China and other Asian countries, and participate in the "One Belt, One Road" in various ways, said Wang Yi, China's foreign minister, according to a separate statement on the website.

 

Hungary hopes to closely cooperate with China and push on with the Hungarian-Serbia railway and other major construction projects, Hungary's President Janos Ader was quoted as saying by the Chinese foreign ministry.

 

China is helping fund and build a railway connecting Hungary and Serbia.

 

Projects under the plan include a network of railways, highways, oil and gas pipelines, power grids, Internet networks, maritime and other infrastructure links across Central, West and South Asia to as far as Greece, Russia and Oman, increasing China's connections to Europe and Africa.

Although highly publicized, “One Belt, One Road” isn’t well understood (which partly reflects the sheer size and scope of the initiative). The program has been cast, by some, as a Chinese Marshall Plan, an interesting characterization, given that we’ve cast the AIIB as an implicit attempt by Beijing to institute a kind of Sino-Monroe Doctrine.As an aside, this also demonstrates an overwhelming tendency (and we may be guilty here as well), to view the world through glasses tinted by the unipolarity that has dominated global politics for more than six decades. Or perhaps it’s a reflection of the fact that China is indeed a rising hegemon, and as such its policies and programs resemble those of the US at critical historical moments when Washington seized opportunities to expand American influence. 

Here, to cast some light on "The Yi Dai Yi Lu", is Barclays:

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Not just a Marshall Plan – bigger, more comprehensive and more inclusive

The Yi Dai Yi Lu (YDYL) initiative has been labelled a “Chinese Marshall plan” in some global commentary. There are some similarities between China’s new initiative and the post World War II US-driven European Recovery Program (popularly known as the Marshall Plan after US Secretary of State George Marshall).

  • The emphasis on infrastructure and heavy industry as a mode to kick-start growth or recovery.
  • The Marshall Plan amount of US$13bn (c.US$120bn in current dollar value) is in the same order of magnitude as the initial US$40bn envisaged for the New Silk Road Fund.
  • The establishment of the Asian Infrastructure Investment Bank (AIIB) could be perceived to be analogous to the formation of the IMF and the World Bank to aid the structural transformation of economies.
  • The perception (in some quarters) of potential for Chinese hegemony in the YDYL countries.

However, there are some obvious differences as well.

  • The world is not recovering from the aftermath of a world war. In fact, most of the countries that are potential YDYL project recipients could do just fine without the project impetus (though growth rates arguably would be lower).
  • The YDYL initiative is open to all countries, regardless of their political or economic regime.

We note that the Chinese government has expressed its displeasure at the Marshall Plan moniker. A government spokesman said in early March 2015 “It is inappropriate to simply describe the Belt and Road initiatives as another Marshall Plan. These initiatives seek common development of countries with different ethnicities, religions and cultures, focusing on wide consultation, joint contribution and shared benefits.”

More than just a political slogan – this concept has potential, in our view

We expect companies in China from SOEs to private enterprises to embrace the YDYL initiative, indentifying the value it could bring to their businesses, rather than simply paying lip service to the leadership’s latest pronouncements. We believe YDYL has captured the imagination of the market. During the FY14 results season, around 70% of the companies in our Chinese metals & mining coverage universe – including both SOEs (eg, Shenhua, Chalco, Jiangxi Copper) and private companies (eg, Hongqiao) – had YDYL formulated in their strategy and plans in some form or other.
Not just about big projects – infrastructure building is just the start

We believe it would not be overstating the case to say that China’s economic power to date has not been reflected in its influence on the world. China’s economic power has not translated into “soft power” being projected into the outside world.
We see three phases of the YDYL initiative beginning to mould China’s influence overseas over the course of a few decades:
  • (Predominantly) China-funded infrastructure using plenty of Chinese-made materials and machinery, ‘adopted’ technology and Chinese construction companies (with a high contribution of Chinese workforce as well – at least in the initial stages).
  • Increasing awareness and demand for Chinese brands, consumer products and cultural products as a result of increased interaction between the countries that receive YDYL investment increases and China (in short, China becoming “cool”). Chinese consumer goods companies could capitalize on the international growth phase – very similar to Coca Cola and Disney as they became US exports in prior decades.
  • Full integration of China with the global economy as global influences (not just from the economically successful countries) seep back into China. Creation of international companies out of China that are truly transnational in character (eg, the likes of Unilever), rather than those that are just “China-plus”.

Our China Economist, Jian Chang, also believes that development along the New Silk Road could contribute to sustainability of China’s growth at 5-7% in the coming years and have a positive impact on China’s industrial upgrading and economic transformation.

