Belt and Road

by Bruno Maçães

  We have seen in previous chapters how finance works as the hinge holding the initiative together, but that means finance also has the potential to become its weakest link. Just as subprime in the United States concentrated political and financial incentives without proper scrutiny, the Belt and Road could introduce massive distortions in how capital is allocated, with potentially devastating consequences for all the countries involved. According to the Institute for International Finance, between the fourth quarter of 2008 and the first quarter of 2018 China’s gross debt exploded from 171 to 299 per cent of GDP. High leverage is the original sin that leads to risks in the market for foreign exchange, stocks, bonds, real estate and bank credit, but making the necessary changes will be difficult, particularly in a world populated by trade wars and grand geopolitical initiatives.

  In recent months Chinese authorities have started to tighten reins on debt, with debt growth slowing to the lowest rate in more than a decade. These figures point to growing risks of a slowdown for the Chinese economy, but even if the risks are adequately managed, a sharp reduction in credit creation will interfere with the scope and ambition of many ongoing and projected Belt and Road activities. In June 2018 the Financial Times reported that China is scaling back investment in Ethiopia in the face of rising foreign exchange shortages. Business people, diplomats and bankers said Chinese entities were taking a “more cautious approach” to Ethiopia. “Current international conditions are very uncertain, with lots of economic risks and large fluctuations for interest rates in newly emerged markets,” said Hu Xiaolian, the chairwoman of the Export-Import Bank of China at a forum that month. “Our enterprises and Belt and Road countries will face financing difficulties.”2

  As for participant countries, they too are struggling with exploding debt levels, and unsurprisingly the problem is graver in their case. After the new government in Malaysia announced it was reviewing Belt and Road projects and cancelling most of them in order to avoid bankruptcy, Myanmar said it was reviewing the $9 billion deep-water Kyaukpyu port development, a flagship Belt and Road project, over concerns it is too expensive and could fall under Beijing’s control in case the country defaults on its debt. The amount of debt Myanmar would need to take on for its share of the project would be about $2 billion, or about 3 per cent of GDP. It may be too optimistic to assume that many of the countries in the core Belt and Road regions have the absorptive capacity needed to provide an outlet for as much capital investment as China plans to provide through the initiative. Above that level, capital investment would offer better returns in China, a simple calculus quickly affecting the economic logic of the new integration model.

  Beijing thus finds itself in a bind. If it takes on the bulk of the financing costs for the Belt and Road, risks to its financial system may go into the red, but if it attempts to push those risks onto participant countries, it will ensure that investments become divisive political issues, poisoning relations between China and other countries. Already in many countries, as we saw before, the backlash against the initiative is visible and gaining momentum. Debt is a concern, but other criticisms have been voiced. Mahathir Mohamad, who went on to win the 2018 Malaysian elections, complained during the campaign that Forest City showed that Malaysia was giving its most valuable and beautiful lands to foreigners and that many of the projects financed by China brought no benefits to Malaysia since even workers were brought from the mainland. In September 2018 Mahathir took the dramatic step of announcing that foreigners will not be issued visas to live in Forest City. “They can buy the property, but we won’t give them visas to come and live here,” the Prime Minister told reporters after an event at the National Art Gallery, reported the Malay Mail.

  In many places in South and Southeast Asia and elsewhere China is struggling with accusations of corruption, which have become part and parcel of the political cycle: politicians seen as close to Chinese positions are vulnerable to those accusations during vicious campaigns, almost always turning public opinion against China and its growing economic clout.3 From Cambodia to Pakistan to the Maldives, all of which held elections in 2018, opposition forces are using Chinese-funded ventures to go after incumbent governments. The former president of the Cambodia National Rescue Party, the main opposition group that was dissolved with a controversial court ruling, tried to exploit Prime Minister’s Hun Sen image as a China acolyte: “What Hun Sen is doing is in order for China to help protect his power. The Chinese are allowed to freely enter Cambodia, to take land, islands, beaches and mines.”4 Malaysia’s new government has revealed a possible China connection in the explosive 1MDB scandal, linking the problems at the graft-tainted state investment fund to two Beijing-backed pipeline projects that cost more than $1 billion apiece. Then, in July 2018 President Maithripala Sirisena of Sri Lanka made the announcement of a fresh grant of 2 billion yuan at a ceremony marking the start of construction of a Chinese-funded kidney hospital in his home constituency of Polonnaruwa, 230 km from Colombo. “When the Chinese ambassador visited my house to fix the date for this ceremony, he said that Chinese President Xi Jinping sent me another gift,” Sirisena told the gathering. “He has gifted 2 billion yuan to be utilized for any project of my wish. I’m going to hand over a proposal to the Chinese ambassador to build houses in all the electorates in the country,” he added. The grant offer comes at a time when a Chinese firm is facing heavy criticism for allegedly financing the last election campaign of former President Mahinda Rajapaksa.5 Going one step further, President Rodrigo Duterte of the Philippines revealed in May 2018 that China will ensure he is not ousted from power. “The assurances of Chinese President Xi Jinping were very encouraging. Eh nandyan iyan sila. ‘We will not allow you to be taken out from your office, and we will not allow the Philippines to go to the dogs,’” Duterte explained during a ceremony attended by Filipino scientists.

