CEE pings loudly on China’s economic radar

Chinese cash may never quite come to dominate the CEE region. But it is here to stay

  • By Elliot Wilson
  • 15 Jun 2017
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world 100pxTo ardent followers of China’s brand of economic diplomacy, it all seemed eerily familiar. It was November 2016 and a state-owned financial giant — in this case, Industrial and Commercial Bank of China — was trumpeting plans to roll out a vast new investment fund aimed at snapping up foreign assets and ploughing the nation’s cash into ambitious and faraway infrastructure projects.

But the target wasn’t the Middle East or the landlocked but resource-rich wastes of Central Asia. Nor was it sub-Saharan Africa or Latin America, recent recipients of so much of China’s largesse. This time, China’s leaders were going after a new quarry: the disparate assemblage of 16 nation states — some developed, ambitious and moderately wealthy; others mired in poverty or locked into a lower-middle-income holding pattern — that make up Central and Eastern Europe (CEE).

It seemed to catch the entire region on the hop, yet the announcement was all too real. Jiang Jianqing, chairman of ICBC, the world’s largest commercial lender by assets, was on record, pledging to channel up to €10bn ($10.9bn) into leading CEE retailers, food manufacturers and high-end technology firms. Infrastructure would also get a boost, with the new outfit, Sino-CEEF Holding, set to invest billions of dollars into new roads, rail lines, airports and power plants. Jiang was quick to emphasise the willingness of the region’s presidents and premiers to contribute generously to the new investment fund.

Nor is Sino-CEEF the only fund pumping mainland cash into regional projects. Back in 2015, a Warsaw-based investor, CEE Equity Partners, was handed $1.5bn by Export-Import Bank of China (Exim), one of a trio of China-controlled policy lenders, and told to go forth and invest. So they did. In the past 18 months the fund has bought shares in a raft of regional firms ranging from Slovakian lighting specialist JLR to Hungarian voice and data carrier Invitel Group.

WHY?

But why focus on a culturally diverse region stretching from the Baltics in the north to the Balkans in the south and from the elegant spires of Prague to Russian-occupied eastern Ukraine, which boasts few major multinationals, suffers from human and capital flight and lacks much in the way of natural resources. What is China’s motive here? Why Central and Eastern Europe? Why now?

They are good questions. A booming bilateral trade relationship can hardly be the primary reason for China’s belated interest. Mainland exports to the CEE accounted for 2.7% of all Chinese exports in 2015, according to the Observatory of Economic Complexity (OEC), a data tool created by the MIT Media Lab in Massachusetts. Compare that with the US (the destination for 18.4% of all mainland exports in 2015) or the European Union or Japan, which respectively accounted for 16.2% and 6.2% of all Chinese-made goods.

It’s even harder to make a compelling case for ICBC’s investment pledge when you drill down to a sovereign level. Poland, the CEE region’s largest economy, accounts for around 0.6% of Chinese exports, reckons Tatiana Lysenko, chief emerging Europe economist at Standard & Poor’s. For the Czech Republic, the region’s second largest economy, that share falls to 0.2%. “Generally,” notes William Jackson, an emerging-markets economist at Capital Economics, “CEE-China ties are a trifling matter. China makes up a small share of CEE exports and the CEE region makes up a small share of Chinese exports.”

In truth, China’s interest in a region that has, notes Chris Hartwell, president of the Centre for Social and Economic Research (Care), a Warsaw-based think tank, “spent 20 years re-orienting its trade links toward western Europe and away from [its former political masters in] Russia” is complex and nuanced.

On a purely commercial level, China’s interest in Europe’s eastern reaches is easy to explain. Mainland exports to CEE countries totalled $63.8bn in 2015, according to the OEC, while the value of goods travelling in the opposite direction was $10.8bn. Thus, China’s export-to-import ratio with the CEE region that year was 593% compared to 355% with the United States, 228% with the UK, 218% with the EU and 211% with Africa.

That data is yet more eye opening when viewed at the sovereign level. The Czech Republic’s trade deficit with China was a whopping 8.9% of GDP in 2015. Other regional states have lower, but far from insignificant, trade deficits with the People’s Republic: Slovakia’s stands at 5.2% of GDP, Estonia’s is 4.5% and Poland’s is 4.1%. Compare those to the trade deficits that major developed nation states run with China, from the US (1.8%), to France and the UK (1.2%), to Germany (0.6%). Little wonder, notes Stefan Kawalec, founder of Warsaw-based financial consultants Capital Strategy and a former chief economic advisor to the Polish government, that “the CEE is a region worthy of China’s attention”.

Slowly, then, a picture begins to emerge. At a very basic level, China views the region through the prism of trade. CEE states have little in the way of energy reserves or natural stores of commodities to offer China but it is teeming with ambitious and low-to-middle-income economies that are in the main democratic and open to free trade. And that makes them “natural destinations for Chinese capital, goods, investment and labour”, says Gu Hongfei, an associate at the central and Eastern European Centre for Asian Studies, a Budapest-based think tank that draws together academics from 12 CEE and Asian states. “For China, the region presents an opportunity to ease excess capacity at home.”