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As you can see, One Belt, One Road has far-reaching implications for China. For Chinese state-owned companies, return on investment is falling (diminishing returns in the face of overcapacity) and now sits just above 4%. Investments in US Treasurys yield even less.

 

On the other hand, Barclays estimates ROIC on YDYL projects to be between 10-15%, an obvious improvement over both domestic investment and money parked in US safe haven assets.

 

Meanwhile, embarking on large infrastructure projects with YDYL recipients can also help alleviate one of China's pressing problems. The transition away from investment-led growth to a consumer-driven economy and a dearth of global demand have combined to leave China's industrial sector in a state of perpetual overcapacity.

 

YDYL countries offer a potential outlet (a pressure valve, if you will) as there is a pressing need for FAI in the form of roads, railways, and power generation. While infrastructure development in these countries has the potential to provide a short-term economic boost for China, an expanded Chinese presence could also yield medium- and long-term benefits. Here's how Barclays sums things up:

China could benefit in the short, medium and long term from achieving various levels of the targets outlined in YDYL. Many sectors could benefit from increased revenue, while non- monetary benefits such as goodwill and political clout could arise if China successfully helps developing countries improve their economies.
  • Short term: Ease industrial overcapacity, create demand for Chinese capital and consumer goods. Help reduce the economic disparity between inland and coastal China as YDYL land-based projects are focused on central and western China.
  • In the medium term: Raise demand for Chinese capital goods and Chinese products in general, effectively helping China transition to a consumption-driven economy. Maintain export growth.
  • Medium to long term: Internationalization of China’s currency as some loans to YDYL countries will include RMB in the basket of currencies used to denominate and settle loans, versus using US dollars.
  • Long term: Promote travel, cultural exchange and long-term cooperation in geopolitical, military and trade areas. Improve general image of China on the world stage. Increase returns for the portion of China’s reserves contributed to the development funds and diversify risks. Potentially ease tension between countries over territorial disputes.

In sum, China benefits economically from YDYL in three important ways. First, investing in countries where FAI is needed to improve infrastructure not only helps China's SOE's achieve a higher ROIC than they could get domestically, but also helps to alleviate China's industrial overcapacity. Second, establishing a Chinese presence in emerging, rapidly-growing economies will boost demand for Chinese products, which will aid the country in its transition to a consumption-driven economic model. Third (and we've mentioned this on a number of occasions in the past), using the yuan to settle AIIB loans will help establish the renminbi and decrease dependence on the US dollar on the way to ushering in a new era characterized by yuan hegemony.

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Bonus: More from Barclays on the extent to which YDYL will relieve China's industrial overcapacity problem and a bit on the differences between the Silk Road Fund and the AIIB.

YDYL demand should help China export overcapacity

We estimate that YDYL projects would absorb some of the overcapacity in Chinese industries such as cement, steel and aluminium, even under conservative assumptions. If we envisage a scenario assuming that roads, railway, power generation and power distribution assets grow by 5% from their existing asset base among YDYL countries, this could create 137mt of steel demand based on the existing asset base. This represents around 14% of China’s total steel production capacity as of 2014. Such a boost to demand could effectively give back steel producers in China pricing power, as the industry would go from 22% oversupplied to 8%, based on our estimates.

Asian Infrastructure Investment Bank (AIIB)

The AIIB was proposed by President Xi in his speech at the Indonesian Parliament on 3 October 2013. It was proposed to finance infrastructure construction and promote regional interconnectivity and economic integration. Application to be a founding member of AIIB ended on 31 March 2015 and 57 countries have been approved to be founding members. China has stated that it will not seek to be the single majority shareholder and is aiming to dilute its 50% of capital as other countries join and contribute their own capital. The bank is expected to be set up at the end of 2015.

Silk Road Infrastructure Fund

The US$40bn Silk Road Infrastructure Fund is to provide funding to carry out infrastructure, resources, industrial cooperation, financial cooperation and other projects related to YDYL. The company that manages the fund, The Silk Road Fund Co. Ltd, is backed by China’s foreign exchange reserves, China Investment Corp, Export-Import Bank of China, and China Development Bank. The fund started operation in February 2015 with US$10bn in capital, which was 65% contributed by China’s SAFE, which manages China’s Foreign Reserve. The fund is chaired by Jin Qi, the assistant governor of PBOC.

Jin Qi, the chief executive of the Silk Road Fund, said in March 2015 that the fund will invest in projects with reasonable mid- and long-term returns, and it is not an aid agency that does not consider returns. She added that the Silk Road Fund will not be the sole financer of projects; rather it will seek to cooperate with other financial institutions when investing in projects in the future.