  Even in Pakistan—the crown jewel of the initiative—the authorities have fallen behind on payments for electricity from new Chinese power projects because of longstanding problems getting Pakistanis to pay their bills. The Belt and Road has certainly contributed to the balance of payments crisis. Raw materials are required to construct buildings, bridges and roads, and Pakistan has to bring in all of them from abroad. The same applies to heavy machinery, where Pakistan’s imports are set to top $27 billion by 2021. Pakistan can pay for Chinese machinery with Chinese loans, but unfortunately these loans are due before the economic gains that will be used to pay for them are accrued. A bailout from the International Monetary Fund seems inevitable—and Pakistan has received an IMF bailout twelve times since 1988—but it would create a number of renewed difficulties for the China-Pakistan Economic Corridor, including strict restrictions on borrowing and spending and transparency requirements for existing Chinese loans and projects. “Deals like the Orange Line cannot be secret,” said Chaudhry Fawad Hussain, spokesman for the main opposition Tehreek-e-Insaf party, in a reference to the new overhead railway in Lahore, financed and built by Chinese state-run companies. One civil servant in Islamabad told the Financial Times: “The Chinese are not keen on western institutions learning the minute details of financing of CPEC projects. An IMF program will require Pakistan to disclose the financial terms to its officials.”6

  Finally, in case of a bailout, the United States, the largest contributor to the IMF, would acquire a significant measure of influence over China’s plans in Pakistan. Beijing does have enough sway to ensure that Pakistani authorities reject an international bailout program, but in that case China would have to shoulder the financial costs all by itself and essentially double down on its high-risk Pakistan bet. The Chinese embassy in Islamabad responded to reports about a connection between the Belt and Road and the debt crisis in Pakistan with a statement published on July 23, 2018. There it was argued that 42 per cent of Pakistan’s foreign debt is owed to multilateral financial institutions, with Chinese preferential loans accounting for only 10 per cent of the total. “Even if there is a debt trap,” the s
tatement concluded, “the initiator is not China.” Adding to the complexity, the United States quickly started to have doubts about whether an IMF bailout was such a good idea after all. Secretary of State Mike Pompeo warned in August that any potential IMF bailout for Pakistan’s new government should not provide funds to pay off Chinese lenders.

  After the victory of Tehreek-e-Insaf in the July 2018 elections, the new Prime Minister, the former cricketer Imran Khan, seemed keen on a reset on the Belt and Road. His victory speech included these closely scrutinized lines: “China gives us a huge opportunity through CPEC, to use it and drive investment into Pakistan. We want to learn from China how they brought 700 million people out of poverty. The other thing we can learn from China is the measures they have taken against corruption, how they have arrested more than 400 ministers there.” The phase after the elections will help define the ultimate fate of the Belt and Road in Pakistan. If the new Khan government demonstrates its willingness and capacity to focus on a serious economic reform and investment program, there is still an opening to address the mounting problems with the China-Pakistan Economic Corridor, which China does not believe to be insurmountable. Privately, the Chinese side has also made it clear that there is scope to renegotiate the terms of some of the ongoing or planned projects if it makes political and economic sense to do so.

  If Beijing sees an extended period of political infighting, with a weakened government, distracted by religious and ideological propaganda, if as Andrew Small argues it has to navigate another round of bad press surrounding the Belt and Road, Beijing may well feel inclined to conclude that “Pakistan is unable to channel the requisite energy into making a success of their flagship connectivity endeavor.”7 In September 2018, a report by the Financial Times suggested that Pakistan might follow Malaysia in attempting to revise the terms of its participation in the Belt and Road, which Minister Abdul Razak Dawood—the Pakistani member of cabinet responsible for commerce, textiles, industry and investment—described as unfair, insufficiently thought through and disadvantageous to local companies. The report was swiftly attacked by Chinese and Pakistani authorities.

  In April 2018 the IMF’s managing director, Christine Lagarde summed up these concerns when she warned Chinese policymakers in a conference in Beijing to beware of financing unneeded and unsustainable projects in countries with heavy debt burdens. In an otherwise supportive speech on the Belt and Road, she noted the initiative’s “ventures can also lead to a problematic increase in debt, potentially limiting other spending as debt service rises, and creating balance of payments challenges.” Echoing Western complaints about insider dealing—especially acute for the European Union—she added that “with any large-scale spending there is sometimes the temptation to take advantage of the selection and bidding process.”

  In April 2018 the Financial Times published an editorial arguing that the Belt and Road “is an accident waiting to happen.” So what should Beijing do? “China needs to take a responsible approach to its role as a creditor. That does not mean it should be excessively risk averse. To lend for development is, quite properly, to take risk. But it is also to assess projects and fiscal positions rigorously and, when things go wrong, share in the losses, without imposing unduly onerous conditions. That is what a responsible creditor must do. China should show the way.”8 The fate of the Belt and Road no doubt hangs on how the Chinese authorities are able to manage this set of issues, even if their approach is likely to deviate considerably from that advocated by the Financial Times. Their instinct is more political than financial, their priority to control the sources of income and be relatively less strict on the dispensations of credit.

