China’s Belt & Road Initiative: Purposes, Challenges & Progress

A cargo train leaving Barking station in London arrived in the city of Yiwu in China on April 10th, 2017. The 7,500 miles trip took two weeks, cutting the timespan of a similar maritime route by almost a month. This newly christened line is the second longest after the Madrid-Yiwu 8,000 miles land freight railway. Both are part of China’s New Eurasian Land Bridge, designed to link East Asia to Europe (Worley, 2017). This achievement has been greatly celebrated by China as a testament to the country’s endeavors and the likeliness of successfully implementing their attempt at resurrecting the ancient Silk Road through the Belt and Road Initiative (BRI).

Figure 1: BRI Map of routes and corridors. [Source: The Economist]
President Xi has been actively pushing the ‘Belt and Road’ initiative (Also known as the One Belt, One Road Initiative or OBOR), a policy title that vaguely combines two proposals; a ‘Silk Road Economic Belt’ and a ‘21st Maritime Silk Road’ as seen in Figure 1. This leviathan project is meant to spur a range of infrastructure projects from roads, highways, ports, pipelines to economic zones that will link East Asia to Western Europe as well as Africa passing through 66 countries. When combined together, these countries falling on the six trajectories of the project represent 65% of the global population, three-fourths of its energy resources, and 40% of its annual GDP. Their cumulative yearly trade with China is $1.4 trillion (Campbell, 2017). With Asian countries possessing an infrastructure deficit of $26 billion as estimated by the Asian Development Bank, the Chinese hope to capture many projects in the future (Peel & Mitchell, 2017).

Yet, Mr. Xi’s policy, although economic on the facade, has many geostrategic goals within. Many observers see it as an attempt to create spheres of influence where China can gain political and economic precedence over its western counterparts. That is chiefly feared in low income nations, where the BRI may become a tool for China, as well as the affected countries themselves, to counter the influence of the G7 and G20 heavily conditional funding and aid through well-established organisms like the World Bank, International Monitory Fund, and World Trade Organization (Campbell, 2017). Although China’s immediate neighbors are primarily targeted and allured by this policy, the impact is seen to affect the global economy as Chinese exports find cheaper manufacturing and logistical hubs. Beijing plans to invest around $150 billion in infrastructure projects a year in countries that fall on the pathways of BRI (The Economist, 2017). Overall, Beijing itself forecasts the total cost of this initiative to be between $4 and $8 trillion (The Economist, 2016). However, Chinese businessmen outside the government, are left bewildered by how these investments are to be recouped.

Geostrategic Motives

More apparent and much debated are the geo-strategic aims of this project. It has been dubbed the ‘Chinese Marshal Plan’, where Beijing intends to replicate how the United States created internal growth by keeping its companies busy exporting abroad while using this leverage to reshape post Second World War Europe. Many see BRI as the Chinese attempt to restructure world trade to Beijing’s terms. However, China itself might be eager to implement this project to reduce own security threats imposed by geographic confines. 80% of China’s oil imports come through the Strait of Malacca. A 2015 report by the United States Department of defense, highlighted this crucial sea crossing as part of several choking points to be utilized in a naval confrontation with China, helping Washington implement sanctions and blockades if necessary to deter Beijing (Department of Defence, 2017). The need to diversify energy and trade routes is the main driver behind recent Chinese island acquisitions in the South China Sea. To Beijing, the BRI brings both traditional and trade security gains.

Figure 2: Oil transit directions through the Strait of Malacca and new Chinese port developments at Gwadar and Kyaukpyu. [Source: SCMP]
Two projects stand out to be the epitome of this strategy; Gwadar port development (discussed in more detail on page 15) as part of the $63 billion China-Pakistan Economic Corridor providing access to the Arabian Sea and the $7.2 billion deep-sea port project in Myanmar’s Kyaukpyu, a city in the Rakhine state with direct access to the Indian ocean. Both seen in Figure 2. In April 2017, an oil pipeline with 442,000 barrels per day capacity stretching from Kyaukpyu all the way to China’s Kunming started operations signaling the beginning of oil transfers into western mainland China that effectively bypass the Strait of Malacca. Myanmar is promised Chinese investments in an industrial park located just in the middle of the pipeline route. Further electricity grid connections and transportation hubs are planned. Similar in purpose, to diversify energy and trade routes, these two projects signify the political challenges of China’s BRI. Myanmar is facing international outcry over its ill-treatment of the Muslim Rohingya minority that faces systematic discrimination and human right abuses. While Gwadar courts and further interknits strategic relations with an Islamic Republic like Pakistan. So far, China has managed to sail the waters safely. Beijing considers the Rohingya struggle an internal dispute while manipulating that position to further pressure Naypyidaw in trade deals. From an initial 15%, Myanmar upped their contribution to the deep-sea project to 30% (Bloomberg, 2017; Nitia Yuichi, 2017).

