For evidence of how profoundly China has cribbed from history in its efforts to flesh out the Belt and Road Initiative (BRI) one need only glance at a map of the old Silk Road.
The original stretched from northern China to Europe via Central Asia. But along the way it intersected with a host of other trade routes, one of which diverged at Bukhara in modern-day Uzbekistan. It pushed south to Barbarikon, a trans-shipment hub for Persian lapis lazuli and Afghan turquoise on the Indian Ocean.
Barbarikon is long gone but a few miles along Pakistan’s coast lies Gwadar, a port city all but owned by China.
China has built a 2,280 acre free trade zone here along with an industrial port and a naval facility. In time, its aircraft carriers will dock here, a further sign of its regional aspirations.
Pakistan: BRI central
For now, though, the real action is taking place north of Gwadar in the heartland of this troubled country. China will spend around $50bn by 2030 — the final bill may be higher — to build the infrastructure Pakistan needs, from highways and power plants to gas pipelines and transmission grids. Much of the funding flows in from China’s main policy lenders, China Development Bank and Export-Import Bank of China (Chexim).
Long term the aim is two-fold. First, China wants to transform Pakistan into a captive trade conduit. Commodities and energy will flow north from Gwadar to western China with completed goods making the return journey south. That, says James Cameron, Asia co-head of infrastructure and real estate at HSBC, allows Beijing to “open up new trade routes between China and the Indian Ocean, to compliment or compete with current trade routes that pass through [Southeast Asia] ports and through the Strait of Malacca, potentially cutting the time it takes to get goods to southern China from the Indian Ocean, and linking up regional value chains.”
Second, by piecing together the South Asian state, China aims to do some nation building. It wants a stronger and wealthier country to emerge overseen by a government able to stifle conflict.
The same pattern is playing out across a region dotted with low-income countries bedevilled by corruption, weak institutions and patchy infrastructure. In April, a pipeline opened that will carry 22 million tonnes of oil a year from Myanmar’s coast overland to the southwest Chinese city of Kunming, helping China to receive faster supplies of crude from Africa and the Middle East.
Chinese firms are building a $2.3bn industrial park and a $7.3bn port, both at the Myanmar port of Kyaukpyu in the Bay of Bengal. They are also pushing ahead with $6.8bn worth of infrastructure projects in Bangladesh, while in Sri Lanka policy lenders have funded highways, ports and the $209m Mattala Rajapaksa International Airport.
It’s the number and sheer scale of these grands projets that compel experts, when asked to identify the key sovereign constituents of the BRI, to point in the region’s direction. “Pakistan is obviously the most important BRI country,” says Paul Sheard, chief economist at S&P Global in New York. “Myanmar comes in second, with Central Asian states further back.” South Asia can also be seen as a vast economic hinge: a point where the overland ‘belt’ and the maritime ‘road’ meet.
Too much of a good thing?
Much of this infrastructure is useful and needed — but not all. That new airport in Sri Lanka, funded with a $190m Chexim loan, was built too far from major cities — 100km from Galle and 200km from the capital Colombo — to be of any use. Built to handle a million passengers each year, it processes a dozen a day. The airport earned $300,000 in 2016, according to the transport ministry, but faces $23.6m in debt repayments made out every year to Chexim until 2025.
Pakistan faces a problem that will seem familiar to African states that borrowed heavily from the IMF in the 1970s only to get trapped in a debt spiral. China has on two occasions over the past year come to Pakistan’s help, providing $1.2bn in loans to stave off a currency crisis. Yet even that did little to bolster its finances: the country’s forex reserves fell 10% month-on-month in July to $14.6bn, according to the State Bank of Pakistan. One of the chief financial drains is China itself, with Pakistan forced to deplete its coffers to meet the interest on mainland bank loans — and to pay Chinese contractors and suppliers.
Indebtedness is also changing the composition of Pakistan’s liabilities, with non-governmental debt up from 7% of total external debt in 2010 to 14% in 2016, according to World Bank data. Moody’s Investors Service noted in a September 2017 report that the shift was mainly “because of inbound investment flows, which are likely to be a result of BRI projects”.
This raises another issue for a state increasingly reliant on capital from its giant neighbour. “With Pakistan’s external debt shifting to a bigger share of ‘private’ debt, the question is how stable that source of funding is in the long term,” says Michael Taylor, chief credit officer, Asia Pacific at Moody’s in Hong Kong. “It is never going to be as readily available as funding from the IMF or the World Bank.”
India sitting out
There is one state in South Asia that has refused to play any part in the Belt and Road and that is the one that really matters. India, as S&P’s Sheard drily notes, is “sitting this one out”. The government’s antipathy toward China dates back to a brief border war in 1962 started and won by Chinese forces. India, says Charlie Robertson, chief economist at investment bank Renaissance Capital in London, sees the BRI and China’s funding of Pakistan’s economy and military “as a means to check its own ambitions in the region”.
This puts India in a tricky situation. Its finance minister Arun Jaitley reckons it must find $1.5tr in fresh investment by 2025 to bridge its infrastructure gap — and China, flush with cash, can help. Yet the longer India holds out, refusing to play any role in the greatest pro-trade project of the century, the less money will be forthcoming later. “When China makes the next round of BRI investments, that money will be less likely to go to India,” says Matthew Oxenford, a research associate in Chatham House’s global economy and finance team in London. “A funding framework is now in place for BRI countries and India isn’t part of it.”
Finally, there’s Southeast Asia. China has to tread more carefully here. Some nations here are backward and in dire need of funding while others are highly economically and politically advanced. Projects in the region typically fall into one of two categories: big-ticket infrastructure deals and corporate acquisitions.
The latter has been a boon to the banking industry, with global lenders such as HSBC and Citi better able (versus their mainland peers) to pitch, plot and process financially complex deals that cross borders, currencies and cultures. HSBC’s Cameron points to the $1bn sale of John Holland, an Australian engineering contractor, to infrastructure giant China Communications Construction (CCC) in 2015. “We provided CCC with acquisition financing and cash management services and later helped to finance their first public-private partnership in Australia.”
Summoning the spirit of BRI
True, it can at times be hard to draw a line between some individual deals and China’s overarching pan-regional trade initiative. If a mainland firm buys an Indonesian utility or a Vietnamese power plant, does that not constitute straightforward M&A, albeit led by corporate vassals of the Chinese state? But ambiguity is perhaps the greatest genius of the Belt and Road. Because no one knows clearly how to define it, virtually any deal, whether small or sprawling, can claim to be part of a greater whole. That’s a boon to bankers and nation states, both of which need only summon the spirit of the BRI to justify a project.
In Southeast Asia, the Belt part of the BRI comes into play in the field of high-speed rail. In July, China’s railways operator secured its first major export order when Thailand approved a $5.5bn high-speed service connecting southern China with Singapore. A month later, Kuala Lumpur broke ground on a $13bn rail project, built by China’s CCC, that will run from Malaysia’s eastern coast near its border with Thailand to its western coast on the Malacca Strait.
China won’t have everything its way. Japan has signed deals to build high-speed rail lines in Thailand and India using its own shinkansen bullet train technology and more will follow.
Alexious Lee, head of China industrial research at Hong Kong brokerage CLSA, says this competition will help the region. “The BRI is a catalyst,” he says. “It boosts competition and drives down prices. China, better at construction, will win some rail deals; Japan, better at technology, will win others. Everyone benefits.”
Tomorrow: the western section of the belt (overland) route