There are several reasons why it has become increasingly inappropriate to view infrastructure development through the prism of domestic markets, financial systems or regulatory regimes.
First, many big ticket infrastructure initiatives are trade-related projects involving two or more countries, most obviously in the transportation sector.
Second, institutional capital looking for longer-dated assets is flowing across borders more fluidly than ever. Witness, for example, the growth in demand for exposure to real assets in general, and infrastructure in particular, among sovereign wealth funds over the last decade.
Third, even those infrastructure developments that appear to be purely domestic projects will often have environmental reverberations well beyond national boundaries. After all, greenhouse gas emissions don’t carry passports or require visas.
The Silk Road trading route
Today, the most striking example of the borderless nature of infrastructure development is China’s One Belt, One Road initiative, which aims to foster economic growth and investment along the ancient Silk Road trading route between Europe and the East.
An extensive report on the project published recently by CLSA and CITIC Securities explains that “One Belt” refers to the Silk Road Economic Belt where China plans to invest heavily in infrastructure to underpin its long-term presence in Eurasia. “One Road”, meanwhile, is the 21st century maritime Silk Road which will call for the construction of ports and maritime facilities from the Pacific Ocean to the Baltic Sea.
As the CLSA/CITICS guide explains, the initiative serves two key economic objectives for China. First, it creates demand overseas for China’s excess capacity in areas such as steel, cement and aluminium. “Difficulty in maintaining rapid investment growth due to heavy local government debt has meant excess capacity cannot be fully used through domestic investment,” notes the CLSA/CITICS report.
Second, by expanding and strengthening its trading links with a large block of countries in Asia, the Middle East, Africa and Europe, it supports the transformation of China’s economy away from the domestic investment-led model that is no longer as robust as it once was.
Investors agree that this is a significant step in the readjustment of the Chinese economic model. “One Belt, One Road is a smart way for China to develop new markets and secure new investment opportunities, especially for infrastructure-related equipment manufacturers and service providers,” says Karine Hirn, a partner at the emerging and frontier markets specialist, East Capital. “Another long-term implication is that as the RMB will be the main currency for One Belt, One Road-related projects, it will support the strategic objective of the Chinese government to internationalise its currency.”
The Chinese government says that the principal focus of the One Belt, One Road project is connectivity in areas such as policy, transport, trade and currencies, which will create a number of other benefits across several sectors. As HSBC explains in a recent research note, “the build-up of physical links will have an immediate effect on trade and productivity growth. Other related industries, such as agriculture product processing, machinery engineering and tourism, will also develop as the result of better connectivity. Tourism in particular has huge potential given that China is rapidly turning into a nation of holidaymakers.”
The HSBC research report puts the geographical scope of the One Belt, One Road project into perspective. This notes that the countries along the land and sea routes on the Silk Road account for 63% of the world’s population and 29% of global GDP.
In 2014, trade between these countries and China reached $1tr, which is 26% of China’s total trade value, and President Xi Jinping is banking on annual trade between China and its One Belt, One Road partners surpassing $2.5tr within the next decade.
The same report notes that according to estimates by the China Development Bank (CDB), the number of cross-border co-operation projects envisaged by the Silk Road plan already exceeds 900 and involves 64 different countries. The total investment value of these projects — most of which are concentrated in the infrastructure sector — is estimated at $890bn.
The role of the financial services sector
Bankers are optimistic about the opportunities for trade, investment and job creation that the project will generate. If the initiative is to deliver on its ambitious objectives, however, it will need the full backing of the financial services sector at two levels.
First, China will need to develop and expand its local financial services industry to provide enhanced support in some of the less-developed areas of the country that are pivotal to the project’s longer term success. Second, it will need to provide support for the new supranational agencies that will play anchor roles in financing much of the cross-border projects underpinning the project.
As HSBC comments in its research on the Silk Road, “the way the New Silk Road is financed could be the most important factor in terms of the sustainability of the entire initiative.” This is why China is channelling investment into a number of projects designed to develop local financial markets along the Silk Road — including financial centres in Jinbian and Xi’an to serve inland regions and focus on energy transactions.
David Gardner, head of project and export finance at HSBC in Hong Kong, says he is encouraged by the financial firepower and expertise that has already been assembled in support of One Belt, One Road.