Economic Targets

Geostrategic aims for BRI cannot be viewed detachedly from their economic ones, they are intertwined. Regional industrial development in China itself is not equally distributed, Beijing aims to link remote underdeveloped regions via manufacturing production chains ending in Chinese owned or financed projects in other countries. In 1999, the Chinese government, through the National Development and Reform Commission (NDRC), set out a number of policies to bring economic parity between rich eastside coastal provinces and poor ones in the west. Dubbed the ‘Western Development Strategy’, it was used as a delivery instrument of preferential budgetary monetary infusions and a central allocation of state-owned investments. Nevertheless, mixed results were obtained, the contribution of these underperforming provinces merely rose from 17.1% of GDP in 2000 to 16.7% in 2010. Access to Foreign Direct Investment (FDI) was hindered by this high state-owned company penetration benefiting from high subsidies. With BRI, Chinese officials (both central and local) see an opportunity of both developing domestic economies through integration with neighboring countries and securing markets. Estimates by local economists see almost a trillion RMB in planned projects by provinces included in BRI. 68% of them targeting new roads, railway and airports (brandenburg, 2018).

The political and security dimensions of growing poverty in the western regions is greatly debated in Beijing. Apart from industrial and market integrations, BRI offers the opportunity to mitigate these threats. As mentioned in the upcoming pages, the development of Gwadar in partnership with Pakistan is wished to reduce fundamentalism in the Muslim majority remote Xinjiang region of China, 5000-6000 kilometers away from the prosperous east coast. Mired by radicalization, demands for greater autonomy and even outright separation, Xinjiang’s economic integration has always failed on the account of higher transportation costs of manufactured products. Furthermore, BRI is expected to combat this disparity in poor North-East and South-West regions (Cai, 2017).

As the middle-class swells and subsequently labor costs increase within a Chinese economy that doesn’t grow in double digits anymore, an evolution from product dumping to the migration of manufacturing capacities has to be accelerated. In response to the 2008 economic crisis, China chose to stimulate and consequently protect the local economy by infusing capital into commodity-based industries, majorly steel, cement and pleat glass. As a result, excess capacities were created. China’s steel production grew exponentially from 512 million tonnes a year in 2008 to 803 million tonnes by 2015. In comparison, the production of the United States and the European Union stands totally at almost 300 million tonnes annually, just equivalent to the size of the extra portion added by China. Many western producers claimed that China was involved in a dumping war where they under-price their steel. Also, this factor has become the reasoning for a recent trade war started by President Trump, as discussed on page 12.

Seen as a ticking danger, the government had taken measures to reduce extra production, this including the discharge of 1.8 million steel and coal mining workers, as well as upgrading the technologies used in mills and furnaces, effectively taking less efficient ones out (Yao & Meng Meng, 2016). President Xi’s recent financial market reforms also target creditors financing bad loans that fueled this expansion. Even when combined, BRI announced projects are not sufficient to swallow a significant portion of the excess capacity. Slowly, it is becoming evident that Beijing is eyeing a more ambitious approach by migrating full factories and companies to other nations. After all, the Chinese themselves kick-started their development on used machinery bought from Taiwan, Germany, and Japan, where they were considered as excess or outdated (Hirst, 2015). For example, Hebei province, the country’s largest steel producer, plans to move 20 million tonnes of production to Southeast Asia, West Asia or Africa (Wei Yap, 2014). Commendably, this approach will turn China’s domestic capacity liabilities into foreign investments.

