China's "One Belt, One Road" intiative challenges existing project-financing banks for new Asian development.
China’s “One Belt, One Road” (OBOR) initiative is the most ambitious overarching infrastructure project to be proposed in the modern era. OBOR, which was unveiled in 2013 and is the brainchild of China’s president Xi Jinping, aims to connect China with more than 60 countries—stretching from Western and Central Europe to East Africa and including South East Asia, the Middle East and Russia—via infrastructure development as well as trade and cultural exchange.
Also referred to as the New Silk Road project—a reference to the route by which ancient China traded with the West—the proposal has drawn comparisons with the Marshall Plan, which was instrumental in rebuilding Europe after World War II. But it is more ambitious: various estimates put OBOR’s scale, adjusted for inflation, at ten to 30 times the Marshall Plan; upon successful completion it will touch the lives of more than half the global population. No concrete timeline for completion has been stated.
This project, or rather, collection of projects, is projected to require investment of as much as $4 to $8 trillion. Much of that is expected to be raised in Chinese renminbi.
Roads, railways, ports and the integration of maritime trade are the core features of OBOR. And the project emerges at a time when China has been flexing its muscles against the perceived hegemony of the United States in the multilateral development bank (MDB) sector. To date, the MDB infrastructure lending business in Asia has been dominated by the Asian Development Bank (ADB), established in 1966, headquartered in Manila and with Japan as its major shareholder.
CHINA FLEXES ITS MUSCLES
China aims to counter the dominance of the World Bank and the International Monetary Fund in international development banking through the establishment of the Asian Infrastructure Investment Bank (AIIB) and the New Development Bank, headquartered in Beijing and Shanghai, respectively. Both became fully operational last year with China as a major shareholder: 26.06% of the votes in the AIIB—where China effectively calls the shots on investment strategy within its borders—and 20% in the NDB. In addition, in seeking to boost OBOR, China in 2014 established the Silk Road Fund under the auspices of the State Administration of Foreign Exchange, China Investment Corporation, Export-Import Bank of China and China Development Bank, with total capital of US$40 billion earmarked for financing OBOR-related projects.
AIIB president Jin Liqun said the bank plans to invest $3 billion to $5 billion in infrastructure in 2017 and $10 billion next year, a large part of which will be earmarked for OBOR-related projects. China’s policy banks—Export-Import Bank of China and China Development Bank—are also expected to extend their chunky balance sheets to OBOR. Some $80 billion was lent by China Exim in 2014, which included 1,000 enterprises located in OBOR-targeted countries. But these institutions will fall far short of providing the estimated annual investment of $2 trillion if OBOR is to advance to reality. Early indications are that rather than seeking to go it alone in the face of competition from the new China-initiated MDBs, the ADB will collaborate with these institutions.
LEVERAGING PRIVATE FUNDS
China hopes that public-private partnerships (PPP) will mobilize private capital to plug the shortfall, and a variety of funding options are on the table to encourage private interests, from standard nonrecourse bank financing accompanied by equity injections to project-bond issuance in onshore as well as offshore formats.
“There is a need to further the public-private partnership framework in China and in many of the countries that are part of the OBOR project. There must be open bidding for projects,” says Ayumi Konishi, director general of the East Asia department at the Asian Development Bank (ADB) in Manila. “Of course, in order to attract private capital, the projects must be commercially viable.”
The initial response from the capital markets has been promising, and momentum is underway to create from scratch a new asset class: bonds and loans under the “Silk Road” label. China has proposed a stand-alone trading and settlement system for debt issued under this brand.
“Adding the ‘Silk Road’ label to a debt-financing exercise can give it more focus and attention from investors due to the publicity already garnered by the Silk Road initiative,” says Clifford Lee, head of debt capital markets at DBS Bank in Singapore. At the same time, he adds, “the impact that this will have on the Asian project-finance market will depend more on the actual feasible project-finance opportunities that can surface from this initiative.”
Lee expects the project-bond market to take longer to develop. Currently, it serves “only as an ‘add-on’ to traditional nonrecourse project financing at a later stage,” he says. “This is due to the limited supply of financing opportunities in this space that are deemed bankable.” The received wisdom among market professionals is that investment in OBOR-related projects will not follow international best practice in PPP terms and that despite the rhetoric from the Chinese authorities, many projects will not be driven by commercial risk-return considerations.
STRATEGIC CONCERNS VIE WITH COMMERCE
“As is known publicly, and acknowledged by the Chinese authorities themselves, purely commercial motivations alone may not drive every single one of these projects—strategic considerations could very well dominate the decision on whether or not to fund a particular project,” says Vijay Chander, executive director of fixed income at the Hong Kong–based Asia Securities Industry and Financial Markets Association. “My view is that while this entire initiative represents a great opportunity, commercial banks and specialist Asian project-finance teams will very much adopt a wait-and-see approach to see if they are being adequately compensated for the risks before committing significant project financing.”
This view has been echoed by project-finance professionals in the region who are nervous about a range of issues regarding OBOR, from shoddy bidding and procurement processes to the effective subsidizing of projects by the big Chinese lenders and the mispricing of project loans. Long construction periods for projects, as well as high levels of political risk in OBOR-related countries, are also a deterrent to potential sponsors and lenders.
“At the moment, the Silk Road projects are dominated by bilateral lending on the part of the leading Chinese policy banks. Of course, at the margin there will always be opportunities for Chinese and regional commercial banks to participate in syndications, or indeed in project bonds,” says Chander. “But project-finance teams and other investors will very carefully assess risk-return profiles before committing significant funding.”
Still, the Chinese policy and commercial banks have met demand from private equity, pension funds and insurers in their attempts to syndicate OBOR-related
debt. A recent milestone in this regard has been the tie-up between Singapore government–owned IE Singapore, a trade development board, and China Construction Bank, which has earmarked $22 billion for investment in OBOR-linked projects.
“The momentum behind the Silk Road project can be seen from two angles with regard to China: On the one hand it is about China’s foreign policy and its desire to work more closely with other countries,” says the ADB’s Konishi. “On the other, it is about domestic policy and China’s aim of developing its provinces.”
Early indications from the AIIB—if its first loan forays are anything to go by—are that it will collaborate with the ADB on OBOR-related financing, despite expectations that institutional rivalry would have the two lenders at loggerheads.
“While the OBOR plan is hugely ambitious, it builds on policies that have been in place for many years in the multilateral development-bank sector. For example, the Asian Development Bank has been promoting greater connectivity as part of its mandate since its inception, and OBOR is another element in the drive to ‘shared prosperity,’” says Konishi.
In June, ADB approved a cofinancing with AIIB for a highway project in Pakistan (an OBOR country), with each lender providing $100 million and the UK’s Department for International Development providing $34 million. DBS’s Lee views that model of financing as likely to remain central to OBOR efforts for now. “Most of the immediate feasible project-finance needs in Asia can likely be met by traditional project-financing banks,” he says. “This avenue would need to be exhausted more before project-finance bonds can be seriously explored.”