“In assessing how it can help investors and developers explore opportunities outside China, the government has used the model of other countries that have been successful internationally,” says Gardner. “Japan, for example, set very high standards because companies such as Marubeni and Mitsui are among the best developers in the world. But they did not achieve their global success on their own. They needed the support of liquid and competitive commercial bank debt, and the icing on the cake was provided by JBIC [Japan Bank for International Co-operation] and NEXI [Nippon Export and Insurance Company].”
Some of the firepower supporting the One Belt, One Road initiative will be provided by seasoned entities such as China’s Export-Import Bank and the China Export and Credit Insurance Corp (Sinosure) which have been supporting China’s trade for many years. This will be complemented by the newly created BRICS Development Bank, which has a broad mandate to fund infrastructure and sustainable development projects, and by two new organisations established specifically to help finance One Belt, One Road-related projects.
The Silk Road Fund
The first of these is the $40bn Silk Road Fund, which was established in Beijing in December 2014, and is mandated to “seek investment opportunities and provide monetary services throughout the Belt and Road initiatives,” according to the People’s Bank of China (PBOC). Aside from the government, the Silk Road Fund’s backers are China Investment Corp (CIC), the Export-Import Bank of China and the China Development Bank.
“The Silk Road Fund is a very versatile source of funding, which can provide senior and mezzanine debt as well as equity,” says HSBC’s Gardner. Details about the fund’s investment strategy have so far been sketchy, although the governor of PBOC, Zhou Xiaochuan, has been quoted as saying it will operate like a private equity investor, but with a longer time horizon. It has been reported that the Silk Road Fund, which is adamant that it is a profit-making entity rather than an aid agency, will aim to exit from its investments through a combination of stock market listings and government transfers.
To date, the Silk Road Fund has made three very different investments. The first of these was the Karot hydropower plant in Pakistan, which is a strategically important staging-post on the Silk Road. Another arose from an agreement announced in September with Russia’s state development bank, Vnesheconombank, to co-invest in infrastructure and other projects, especially in the electricity and energy sectors. At the same time, the Silk Road Fund signed an agreement with Russia’s second largest natural gas producer, Novatek, for the acquisition of a 9.9% stake in a Yamal liquefied natural gas (LNG) project at Sabetta on the Yamal Peninsula in the north of Russia.
Sandwiched between these projects was the announcement of an equity investment in the Italian tyre maker, Pirelli, which at first sight seems to be only very loosely connected with the One Belt, One Road plan.
The role of the Asian Infrastructure Investment Bank
The second newly-established entity designed to support the One Belt, One Road initiative is the Asian Infrastructure Investment Bank (AIIB), which has capital of $100bn and is co-owned by 57 countries, with China holding approximately 30%.
“As well as providing finance, AIIB will add another layer of credibility and bankability which will be important for Chinese developers as they increase their outbound investment,” says Gardner. “This will be very valuable in some of the less developed markets on the Silk Road which many of the commercial banks still regard as too risky.”
The creation of the AIIB has been controversial from a political as well as an ecological perspective, with some concerns having been expressed that as China is such a large shareholder in the bank, it will effectively enjoy a veto over major issues.
Small wonder, against this backdrop, that the Chinese authorities have emphasised there is no question of the Silk Road initiative being used as an instrument of Chinese regional economic hegemony. When Wang Yang, vice premier of the State Council, spoke about the Silk Road project at the opening ceremony of the China-Eurasia Expo in Ürümqi in September, he told the audience that it was all about “openness and inclusiveness, [and] joint development based on consultation and mutual benefit”.
He added that the Silk Road is, “first and foremost, a trade route” and that China would be scrupulous in ensuring that this would create equal opportunities for all trading partners along it. “China is ready to import more competitive products from other countries along the economic belt, especially non-resource products, so as to promote balanced and sustainable development of trade,” he said. On a similar note, he promised that China would provide “favourable conditions” for companies in the economic belt to “explore the Chinese market”.
Equally significantly, Wang pledged that China would remain committed to a “reasonable division of labour” in Silk Road projects. That may have been a nod to the complaints that have been expressed in some developing countries that Chinese companies often import their own workers for big-ticket infrastructure projects, doing little or nothing to create local jobs.
Ecologically, meanwhile, there have been some suggestions that China may be less meticulous about observing high environmental standards in its overseas investments than it has become within its domestic borders. Some recent press coverage, for example, has reported concerns that the AIIB may take a light touch on some of the environmental and social safeguards that can sometimes slow down projects backed by other multilateral development banks.