As this capacity is reduced, a simultaneous upgrading of domestic capacity for producing high-end goods based on quality rather than quantity is one of the core objectives of the Made in China 2025 strategy. This plan advocates pressuring Chinese companies to become internationally competitive, encourage them to enter new markets, while more crucially spread Chinese standards abroad (Kennedy, 2015). BRI backers believe that neighboring nations will be less reluctant to embrace Chinese high-end products over their American or European counterparts if motivated financially. Increasingly, Chinese credit facilities provided for offshore projects are becoming conditional, requiring borrowers to integrate Chinese technology and standards (Klacik, 2017). A good example is Chinese high-speed rail projects outside China. With years of development, generous support and local expertise boost, 50% of the world’s high-speed rail capacity is in China today (Xinhua, 2018). As a result, China has sought a ‘High-Speed Rail Diplomacy’ where it offers gracious financing to nations like India, Indonesia, Malaysia and others for choosing Chinese trains. Economically unfeasible and loss-generating on the short term, this approach will be most rewarding in the long term as these countries’ high-speed rail standards become Chinese. Other sectors where economic upgrading was highlighted by ‘Made in China 2025’ are; energy and telecommunication. Companies like Huawei, ZTE and Xiaomi are seen as standards’ leaders in the latter. Huawei has established a European logistics center in Hungary while quietly conducting research and development at another in Germany (Politico, 2018).

Rising Renminbi

China’s efforts to internationalize its own currency has been accelerating since the early 2000s with a number of initial steps including; the creation of the Dim Sum bond market, cross-border settlement, offshore pools, and the Renminbi Qualified Foreign Institutional Investor (RQFII) program (Prasad, 2016). The latter allowed other countries to build their own reserves of the Chinese currency. In 2012, the RMB was the 17th most widely used currency and by 2018, it leaped to the eighth position according to SWIFT RMB tracker service (SWIFT, 2012, 2018). Another important milestone was its recognition by the International Monitory Fund (IMF) as part of the currency basket comprising the Special Drawing Right (SDR) for lending to other countries and entities (Bhattacjarya Pinaki, 2016).

Figure 3: RMB share as an international payment currency. [Source: SWIFT RMB Tracker]
The BRI provides another channel for driving up this effort. Local Chinese construction companies and other manufacturers, especially those with limited international experience may soon have access to a broader market regionally, and even farther, that would substitute for slower development at some of the mainland’s provinces. Although this may impact foreign currency flow to China, especially U.S. dollars, it might also increase the applicability of RMB as a currency for cross-border settlement, shining more spotlight on its financial prospect as a reserve currency.

In March 2018, the Shanghai International Energy Exchange (INE) introduced China’s own RMB denominated crude oil futures contract (Clark Grant & Park Sungwoo, 2018). First futures contract to be based in a geographical area remote to sources of production, the idea has been planned since 2012. Yet, the delay has been attributed to higher oil prices, reaching $100 per barrel, in the past. Today, as the price of oil has stabilized in the $60-70 per barrel range and as China has overtaken the United States as the world’s largest crude importer, Beijing’s move seems logical. The main objective of this contract is to wrest a measure of control over pricing away from other international benchmarks, like Brent and West Texas Intermediate (WTI), that are priced in U.S. dollars. Investigating the crude types involved in the contract, they come from seven Middle Eastern countries targeted by President Xi’s BRI expansion. Namely; Abu Dhabi, Dubai, Iraq, Oman, Yemen, and Qatar (Mills Robin, 2018). Interestingly, Iranian crudes were not included, indicating a measure of risk aversion. With its position as the leading importer within the Asia Pacific, a region accounting for more than 35% of petroleum liquids demand (Figure 4), China aims to establish the RMB as the currency of choice for refiners in the region, providing trading opportunities for domestic refiners in China to arbitrage on foreign currency rates in the region (EIA, 2018b). Also, giving more freedom of movement to Chinese stored barrels as other regional nations are dependent on oil for their energy needs. After a month of trading, the Shanghai September contract has settled at 440.9 RMB per barrel, a price equivalent to $69.91, higher than the Oman benchmark (Figure 5), traditionally indicative of demand in Asia while exceeding Oman even at trading volumes. Yet, open interest or trading options, have been lower. In terms of risk, it is seen to fall on the side of producers. The Shanghai future contract was designed to serve Chinese consumers, with advantages ranging from eliminating currency risk, price movement threats, while reducing cash flow limitations on refiners as cargos are stored by the exchange and transactions are considered as domestic, within China itself (EIA, 2018b). For producers to hedge their risks, they will have to build RMB reserves and enter the exchange as investors, a move Beijing will happily induce. Eventually, the goal might be to utilize these reserves, accumulated by crude oil producers, to attract Chinese firms’ interest in planning infrastructure projects on the BRI routes.