Others see a deeper vision at work, one that plays to the comparative advantages of both sides. Eastern Europe offers investors two genuine and compelling benefits: high levels of employee skill and low unit labour costs. China’s own labour costs are rising fast as its economy gets older and richer but thanks to its vast foreign exchange reserves, which stood at just over $3tr at end-March 2017, it boasts vast pools of accessible and fungible state capital.

This, says Care’s Hartwell, will result “not necessarily in a huge expansion of bilateral trade, but in an acceleration of investment from the Chinese side that will drive trade into the CEE, through it and beyond. China’s new emphasis on high-end technology, innovation and knowledge-based industries could be really beneficial for the CEE region. There is a nice symbiosis there and it could drive innovation for all of Europe.” Capital Strategy’s Kawalec believes China is keen to use the region as an industrial base camp, manufacturing consumer goods and specialised high-end products at a lower cost before shipping them to wealthier western European markets.

CONNECTING THE DOTS

Then there’s infrastructure. If there is one thing China does effortlessly well it is this. Mainland construction firms have in recent years built maritime toll bridges in Mumbai and highways in eastern Africa; future plans include new rail lines in Latin America, ring roads encircling Kazakh cities and a giant road and rail system linking western China with the Pakistan port city of Gwadar.

So it makes sense to fund and build infrastructure projects across Central and Eastern Europe, particularly when, as Capital Strategy’s Kawalec notes, they help “facilitate the transport of Chinese-made products to European markets”. Or, to put it another way, to convey goods made by mainland-owned factories located within European Union-area CEE states to the likes of Germany and France.

China’s interest in the region varies from state to state, experts say. Larger regional economies such as Poland and the Czech Republic, boasting developed-world-level infrastructure, have less need of mainland cash to fund roads and tunnels. But Hungary, a country that has benefited in the past from Chinese aid and which is currently struggling to see eye-to-eye with the EU, is more likely to welcome mainland capital with open arms.

BALKAN FOCUS

Another likely target for China is the Balkans. “China wants Serbia to become a key logistics and transportation hub that can be used to convey Chinese-made goods to Europe and to open markets that might be closed or restricted,” says Care’s Hartwell. “China really has been targeting the underbelly of Europe in the Balkans, and Serbia is probably one of the largest recipients of Chinese tied aid. The Balkans seem to be more of a multiplier for them in terms of infrastructure.”

Standard & Poor’s Lysenko believes the need for China-originated infrastructure capital is greatest not in the non-EU western Balkans but in the Black Sea states of Bulgaria and Romania.

Focusing on poorer markets that mainstream capital often bypasses, rather than scattering cash to the wind in the hope that some of it will stick, makes good sense. After all, China is a newcomer to a region long dominated and influenced by Russia and the big economic beasts of western Europe. Infrastructure capital is also flowing into the region from Russia (which is funding two new €12.5bn reactors at a nuclear plant on the Hungarian stretch of the River Danube) and the EU, which is half way through a three-year plan to channel €21bn into Europe-wide (including CEE) infrastructure projects. In the short run at least, China will not have everything its own way.

OBOR — WRAPPING SOFT POWER AROUND HARD ASSETS 

Encircling this entire discussion is an acronym that may come to define the 21st century. China’s vastly ambitious One Belt, One Road plan, or OBOR, is often misunderstood, in large part because few outside China (and possibly very many living within its borders) do not, or cannot, grasp the project’s ultimate intent.

Whether you view it as a genuine game-changer, a paper tiger or just a handy phrase designed to give China’s globalisation plans focus and definition, no one can accuse it of lacking ambition. OBOR spans 65 countries, 60% of humanity, and more than 25% of the world’s GDP. Its overland route, which starts in the Chinese capital, stretches eastward through Central Asia and Russia — whose own trade ties with China have improved markedly in recent years — and Poland, culminating at the great Dutch port of Rotterdam.

Paul Sheard, chief global economist at Standard Poor’s, believes OBOR is all about “wrapping soft power around hard assets”. He says it speaks to China’s desire to achieve multiple goals, from increasing its global reach and influence, to boosting returns on its external financial assets, to winning over foreign markets and making them reliable and stable conduits for its capital and exports.

In this sense, Central and Eastern Europe is very much part of China’s long term plans. A strong CEE region is cricial to the OBOR project and thus crucial to China’s long term interests. Viewed in this light, the decision by major Chinese lenders such as ICBC and Exim to pump capital into a region far from the country and traditionally under the political, financial and cultural aegis of Russia, Germany and the EU makes an awful lot of sense. Chinese cash may never quite come to dominate the CEE region. But it is here to stay.

  • By Elliot Wilson
  • 15 Jun 2017

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