How is Belt and Road being funded?
“If you want to get rich, you have to build roads first,” Xi Jinping told the delegates at the signing ceremony to formally establish the Asian Infrastructure Investment Bank (AIIB), citing a Chinese proverb.
But to build roads, you have to finance them, and a key question surrounding the Belt and Road plan is how it is going to fund its ambitious mission.
The new banks
The AIIB is the most dramatic example of how the Chinese plan to underwrite the economic development along the new Silk Road, although it has the remit to lend outside Belt and Road countries as well.
The bank’s creators say it has been designed to finance badly needed transportation, telecommunications and energy projects, and it joins the Silk Road Fund, backed by $40 billion of Chinese capital, some of it provided by China Investment Corporation, the country’s sovereign wealth fund.
The Fund’s initial project – investment capital for the first hydropower project in the new economic corridor between Xinjiang and the Pakistani coast – began construction earlier this year.
Another lender with a focus on infrastructure is the New Development Bank (NDB), where China has allied with Brazil, Russia, India and South Africa as founding investors. This ‘BRICS Bank’ has raised initial capital of $50 billion, which is set to increase to $100 billion. It has made investments worth $800 million in the past year and it issued its first yuan-denominated bonds in Shanghai in July. The proceeds will be used to fund clean energy projects.
However, the 57-member AIIB is making most of the headlines because of its billing as the Chinese counterpoint to multilateral lenders like the World Bank, led by the Americans, and the Asian Development Bank, which is headed by Japan.
The AIIB is based in Beijing and chaired by Jin Liqun, a former finance minister. China put in $30 billion of the initial capital and it holds 26% of the bank’s voting authority. That gives it a strong voice. In most cases, a simple majority of votes is required to reach a decision. But there are instances that require a “supermajority” of 75%, allowing Beijing some form of veto power.
In contrast, the New Development Bank’s initial capital is “equally shared” among the five founders and each participant has one vote, so none of the countries will have veto power.
China’s backing for the AIIB has stirred suspicions in Washington that the bank will try to erode American leadership in global financial affairs and chip away at the dominance of the dollar by pushing for a greater share of lending denominated in the renminbi.
The Americans urged their allies to steer clear of the new bank and it was a diplomatic disaster for them when European states including the United Kingdom, France and Germany joined up with the China-led initiative last year.
Total amount of the first four loans announced by the AIIB in June 2016
Now the AIIB has a waiting list for membership with its president Jin Liqun extending “a warm welcome” to representatives from 24 potential joiners at the first annual meeting in June. Canada was the latest Western nation to break ranks with the Americans, announcing in August that it too would be joining the new multilateral lender.
What’s the attraction? For a start the AIIB will focus its loans on projects in its member territories, so there is a financial incentive for countries to join. Jin has promised to make the AIIB “lean, clean and green” and the bank says that it plans to build up its loan portfolio gradually, investing about $1 billion this year. Nonetheless, borrowers seem motivated by the expectation that it will be nimbler than the other multilateral lenders in disbursing funds. It certainly acted swiftly in approving its first four loans, and the first $500 million went to four projects in Belt and Road countries – an electricity grid in Bangladesh, a slum redevelopment initiative in Indonesia, and highways in Pakistan and Tajikistan.
Perhaps tellingly, all but one of the loans was co-financed with other development institutions, including the World Bank, the Asian Development Bank, and the European Bank for Reconstruction and Development. And that sends a message that the bank is starting out with a collaborative approach – even if it is Chinese-led.
Despite all of the attention for the AIIB, it is the Chinese policy banks that are doing the heavy lifting for Belt and Road lending.
The two main institutions of this type – the Export-Import Bank of China (ExIm) and China Development Bank (CDB) – are the largest sources of finance for Silk Road loans. ExIm Bank lent more than $80 billion in total last year, almost three times as much as the Asian Development Bank. More than a thousand of its loans were in 49 countries considered targets of the Belt and Road Initiative, Xinhua says. CDB hasn’t released a comparable figure but it reported last year that it was tracking more than 900 cross-border projects. Most of them were infrastructure-related, with total investment value estimated at $890 billion.
“There will be times when we take a different approach [to the United States],” a spokesman for the former British Prime Minister David Cameron told reporters last March, after the UK government had announced that it wanted to become a founding member of the AIIB.
The policy banks have headed confidently into places where commercial lenders fear to tread. Liu Liange, chairman of ExIm Bank, made the point in June at the opening of a tunnel in Uzbekistan, dug by the China Railway Tunnel Group. “The world’s major commercial banks will seldom give loans to these countries, because they can hardly pass the rigid risk assessment,” he explained. “China’s Import and Export Bank is more flexible, because it’s a state-owned, policy-oriented bank, which does not aim for short-term returns. China will be rewarded much more in the long term, if the logistics corridor can be built up.”
The contribution from the policy banks was highlighted further by Kelvin Wong, an executive director at Cosco Shipping Ports, during a ratings agency conference in Hong Kong in September. He said that Cosco looks for local sources of funding for its overseas deals because it helps to have local supporters for its projects, and sometimes the debt is cheaper. But getting finance can be tricky. His example was Cosco’s deal for Kumport container terminal in Turkey, where it drew a blank because local lenders knew little about the company. So Cosco went back to China’s policy banks for the loan, and Wong expects this to continue until China’s companies – and the Belt and Road plan in general – are better understood overseas.
Although the new banks and the policy lenders have significant firepower, state-backed funding isn’t enough to support all the investment envisaged under the Belt and Road banner.
That means that asset managers, insurance funds and private equity outfits will have to help with financing the plan on a longer-term basis.
The challenge is that many institutional investors will need convincing that there are sufficient ‘bankable’ projects in the Belt and Road portfolio. Risk management is a particular concern. The Financial Times has already reported a cautionary tale in which Chinese officials were said to have admitted privately that they expect to lose 80% of their investment in Pakistan, 50% in Myanmar and 30% in the countries of central Asia. These kind of dangers might leave private investors more cautious about betting on Belt and Road – at least until they have seen how successfully the state capital has been deployed.
The potential losses on loans in Pakistan, according to Chinese officials
“I’m not worried about the sovereign risks – as long as the project is good for that [recipient] country,” the AIIB’s boss Jin assured the Boao Forum for Asia Financial Cooperation this summer. He then urged investors to focus on the standalone prospects for the projects concerned, plus whether the investment would deliver wider benefits to the local markets. “In some other cases, probably a road… in and of itself [it] doesn’t add a lot to the country. However, if it is part of a network… that can create a major role in promoting the [business] environment of that country. Some projects can quickly generate revenues if they are connected… You don’t have to worry about debt sustainability,” he advised.
But another of the delegates at the ratings agency conference in Hong Kong pointed out that 16 out of 65 countries on the Belt and Road are yet to be rated on a sovereign basis. Plus there’s wide divergence in the creditworthiness of the countries that do have ratings – from AAA down to B- (“one step from default” as the contributor put it). Investors are going to be cautious, he suggested. They will be looking for partnerships with local development banks and state guarantees in some of the recipient countries.
Elsewhere, financial centres like Hong Kong are already positioning themselves as fundraising hubs for Belt and Road projects. Public-private partnerships for investment in hospitals, railways, roads and bridges are likely to feature. ‘Green bond’ lending for renewable energy, waste and water management, and sustainable transport will also be important. This is an area where the Chinese already lead the world – more than $17 billion of the green bonds, which require proceeds to be used for environmentally friendly purposes, have been issued so far this year. And another major theme for Belt and Road borrowing is the spread of the Chinese currency, as the world’s financial centres start to package more of their products in offshore yuan.
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