Figure 4: Shares of petroleum liquid demand in the Asia Pacific. [Source: EIA]
Figure 5: Crude oil futures benchmark prices. [Source: EIA]

Concerns

Amongst countries that sit on the pathways of BRI, there are those who do not view Chinese actions with trust; recent land grab by Beijing in the South China Sea is seen as an attempt to impose facts on the ground using force rather than diplomatic engagement. On the other hand, India has not made its stance official on whether it wishes to be an active participant in BRI or not. Naturally, New Delhi may view itself as a future economic nemesis to Beijing. Also, massive Chinese investments in Pakistan are viewed with much distrust. According to the IMF, the government of Sri Lanka has $48.2 billion in external debt. Beijing, owning $8 billion of that amount, has very efficiently utilized the ‘debt trap’ to secure a 99-year lease for the port of Hambantota (Figure6), for a meager $1.1 billion. Since then, lesser cargo volumes have been received in the already underperforming port. Also, the new Chinese management has skyrocketed handling and transit fees. Increasingly, these moves are seen as precedents to converting this port to a Chinese naval base. To the Indians, this confirms their concerns as this port may become a future threat (Kuronuma, 2018).

India is not alone, the BRI has caused ruptures within the Association of Southeast Asian Nations (ASEAN). Members are divided between those who are eager to attract Chinese investments and others who envision a ‘string of pearls’ of Chinese naval installations that project Beijing’s power in the Pacific and Indian Oceans. The Sri Lankan model is expected to be replicated by China in the Maldives. With trade port future acquisitions all over the region, strategists are fearing a ‘dual use’ by China’s navy.

Figure 6: China’s ‘String of Peals’ dual use ports. [Source: Examrace]
Under much scrutiny and objection by western powers, China pushed forward the establishment of the Asian Infrastructure Investment Bank (AIIB) as the flag barrier of BRI project investments. Immediately, $100 billion was set as the bank’s initial capital (Huang, 2015). AIIB has been the only institution to be associated with BRI, still informally. With little transparency from Beijing on the plans by which their initiative is to progress, a lot of confusion has been created. Until today there is not a single unified Chinese organization created solely for the administration of the initiative, but a lot of Chinese government subsidiaries and few, and sometimes even contradicting, glimpses provided by Xi and his officials in public speeches.

Although China’s promise to provide know-how, financing, and physical assets as part of their excess capacity migration plan, may sound honorable, the production excess issue might not be limited to China. It is a global issue (USTR, 2016). Hence, the effect of this approach may simply shift roles rather than volumes. Moreover, this move may bring uncalculated political and social risk as Chinese workforce is reduced with the phased out or relocated manufacturing capacities. Also, as many Chinese provinces are jumping on the bandwagon, that is BRI, by announcing associated projects, how can the Chinese government ensure the segregation of BRI related projects from fiscal rent seeking? BRI was announced during a period of high commodity pricing when China needed to secure its access to vital resources needed. Today, as commodity prices have crashed, are the Chinese as serious as they were in 2013?

Then comes the uncertainty that faces many Chinese financers on recouping their investments. Although many banks and equity funds have pledged to be part of Mr. Xi’s legacy project, many are easily scared away by the fact that two-thirds of the BRI countries have a sovereign creditworthiness of below ‘investable’ (S. Morris, 2018). Add to that the political, security and social risks imagined, then it becomes quite hard to convince risk-averse and over-leveraged Chinese investors to trust the government’s push. With effects of the 2008 stimulus still evident in the form of non-performing loans that haunt the future of major banks in China, executives are pushing for a gradual approach where the return on investment is prioritized over geopolitical connotations where countries may exploit Chinese financial facilitations for ‘white elephant’ projects.