Sean Kidney, chief executive of the Climate Bond Initiative (CBI), is prepared to give the AIIB the benefit of the doubt on this score. “We’ve been encouraged by the statements that have been issued by the AIIB,” he says. “The incoming CEO has promised that green finance will be at its core, and we have also heard that AIIB plans to issue green bonds to raise capital, which is fantastic news.”
China’s green credit guidelines
Kidney says he is also comfortable that the Chinese banks themselves will be as committed to green criteria in their overseas lending activities as they have been in the domestic market, in conformity with the Green Credit Guidelines issued by the China Banking Regulatory Commission (CBRC) in February 2012. According to the IFC, these specified “how to integrate sustainability practices into the lending cycle and [directed] banks to apply them to both domestic and overseas financing”.
The WWF, the global conservation organisation, meanwhile, has also acknowledged the significance of the CBRC guidelines for Chinese banks’ international activities. It described the publication of the recommendations as “a significant milestone in transforming China’s economic development and China’s growing overseas investments”.
The recommendations published by the PBOC’s task force on establishing a green financial system should also be reassuring to those who are concerned about environmental best practice in China’s international investment and in AIIB’s lending policy. The PBOC’s report insists that the lending mechanisms supporting OBOR “cannot become channels for Chinese companies to offload outdated and polluting capacities to other Asian developing countries”.
In order to safeguard against this risk, the report calls for the AIIB and Silk Road Fund to adopt a “highly transparent environmental disclosure mechanism”. Lenders to One Belt, One Road projects, says the PBOC’s report, should “not only require the disclosure of environmental and social risks of projects and risk mitigation measures by loan applicants, but also prescribe a minimum value for the percentage of loans to environmental projects and disclose such information in their annual reports.”
Strong and well co-ordinated support for One Belt, One Road from the AIIB and the Silk Road Fund will be as critical to its success as the €315bn Juncker Plan is for Europe. “For years, Europe muddled along with no coherent, joined-up strategy to address its infrastructure deficit,” says Scott Dickens, global co-head of infrastructure finance at HSBC. “The Juncker Plan creates a co-ordinated strategy for infrastructure investment, and I’d expect One Belt, One Road to do the same for China.”
International investors and joint venture partners will also have an important contribution to make to projects developed by Chinese companies along the Silk Road. As HSBC’s research explains, this is because the track record of China’s overseas investments to date has been unflattering. This points out that between 2005-2014, the value of troubled Chinese investments overseas reached just shy of $200bn, or about 33% of their total international investments over the same period.
“Losing money in developing countries is nothing new for China, international investors or private sector investors in recent history,” cautions HSBC. All the more reason why Chinese investors venturing down the Silk Road would be well advised to use as much support as multinational banks and joint venture partners can provide.
Developing the China-Pakistan Economic Corridor
Pivotal to the Silk Road initiative is the development of the western region of China, which has benefited less from the economic boom of the last decade than the heavilypopulated eastern seaboard. “The One Belt, One Road initiative is an important strategic move for China, which has recognised that although the eastern part of China has been an economic success story, there is a lack of development, employment and social infrastructure in the west,” says HSBC’s Gardner.
The basic numbers speak for themselves. According to research published recently by HSBC, the central and western provinces cover a third of China’s territory and are home to about a fifth of its population. But its railway density is just 6km per 1,000km sq, well below the national average of 10km — which is why these less-developed regions account for most of China’s planned Rmb800bn ($125.22bn) investment in its railway system in 2015.
Infrastructure development in this region will create substantial opportunities for overseas as well as local companies. This explains why, on his recent visit to China, Chancellor of the Exchequer George Osborne became the first British minister to visit the northwestern province of Xinjiang, which has extensive resources of minerals, oil, gas and coal. “I want Britain to be connected to every part of this vast nation,” said the chancellor in a speech in Shanghai the day before he headed west to Ürümqi, capital of Xinjiang.
The development of Xinjiang means the province will play a central role in the ambitious $45bn, 3,000km China-Pakistan Economic Corridor (CPEC) project, which aims to connect Kashgar in Xinjiang with the warm-water port of Gwadar. Located 130km from the Iranian border and 380km north-east of Oman, Gwadar is strategically positioned close to the Strait of Hormuz, giving it easy access to a key shipping route in and out of the Persian Gulf.
