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Emerging Markets

The new coupling

China is stepping up its investment in Africa, as western investors pull out. But western criticism of Chinese lending practices misses the point that many cash-strapped countries seeking infrastructure funding welcome China’s counter-cyclical backing

The global financial crisis is accelerating China’s investment in Africa. Up 81% during the first half of 2009 compared to last year, Chinese financial institutions are investing capital on the continent in a counter-cyclical manner, financing Chinese firms that, in most cases, are venturing abroad for the first time.

Over the past decade the economic destinies of the two regions have become increasingly intertwined – a trend that could be called the “new coupling”. GDP growth trends for China and Africa have tracked each other in almost absolute parallel over this period.

Africa’s recent robust growth has been driven by China’s demand for commodities; China is very likely to be ranked as Africa’s single largest trading partner this year. Even in commercially diversified South Africa, China was its largest trading partner over the first half of 2009.

But with the rapid drop off in Chinese growth following last year’s global crisis, Africa’s GDP growth outlook has followed suit. While Africa’s growth is largely underpinned by Chinese demand, China’s growth prospects will increasingly become dependent upon Africa’s ability to supply the resources. This dynamic explains the roll-out of Chinese-funded infrastructure across the continent in a bid to ease supply-side constraints.

Vocal support

The Chinese leadership has been vocal in pledging continued support to Africa during the global financial crisis. During a trip to Mauritius earlier this year, president Hu Jintao reminded developed countries that they should “assume their responsibilities and obligations” to Africa during the global crisis. China’s commerce-first approach towards Africa is increasingly appealing to African states over the traditional aid-led approach.

The current crisis has resulted in African policy-makers openly spurning the so-called ‘Washington Consensus’ model of economic development. Instead, the ‘Chinese model’, if one can be said to exist, is increasingly attractive to African leaderships disillusioned with traditional prescriptions for development. A ‘Beijing Consensus’ emerging in Africa? Perhaps.

Doing business

China has a long and politically close relationship with Africa, but this does not make business there any easier for China’s emerging multinationals. A number of African investments have already failed, and more will undoubtedly do so in future.

But Chinese firms have proved rapid learners in foreign markets. Their ability to adapt to local African market conditions and operate in often challenging political and economic environments will determine whether Chinese investment in Africa is truly long-term strategic, rather than merely short-term mercantilist.China launched a new Africa policy a decade ago when it started to conceptualize and plan the establishment of the Forum of China-Africa Cooperation (FOCAC) – a multilateral forum through which Beijing implements its foreign policy goals. Since its launch in October 2000, China has set out three-year engagement plans that it has put into practice in Africa. The next FOCAC summit takes place in November in Egypt when Beijing will announce another series of strategic initiatives toward the African continent. The focus will be on the agricultural and infrastructure sectors.

A new model

Criticism is common of Chinese firms that often operate as ‘insulated actors’ in recipient African economies. Construction firms that use only Chinese labour for their contracts do so in the interest of rapid completion of their projects. The desire to deliver the infrastructure on time often takes precedence over local employment generation.

But research carried out by the Centre for Chinese Studies shows that as Chinese construction firms’ time in their host African economy increases, they begin to integrate – employing a local labour force and having a locally focused supply chain. Chinese financial institutions are now the largest financiers of infrastructure in Africa. The World Bank estimates Chinese funding of roads, railways and power plants in Africa at $7 billion in 2007. As OECD investors have withdrawn capital from Africa over the past year, it is being supplanted by Chinese investment in hard infrastructure. In the first quarter this year, investment in Africa plummeted 67% year-on-year. The Chinese ‘package deal’ type financing structures are very appealing to recipient African economies. The finance, often linked to broader aid packages and commodity purchases, allows Chinese construction firms to enter and rapidly gain market traction in the state in question.

The state-driven nature of this finance, through the so-called concessional finance model implemented by China’s Export-Import Bank, has attracted criticism from western observers, including the IMF, in the case of the Democratic Republic of Congo, where there is a fear that a multi-billion dollar loan will exacerbate its debt burden.

The concern centres on the sovereign guarantee that recipient African states provide for the concessional loan. While controversial in some quarters, many cash strapped African governments seeking investment in their infrastructure sectors welcome China Exim Bank’s model.

Competitive advantage

The bulk of China’s financial engagement of Africa is through sovereign wealth. The state-supported nature of China Exim Bank’s engagement in Africa may be distorting the capital-raising market for large commodity finance projects on the continent. Centred on off-take contracts, the long-term strategy employed in constructing these deals and low cost of capital provided to fund them, gives Chinese contractor firms tapping into the credit facilities a competitive advantage in Africa.

The political construct of these Chinese policy bank deals affords them a longer lead period to realize their investments. A new risk model is being constructed that is calculated differently to traditional (western) investors. The state-owned structure of Chinese policy banks allows for an approach where capital is invested in a manner suited to the needs of developing economies.

Indeed, China’s own phenomenal economic development over the past three decades has been underwritten by a state-owned banking sector. This has been coupled with the creation of a vibrant private sector that now contributes two-thirds of China’s GDP. This is the model that Beijing is pursuing in Africa – sovereign allocation of capital focusing on infrastructure and commodities (rather than the tired aid model) that is intended to support long-term economic growth.

Before the financial crisis, there was much debate about the investment strategies and lack of transparency of sovereign wealth funds (SWFs). The attempt to regulate SWF investments has been a thinly disguised attempt to constrain China’s sovereign investments abroad, in particular into African commodity assets.

But the sovereign nature of Chinese capital deployment in the global economy is allowing Chinese financial institutions to invest in a counter-cyclical fashion. Western investors are withholding credit while Chinese bankers are expanding their loan portfolios in Africa. This is true of Chinese policy banks as well as it is of its commercial lenders. The main actors are China Exim Bank and China Development Bank through its recently launched China-Africa Development Fund, a $5 billion fund for Chinese firms to invest in Africa.

Going steady?

Yet beyond the impressive statistics and numbers from China and Africa’s expanding commercial relationship, the question remains whether it will be sustainable. This will depend on the ability of Chinese firms to integrate their business models into the local African environments in which they are operating.

Chinese firms are used to dealing with tough and competitive conditions but are far less adept at understanding local cultural circumstances. Managing cultural difference is the primary challenge of Chinese business moving to Africa. Meanwhile African societies in general have a poor understanding of China and the Chinese, so Africa needs to build its knowledge, networks and influence in China.

Africa has not yet grasped the long-term strategic implications of China’s growing presence on the continent. But what’s clear is that Africa must pragmatically align itself to China – and its expanding global power.

Martyn Davies is CEO of Frontier Advisory (Pty) Ltd and executive director of the Centre for Chinese Studies

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