Trade War

Recently, President Donald J. Trump announced his intention to enter into a trade spat with China. Not foreign or reluctant to impose tariffs on imports to the United States since taking office, he declared a 25% tariff on imported steel and a levy of 10% on imported aluminum. Although non-orthodox to a Republican candidate, Trump campaigned on a protectionist platform where he promised to protect American jobs and traditional manufacturing sectors against foreign mass imports, especially Chinese steel dumping. A week earlier, domestic voices, even within the Republican party, urged the president not to go ahead with these measures as they may alienate important allies and trade partners. Bowing to pressure, Trump excluded Mexico and Canada. The latter accounted for 16% of all US imported steel and 41% of imported aluminum (Horsley Scott, 2018). Against the will of the Department of Defence itself, the president based his decision on a rarely-used law written in the 1960s with the aim of protecting domestic American industries vital for national security (Mattis, n.d.). This by itself, has given mixed messages to long-standing allies targeted by the decree. More importantly, countries that were seen as instrumental to President Obama’s ‘Pivot to Asia’ strategy of estranging Chinese influence in Asia, like India, Korea, Thailand, Malaysia, and Vietnam. Bewildered on how to deal with the new White House administration, these countries may come to see this move as rubbing salt on an open wound after abandoning the Trans-Pacific Partnership (TPP), an agreement President Obama was keen on promoting as a counter to China’s BRI.

Harsh Trump’s actions might be, they were vindicated by findings from the Department of Commerce showing an overall shrinkage of 35% of the steel industry in the last twenty years and a 60% job loss in aluminum smelting jobs. Nevertheless, an important question to tackle is whether this is merely an American problem? During his campaign and media appearances, Mr. Trump focused on steel dumping by China. Yet, the same report by the commerce department showed a 127% global steel production capacity growth since 2000 with demand growing much slower. Out of the current world steelmaking capacity of 2.4 billion metric tons a year, 700 million metric tons are seen as excess. China is the world’s largest producer at 1.65 billion metric tons, in addition, it is the largest consumer. While the United States is the largest importer (Stats, 2018). Naturally, most of this additional production is present in China, where only 69% of the total production capacity is utilized on average yearly. The global excess capacity is seven times the annual steel consumption in the United States of 107.3 million metric tons, inclusive of imports. With 33.8% imports penetration, the United States imports 36 million metric tons while exporting 10.1. This leaves domestic production at 60 million metric tons in 2017, well below 75% of the utilization rate necessary to produce at least 85 million metric tons, a figure vital for the economic feasibility of American steel industry and to attract future investments in the sector. When comparing the numbers, both the United States and China are suffering from similar symptoms; over-capacity and under-utilization. Yet, at different scales. As a matter of fact, there is a steel glut worldwide. Yet, Trump chose to single out China, although Chinese steel imports in the United States have declined from 1.13 million metric tons in 2011 to 784 thousand metric tons in 2017, a decline of 31% that left China as the 11th largest exporter to the United States behind key allies like Canada, South Korea, Mexico, Japan, Germany and Taiwan as shown in Table 1 (Department of Commerce, 2018).

Table 1: United States imports of all steel products. [Source: Department of Commerce]
It is not unlikely that Beijing will see American tariffs as a direct attack on their position as the largest global steel producer. Immediately after Washington’s announcement, China introduced two tariff packages against American imports, with a gross value of $3 billion. In face of Trump’s trade war rhetoric, the Chinese have taken a cool-headed approach initially, but their response had to be toughened after the White House proposed further $50 billion additional levies that would target high-value Chinese exports, especially electronics. In retaliation, Beijing has proposed import tariffs on key U.S. imports, particularly Soybeans. This action is seen as well orchestrated as Soybeans are grown in states that dominantly voted for Trump during the presidential elections. To the Americans, it was an indication of President Xi’s willingness to join the trade war armed to the teeth. Soybeans are important for Chinese hog farmers as they are used as a feedstock for the pork industry. China’s appetite for pork has risen so greatly, that it has become a crucial component for their basket used to determine consumer prices. The US exports $14 billion worth of the product to China. A 25% levy, as proposed by Beijing, will be hardly felt domestically. The list of products targeted by the Chinese expands to 106 items. Other Agricultural commodities to be targeted include cotton, sorghum, wheat, corn, tobacco and beef. The list is diverse enough to range from petrochemical products to aircraft parts. Apparently, both parties are placing their pieces on the chess board effectively pressing each other into negotiations (Cang & Sedgman Phoebe, 2018). The question here is whether China’s BRI progress will be affected with its trade spat with the U.S.? Or will Chinese strategists accelerate their plans in anticipation of a looming U.S. military or economic escalation?

Note: this is the first article of three investigating the precedents and possible impacts of China’s Belt & Road Initiative (BRI).

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Interested in energy, economics, and current affairs. I endeavor to learn and share my views with the world. I hold an MSc in Petroleum Economics & Management from IFP School, Paris.

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