Built in 2007 with technical and financial assistance from China, Gwadar’s deep-water port is regarded by China as a strategic link to the Middle East, Africa and Europe. A signal of that commitment was the agreement signed by China Overseas Port Holding Company (COPHC) in 2013 to manage the port at Gwadar for the next 40 years.
China’s commitment to the development of Gwadar is bold, given its location in Baluchistan — Pakistan’s poorest and least-developed region, where 46% of the population reportedly living below the poverty line. It is also one of its most restive, and has been vulnerable to sporadic terrorist attacks.
As part of its commitment to the China-Pakistan Corridor, the Chinese government is reported to have agreed to build 18 new power plants, half of which will be coal-powered. China will also support the construction of five wind farms, three hydroelectric projects and one solar plant, all of which will be crucial to Pakistan’s economic development. According to CLSA’s research, Pakistan’s peak power demand is 18,000MW, but the country’s total power generation capacity is just 12,000MW. “The power shortage of 6,000MW implies a lot of opportunities for China to co-operate with Pakistan in this field,” CLSA advises. Pakistan’s government has calculated that the country’s energy shortfall results in a loss to GDP of between 4%-7%.
In order to start addressing the formidable challenge of power shortages, in 2008 Pakistan’s Water and Power Development Authority (WAPDA) launched a national water resource and hydropower programme, which is part of Pakistan’s broader development agenda known as Vision 2025, aimed at making Pakistan “the next Asian Tiger”.
In the energy sector, Vision 2025 calls for a doubling of the country’s power generation, to provide “uninterrupted and affordable electricity”, and to increase electricity access from 67% to more than 90% of Pakistan’s population.
The Karot hydropower blueprint
One of the first projects to benefit from the Silk Road Fund is the 720MW, $1.4bn Karot hydropower plant on the Jhelum River in the northeast of Pakistan, which will be jointly developed by China Three Gorges South Asia Investment Ltd (CSAIL) and Pakistan’s Private Power and Infrastructure Committee. The plant, which is due to be built by 2020 and transferred to the government after 30 years of operation, is expected to create about 3,500 local jobs and generate enough power to provide electricity for some seven million homes.
The Silk Road Fund’s co-investors in Three Gorges Investment are PBOC and the IFC, with loans provided by China Exim Bank and CDB.
According to the environmental and social impact assessment of the Karot project, there will be negative ecological and social side-effects, with a number of families needing to be rehoused and the habitat of the endangered golden mahseer fish disrupted, but the net impact on emissions will be beneficial, producing some 1.6m tonnes of CO2 fewer than a fossil-fuelled plant.
More broadly, projects in CEPC’s pipeline will be highly supportive of continued economic expansion in Pakistan, which posted GDP growth of more than 4% in fiscal 2014-15. According to the IMF, the lion’s share of the total investment envisaged under the CEPC will be accounted for by energy, which calls for $33.8bn, with transportation projects requiring the remaining $10.6bn. The transportation infrastructure developments are due for completion by 2017-18, while priority projects in the energy sector are scheduled to add 10,000MW of new capacity by 2017-18 (by 2020 for hydro projects). A further set of promoted projects is planned to add another 6,500MW of capacity “in due course”, according to the IMF.
The IMF adds that the methods of financing transportation and energy projects differ. Transport infrastructure developments will be exclusively financed by long-term government-to-government loans on concessional terms. Energy-related projects, meanwhile, will be FDI-based, financed by commercial loans from Chinese financial institutions to Chinese investors, which will undertake construction of all projects in collaboration with local Pakistani partners. Energy sales by independent power producers (IPPs) will be guaranteed by the government of Pakistan through power purchase agreements (PPAs) at tariffs pre-determined by the National Electric Power Regulatory Authority (NEPRA).
Given that Pakistan is to be one of the earliest beneficiaries of One Belt, One Road, economists will keep a close eye on the broader economic impact of the infrastructure investment and stronger trade links created by the Silk Road initiative.
The IMF is encouraged by what it has seen so far, commenting that CPEC has the potential to raise productivity and growth as long as the projects are well managed and the risks are efficiently mitigated. Imports, says the IMF, will probably rise as Chinese contractors bring in a large share of the required machinery and raw materials. “However,” adds the IMF, “supply-side effects facilitated by higher power generation capacity (including through FDI) and better infrastructure, will be beneficial for economic growth in the medium term.”