  As serious as it may become, China’s debt threat may be exaggerated by not taking into account the peculiarities of the Chinese economy. As Andrew Nathan explains, just as the US dollar enjoys the “exorbitant privilege” of being accepted everywhere as a bearer of value even though it is not backed by any tangible asset, so too the Chinese yuan—which is not freely convertible—must be accepted by participants in the Chinese economy—on its way to becoming the world’s largest—which gives the government the ability to print money at will in order to stimulate economic growth, with limited risk of inflation. Given the nature of China’s economy, both debtors and creditors are mostly government entities, so the government can adjust their debt relationships without precipitating a financial panic.9

  As the problems with their international investment projects keep growing, China’s development banks have decided to intensify their cooperation with overseas financial institutions. China Development Bank is reportedly considering combining its lending efforts with Western financial institutions that require adherence to “international standards”—including open, competitive tenders for project contracts as well as public studies on environmental and social impacts.10 With open tenders, China’s policy banks would be forced to concede loans without the stipulation that Chinese companies must do most of the planned work. Unsurprisingly, as it attempts to mitigate financial risks, China will lose some of the exclusive control over the Belt and Road it has so far enjoyed.

  As the Belt and Road initiative gains speed, China is increasingly finding that it cannot provide the required financial resources all on its own. To attempt to fill these needs at home—using Chinese banks—at a time when its economy is slowing down and its banks are saddled with bad loans would expose the financial system to unmanageable risks. Therefore, it is essential for China to gain access to global financial markets to complement its domestic resources. World financial hubs such as Dubai, Singapore, Zurich or even London could play a role.

  It is true that China continues to limit access to its financial services market, with cross-border lending and offshore bond issuance facing numerous legal and political limitations. Those familiar with the reasons for China’s financial protectionism understand that they are less immediately connected to economic and industrial policy goals than to political imperatives. The determinant of whether a sector of the Chinese economy is open to foreign entities has always been whether state-owned enterprises are already operating in the area. The Belt and Road is a high political priority for the Chinese government, so this may be the best way to frame wider discussions about financial market access. If the question of opening the Chinese financial services market is a political one, any country seeking to engage it needs to address it as such. There is enormous potential to make progress through dialogue between public and private stakeholders, provided motivations on both sides are properly understood.

  It is very likely—perhaps even inevitable—that the Belt and Road will grow more decentralized—less Sinocentric—over time. But this, after all, is not that different from the structure of the existing America-led world order, where the United States insists on being recognized as the state at the apex of the international power hierarchy. Its preeminent role is fully compatible with the preservation of large spheres of autonomy for secondary states, some of which have been admitted to a kind of inner circle where important decisions are made and where their voices are heard. The preferred understanding is that of American leadership rather than domination. Similarly, the Belt and Road may evolve into a complex system where countries occupy different levels in its hierarchy and some may even acquire managing rights in the initiative.

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  Chinese commentators are quick to identify the 2008 financial crisis as a turning point, the moment the world realized Western economic and political institutions were far more fragile than everyone thought and the “China solution” acquired new luster, if only by contraposition. But there should be a cautionary note here to the effect that financial crises now decide the fate of nations, their rise and fall, and these critical moments for building the future have a way of arriving unannounced.

  Debt has emerged as the main challenge faced by the Belt and Road, but for some commentators it is actually part of the grand scheme. According to this view, China deliberately sad
dles countries with debt to make them more vulnerable to its influence. If the Hambantota port remains largely idle and the multibillion dollar investment to build it risks being squandered, perhaps this is as intended. One commentator goes so far as to argue that it is better for China if the projects do not do well, because that increases the debt burden for participant countries. Some countries, overwhelmed by their debts loads, are being forced to sell stakes in critical projects or hand over their management to Chinese state-owned firms. “By integrating its foreign, economic, and security policies, China is advancing its goal of fashioning a hegemonic sphere of trade, communication, transportation, and security links. If states are saddled with onerous levels of debt as a result, their financial woes only aid China’s neocolonial designs.”11

  The truth is surely somewhere in the middle. In cases like Hambantota port—so unattractive is its geography compared to Colombo—Chinese companies will almost certainly shoulder important losses and having a 99-year lease and a management concession is unlikely to change the outcome. Even if China opens its second overseas naval base there, one might still argue that there were much cheaper ways to reach that outcome. In other cases, debt diplomacy may turn out to be extraordinarily successful as China obtains majority ownership in some of the critical infrastructure of the future world economy. There will be obvious and notable successes—projects that capture our imagination as they get implemented, advances in technology happening faster than expected—helping propel the initiative forward and these will be sufficient to keep the political consensus around it. But the historical analogy always invoked in official statements and documents on the Belt and Road may serve as a warning sign: after all, glorious as they were, the expeditions that the Chinese Admiral Zheng led across the full extension of the Indian Ocean in the fifteenth century were abandoned by later Ming emperors, opening the way for European control over Asia, starting with the Portuguese at the end of the century. Might a similar fate await the Belt and Road?