“One Belt One Road” – China’s new growth strategy looks at westwards expansion

The “One Belt One Road” (OBOR) initiative by China is arguably their most ambitious initiative to date. The project which was started in early 2013 by President Xi Jinping, has two parts. First, the New Silk Road is a plan for an overland route running through Central Asia and to Europe. The second is the Maritime Silk Road, which will connect the ports of South East Asia, South Asia and Africa. The end goal is to build a network of sea routes, overland roadways, railways, oil and natural gas pipelines and other infrastructure projects that will connect China to Central Asia to Venice and ultimately reach as far as Moscow.

The drivers behind the One Belt One Road
For more than three decades China experienced double-digit export led growth resulting in the creation of the world’s largest economy. The inevitable slowdown in growth finally transpired in 2014 when an annualised GDP of only 7.4% was achieved, the lowest figure recorded over the past 14 years.

While growth had slowed down, decades of strong manufacturing output, primarily aimed at offshore markets, had left the Chinese economy with a substantial pool of financial capital and foreign reserves along with a huge excess of manufacturing capacity in steel, cement and various other industries. This is a strategic initiative by the Xi Jinping government who, having anticipated a decline in domestic led growth ahead of time, had put in place strategies which could allow China to sustain its growth in the long run by using its excess manufacturing capacity for offshore projects, and allowing for full utilisation of its capital and reserves to fund such projects.

While the first motivation for the OBOR is economic, the second factor was political. The growth of China as an economic power has not been consistent with China’s representation and weighting in major world organisations. Currently, American, Japanese and European parties continue to dominate the international financial institutions such as the World Bank, International Monetary Fund and the Asian Development Bank. At the same time, there has also been a trend of leaving China out of global initiatives. Examples of these are initiatives by Trans-Pacific Partnership countries, the Transatlantic Trade and Investment Partnership and the EU-Japan agreement, all of which failed to reach out to China.

The above factors could all explain China’s decision to ‘go it alone’ and set up its own global institutions. Yun Sun, senior associate at the Stimson Center, links the creation of the Asian Infrastructure Investment Bank (AIIB) to President Xi Jinping’s vision for “the great rejuvenation of the Chinese nation.” She further accentuates “the need of a new, proper international order reflecting China’s greater economic and political weight”.

The AIIB and financing
The projected investment for OBOR is about $1.4 trillion according to a report by the mainland publication China Dialogue. In order to support this enormous budget, the Chinese government created the AIIB, a Beijing based supra national fund. While the bank was initially created for Asian members with the objective of financing infrastructure build across Asia, the Chinese authorities were taken aback as various European nations applied to join shortly after its announcement. Today the AIIB boosts 57 members including United Kingdom, Australia and Russia.

While still in its infancy phase, the AIIB has a capital of $50 billion which is expected to grow significantly with China promising to contribute a further $100 billion.

Combining AIIB’s massive financing engine with OBOR’s infrastructure plans, Xi aims to transform China’s growth strategy from primary production towards a longer term vision of building much needed infrastructure across Asia, Africa and parts of Europe. Such a policy should also have the secondary effect of stimulating production and consumption demand back in China. According to Peter Wong, deputy chairman, HSBC, “The (OBOR) policy will reinforce China’s center stage position in Asian trade and transport. China’s vast transport and shipping sectors would be the biggest beneficiaries of this initiative. Agriculture, textiles, telecommunications, financial and high-tech sectors are also expected to see knock-on benefits.”

UBS strategist Lu Wenjie has pointed out that OBOR should not just be associated with infrastructure and transport. “One Belt One Road’ investment is not just about energy and transport infrastructure, we see increasing investments from real estate, technology and finance”.

OBOR and the RMB
Not all OBOR objectives are growth driven. It is also intended to boost the use of the RMB in the region, a wider goal of renminbi’s internationalisation. The routes encompass 65 countries, with a population of 4.4 billion, and account for 29% of global GDP, all of which gives China a strong platform with which to internationalise its currency. Thomas McMahon of UD Trading attending Remninbi World 2015 stated “the OBOR initiative will have a significant positive impact on RMB’s usage in the region if most of the funding for various infrastructure projects along the belt is done in RMB and particularly through bond issuances”.