Analysts also appear to be encouraged by the economic impact that One Belt, One Road will have on the less-developed countries located on the Silk Road. Moody’s says that it regards the initiative as credit positive for emerging market sovereigns.
The agency commented in a report published in July that the main beneficiaries will be “smaller sovereigns with relatively low per-capita incomes, financing constraints on their current account positions, and low investment rates”.
Supporting development in Bangladesh and Myanmar
Aside from Pakistan, the most notable beneficiaries of the One Belt, One Road initiative may be the countries located on the other economic corridors that the project is looking to develop. Foremost among these is the 2,800km Bangladesh-China-India-Myanmar (BCIM) Economic Corridor.
The East Asian Forum calls this a “win-win arrangement” for the countries involved, which between them account for 9% of the global land mass, but 40% of the world’s population. According to the East Asia Forum, intra-regional trade accounted for just 5% of the total in BCIM countries in 2012, compared with 35% in the ASEAN region in southeast Asia.
The development of a more efficient transportation infrastructure connecting BCIM countries is expected to increase this share, especially if China delivers on its plan to construct a high-speed rail link between Kunming and Kolkata in Bengal. It has been reported that this high-speed line, which would pass through Mandalay in Myanmar as well as the strategic port of Chittagong in Bangladesh, is a candidate for funding from the AIIB and the Silk Road Fund. “To date,” comments the East Asian Forum, “South Asia has not come close to enjoying the same economic success that East Asia has reaped. BCIM might well be the game changer that South Asia needs.”
Bangladesh’s infrastructure could certainly use the sort of game-changer that Chinese capital could bring via the One Belt, One Road scheme. The scale of this capital is not to be sniffed at, with Bangladesh reported to be in negotiations with China over a $13bn loan to finance the production of 24,000MW of electricity by 2021.
It is not just Bangladesh’s energy sector that is in desperate need of investment. According to CLSA’s research — which describes the country’s traffic as “appalling” — paved road coverage in Bangladesh is just 9.5%, flooding is common and maintenance costs are high. As CLSA remarks, it takes 24 hours to drive from the capital, Dhaka, to the port of Chittagong, even though the distance between the two cities is only 240km. The result is a woeful under-development of Bangladesh’s export potential: “The manufacturing export industry in Asia depends on processing imported parts and transport conditions mean that Bangladesh cannot participate well in this production change,” says CLSA.
Closer trade links generated by the BCIM will also be especially appealing for Myanmar, which has set out on a path of reform in 2014 after decades of economic isolation.
A recent analysis by McKinsey describes Myanmar as a “highly unusual, but promising prospect for businesses and investors — an underdeveloped economy with many advantages in the heart of the world’s fastest growing region.”
The World Bank recently scaled back its estimate of economic growth in Myanmar in 2016, from 8.2% to 6.5%, but as McKinsey says, if the country can accelerate its labour productivity growth, Myanmar has the potential to grow at 8% a year.
Beyond South Asia, the other economic corridors which are part of the huge One Belt, One Road plan will have important repercussions for economic growth and infrastructure investment in countries ranging from Mongolia and Russia to the five Central Asian republics of Kazakhstan, Kyrgyzstan, Tajikistan, Uzbekistan and Turkmenistan, as well as in the Middle East and parts of Europe. The new Eurasia Land Bridge, for example, proposes to link Lianyungang in China’s Jiangsu province with key ports in Europe, while the China-Central Asia-West Asia Economic Corridor, which extends from China in the East to Iran and Turkey in the West, will unlock opportunities throughout the resource-rich countries of Central Asia.
A transformational impact
Moody’s notes that “the new silk roads could have a transformational impact for smaller, infrastructure-impoverished countries in South and Southeast Asia, by spurring investment and boosting economic growth potential”. This suggests that the project could kickstart a virtuous circle for infrastructure finance across the region by strengthening credit ratings, supporting the evolution of local capital markets and making projects more bankable.
Although much of the One Belt, One Road project has not yet progressed beyond the drawing board, China’s leading banks have already started to mobilise capital in support of the initiative. In June 2015, for example, Bank of China (BoC) became the first of the banks to issue a bond explicitly for Silk Road purposes.
The $3.55bn (equivalent) transaction was a four-currency issue, raising US dollars, euros, Singapore dollars and renminbi, on which Barclays, Citi, DBS and HSBC joined BoC as global co-ordinators across all four tranches.
A number of heavyweight Chinese investors have also already made a significant commitment to the One Belt, One Road initiative. Citic, for example, has announced plans to invest over CNY400bn in more than 200 Silk Road projects. It has also set up a CNY20bn One Belt, One Road fund.
Bankers say they are also encouraged by the response of the Chinese corporate sector to the opportunities being opened up to them by the One Belt, One Road scheme. “We’ve had a number of discussions with many of the Chinese infrastructure developers, and a common theme among them is that 90% or 95% of their revenue still comes from the domestic market,” says HSBC’s Gardner. “They recognise that they need to grow their overseas business, but they are also very cognizant of the constraints to international growth.”
Already, there is evidence that in the renewables sector, Chinese companies are benefiting from the One Belt, One Road initiative. Goldwind is explicit about this in its 2014 annual report, commenting that “China’s ‘New Silk Road’ strategy supported Goldwind’s success in the overseas market”. Goldwind completed its first project in Pakistan in late 2014, which the company says will “help to relieve a shortage of power, improve the energy structure and promote economic and social sustainable development in Pakistan”.
Elsewhere along the Silk Road, Goldwind has also won orders in countries ranging from Thailand to Serbia and Romania. Further afield, in April 2014 it won its largest overseas order in the form of a 215MW mandate from Panama — which can hardly be said to be on China’s Silk Road. Another of China’s largest wind farm companies, Sinovel, has sold wind turbines to Turkey and Sweden.
Exporting China’s infrastructural know-how
Global infrastructure investment opportunities for a number of other Chinese companies also extend well beyond those directly created by the One Belt, One Road project.
According to research published recently by HSBC, in 2014 China’s outward direct investment (ODI) exceeded the foreign direct investment (FDI) it attracted for the first time.
As this process accelerates, it is probable that Chinese companies will increasingly look to export their know-how in sustainable infrastructure development.
“You only need to visit China and use the high-speed rail system to see that it is starting to lead the world in terms of infrastructure development,” says HSBC’s Dickens. “China is now focused on starting to export some of that technological and construction experience. Be it in high speed rail, nuclear or renewables, China has a lot of knowledge as well as capital to put to work across the world.”
This process is already gathering traction. Look, for example, at the recent creation by China Railway Corp of China Railway International, which is co-ordinating the company’s overseas investments and has been chalking up new mandates across the globe. In September, for example, it was announced that the joint venture between China Rail International USA and XpressWest had won a mandate to develop, finance, build and operate the high-speed Southwest Rail Network between Los Angeles and Las Vegas.
China Rail International reports that it is now “executing and implementing” projects in countries ranging from Venezuela and South Africa to Indonesia, Malaysia and Nigeria.
Co-operation between China and Europe
While demand for environmentally-sound technology is one area that some Chinese companies are looking to explore as a source of international diversification, others may arise from Europe’s huge infrastructure investment requirement. China has already indicated that it stands ready to support the Juncker Plan, with some reports suggesting it is prepared to invest as much as €10bn in Europe’s new infrastructure fund.
Speaking at the 10th EU-China Business Summit this summer, EC President Jean-Claude Juncker said that Europe is as eager to play a role in One Belt, One Road as China is to invest in the blueprint for reinvigorating Europe’s infrastructure that bears his name. “We see the project as an open hand, an invitation to connect China and Europe better than ever before,” he said. “China and the European Union should now bring together know-how, resources and other strengths to make sure we succeed. The ambition of our response should be equal to the scope of the project itself.”
For both sides, Chinese support for the Juncker Plan is seen as cementing economic and trading relations which have strengthened significantly in recent years and are expected to grow in importance over the coming decade. In his keynote address to the recent EU-China Summit, the Premier of China’s State Council, Li Keqiang, said that he hoped trade between China and Europe would reach at least $1,000bn by 2020, which compares with a little over €500bn in 2014.
China’s enthusiasm for the Juncker Plan, say a number of market participants, contrasts with the lukewarm approach to sustainable infrastructure investment of many European politicians. “Governments like China’s and India’s have been far more aggressive in formulating green infrastructure investment plans than Europe’s,” says CBI CEO Kidney. “In Europe, governments are saying they can’t invest in infrastructure because they’re in an austerity phase. But infrastructure investment is precisely how you climb out of recession and create jobs.”