During the “One Belt, One Road” panel discussion at the Remninbi World 2015 conference, panelists Sun Jianbo, deputy general manager in the international business department at China Construction Bank and Pan Xilong, associate professor at South-western University of Finance and Economics discussed how the OBOR could be facilitated by using RMB as well as how much of the overall investment would actually be in RMB. All panelists agreed that the benefits of settling directly in RMB instead of having a third currency such as the USD would lower transaction costs for both parties.

Similarly, while all panelists agreed that Chinese construction companies building roads or railways along the corridor would prefer to use RMB, Pan pointed out that “whether RMB is used in a particular project would really depend on the nature of relationship of the two parties”.

The OBOR initiative will not rely solely on AIIB funding. OBOR will also look at creating RMB based offshore assets and debt issuances. A scheme to use fixed income markets to create offshore RMB products began in London in October 2015, with two state-owned Chinese banks, CCB and the Agricultural Bank of China (ABC), issuing bonds for the OBOR initiative. The ABC bond in particular is an innovative move by the Chinese bank as it was issued to investors as a ‘green bond’ meaning that the funds will be used to drive projects such as sustainable land use, renewable energy and waste management.

Such “green” investments are “envisaged as a key component of the OBOR master plan as China tries to boost the international business of its environmental companies. The aim is also that Chinese suppliers to such OBOR projects will be paid largely in renminbi.”

While it is encouraging for the Chinese authorities to note the demand for primary issuances of RMB based assets in offshore markets, the real key to successful RMB internationalisation would be in the eventual creation of deep and liquid secondary markets for such offshore RMB bonds. It is too early at this stage to assess how an offshore RMB fixed income secondary market will materialise.

Obstacles and challenges
While the OBOR plan is regarded as highly strategic and, overall, beneficial to China’s future growth, it does carry with it significant risks.

Firstly, there is the element of security as the planned OBOR corridor of 81,000 kilometers will run across three continents that involves 65 countries. The countries involved all have very different political landscapes. Countries such as Singapore, Malaysia, Qatar and Oman may represent a low security risk while others like Syria, Iraq and Iran are high-risk conflict zones. The logistical issue of security and protection for its construction workers, factories and equipment along with its maritime fleets will give rise to controversial questions about whether a heavy Chinese military presence and international naval bases will be required along the belt. While the Chinese government has been very tight lipped about its security planning for OBOR, the government has a draft anti-terrorism law which provides legal backing allowing for its military on foreign soil as long as there is consent from the host nation.

An equal risk to security would be the status of political stability of countries that have signed up to the OBOR. Political changes to a host nation’s government can threaten projects if the new government’s economic and foreign policy are vastly different to that of the incumbent.

From a financial risk perspective, China’s promise to pledge $100 billion to a project involving 65 sovereign counterparties also calls into question the credit risk that the Chinese economy will have to bear with such financing. A sovereign default as a result of war or financial bankruptcy will have an impact on any foreign direct investments made to that country although much of the losses will be absorbed by the collective contributing fund members at the AIIB. Probably more significant is the adverse impacts of OBOR on financial markets. Sudden disruptions in large projects due to, for example, terrorist attacks or climate disasters could potentially cause offshore RMB bond holders or creditors investing in OBOR to panic and cause a sell-off. This could in turn affect other offshore RMB products and create unnecessary volatility and uncertainty for offshore RMB hubs that are still at an infancy stage.

Implementing the OBOR
There is little doubt that China’s strategic plan to transform its growth model from a manufacturing export model to one that creates regional and global infrastructures fuelled by its own capital surplus, is brilliant strategy. Along with revitalising its factories and labour force, it will also meet the objectives of building regional cooperation and relationships as well as promoting its offshore RMB currency and assets.

Despite the attention OBOR has drawn and the overall positive feedback from its international participants, there are various security, political, credit and market risk eventualities that China will have to assess and plan for. As McMahon mentioned, “The One Belt One Road is both ambitious and strategic on paper. But let’s see how China actually manages to implement it”. In summary, the success of OBOR should not be attributed to its strategy but to the planning and implementation of this strategy. How OBOR unfolds over the next ten years will determine China’s credibility and stature as a major economic power.