This argument appears to be borne out by recent research from Standard & Poor’s (S&P) on infrastructure investment’s economic impact. “In Europe,” this advises, “investment in infrastructure is lower than a decade ago and we believe this low investment has been a major cause [of] the slow recovery in the EU economy — moreover, chronically weak capital spending endangers future growth.”
The numbers are eye-catching. S&P estimates that for each additional €1 allocated to public sector investment in 2015, €1.4 would be added to real GDP between 2015- 2017. “At the same time,” says S&P, “such an increase would add around 627,000 jobs in the Eurozone and more than a million in the EU.” With the EU’s unemployment rate at 9.3% in September 2015, governments should take note.
Implications for the green capital market
Kidney argues that as well as stoking growth and creating employment, the financing of the Juncker Plan should have a decisive role to play in underpinning the expansion of the green capital market. “The ECB’s charter says that it is meant to meet the social and political goals of the union,” he says. “What better way to do that than to include green bonds in the ECB’s asset-purchase programme? If this were to happen it would ignite a rush of green bond issuance.
“I’m a great fan of the Juncker Plan, but policymakers’ support for it has been extraordinarily light. By failing to wash it through a green filter, we are missing an unbelievable opportunity.”
Looking for investment opportunities on the Silk Road
Meet the man who says he has the best job in the world. As portfolio manager of the London-based Alquity Asian ESG Fund, Mike Sell’s job is to trawl emerging markets hunting for companies that combine the best ESG standards with the brightest growth prospects. The two, says Sell, are symbiotic. “If you’re reducing your energy usage it’s not just good for the planet because you’re reducing your greenhouse gas emissions,” he says. “It’s also good for your bottom line because you’re reducing your costs.”
About 40% of the assets in the $20m equity fund managed by Sell are in the frontier markets located along China’s Silk Road, with approximately 15% in Vietnam, 5% in Pakistan, 5% in Bangladesh and 4% in Myanmar. These are four of the frontier markets dubbed Asia’s ‘super seven’ by Alquity, with Sri Lanka, the Philippines and India making the others in the septet.
“The exposure of most investors in Asia is concentrated around China, Korea, Taiwan and Malaysia,” says Sell. “While I’m sure there are plenty of good investment stories in those markets, we think the most exciting growth opportunities are to be found in the region’s frontier markets.”
Sell says it is too early to judge how the super seven — let alone individual stocks within these markets — have been impacted by China’s One Belt, One Road initiative. But he says the longer term spill-over from Chinese investment into infrastructure along the Silk Road will be considerable. He points to Pakistan, which is set to receive close to $50bn in Chinese investment over the next few years, as one of the most compelling examples.
“For Pakistan, this is a mind-numbingly large amount which will have incredibly powerful implications for growth and development,” he says.
The size of the planned Chinese investment in Pakistan is put into graphic perspective in a recent HSBC research bulletin. This notes that the $46bn of investment identified under the Silk Road project compares with a historical annual average total of inbound investment over the last five years of just $2bn. Small wonder that it is not just frontier specialists like Alquity that are weighing up opportunities for equity investment in Pakistan. Having been ejected from the MSCI emerging markets index in 2008, in response to the temporary closure of the Karachi Stock Exchange, Pakistan is expected to be reinstated in 2016, which should kick start a virtuous circle for investors.
“We’re not benchmarked, so the inclusion of Pakistan in the index won’t affect our fund directly,” says Sell. “But it will mean that the market attracts plenty of passive money. That will bolster liquidity, which will make me and my investors very happy.”
Curiously, given that it has uncovered compelling opportunities in markets like Myanmar and Laos, the country where Sell’s fund has struggled to find companies that meet Alquity’s ESG requirements is China. “Whilst Chinese construction companies are winning a lot of orders as a result of the One Belt programme, very few meet our governance criteria,” he says. “They may be perfectly good companies but they are not sufficiently transparent for us.” He says that the only notable exception, China State Construction — which is in the Alquity portfolio — is a domestic-oriented group which has not been a beneficiary of the One Belt, One Road initiative.
Karine Hirn, partner at the emerging and frontier market specialist, East Capital, agrees that Chinese companies have the most to gain from One Belt, One Road in the short to medium term.
“The main beneficiaries will be Chinese train manufacturers, nuclear power companies, telecoms equipment manufacturers and banks, because they will be the preferred contractors and financiers for the projects,” she says. For stock pickers, however, she says that the challenge will probably be to sift the genuine winners from companies hyped by the broking community.