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Economy

Five Challenges for the Belt and Road

Oct 18 , 2018

 

This fall, China’s ambitious Belt and Road Initiative (BRI), first announced by President Xi Jinping in September 2013, turned five years old. Since its announcement, the BRI has made considerable progress – notably in the domain of physical connectivity – but not without generating its fair share of controversy and debate. With President Xi’s term extension, his flagship initiative is bound to accelerate, especially as the confluence of burgeoning demand for infrastructure among developing countries and China’s desire to export its surplus capacity continue to be “push” factors for the initiative. Furthermore, the trade war with the U.S. and the increasing stringency of the review process of Chinese acquisition deals in developed economies only intensifies China’s search for alternate markets for investment. Anticipating the increased momentum, it is important to take stock of five critical challenges for the BRI as it enters its fifth year.

The first challenge to the Belt and Road is debt sustainability, which has both domestic and international dimensions. Despite China’s aggressive push to invest overseas and its higher appetite for risk, it is a latecomer in lending and development finance, a club traditionally dominated by advanced economies. However, while extending credit to underserved subprime markets constitutes one entry strategy, it could be a double-edged sword for both China and the host states. For instance, it is hard to reconcile taming China’s mounting public debt with its practice of making investments in risky and volatile places. On the other hand, if China’s bullish outlook on host states’ economic development were to bear fruit, its intervention would be considered a game-changer. Hence, it is a high-stakes tactic which could dramatically backfire if done without due diligence.

The second challenge is finding creative and acceptable risk mitigation measures. The use of natural resources as an alternative form of payment on loans and the use of equity-for-debt swaps have raised concerns internationally. Critics point to Beijing’s use of loans to corner the resources and strategic assets of debtor countries, which provides fodder to the narrative of “debt trap diplomacy.” While the BRI is not charity and the Chinese enterprises involved rightfully expect returns, devising reasonable terms for heavily indebted countries is crucial for the BRI’s public image. China’s capacity to build and manage world-class infrastructure at home is beyond doubt, but developing a framework to make overseas projects viable may take time. This is especially true for countries where the state does not play as dominant a role in the economy as it does in China. Hence, an element of prudence when planning commercially unsound, big-ticket projects is needed in order to lower the financial risk for China and ensure the project has a positive impact for host states.

The third challenge is the need to expand the local element of BRI projects to address concerns that China’s supply chain stands to benefit more than host states from infrastructure projects. Wherever possible, Chinese contractors should source inputs such as labor, materials, and provisions locally, to better contribute to local economies. Partnerships with local firms, known for their intimate knowledge of the domestic business environment, would be ideal. Skills, knowledge and technology transfer are also essential to building local capacity and diminishing dependence on China for operations and maintenance. While this would affect the scale, speed and efficiency of Chinese construction projects, it would bolster the BRI’s inclusivity and disseminate benefits locally right from the construction phase.

The fourth challenge is factoring in potential leadership changes in BRI participating states. Recent electoral cycles in Sri LankaMalaysia, and Pakistan placed China-backed projects in a quandary. Threats to review, postpone, renegotiate or cancel projects hurt Chinese investments, sour relations, and cast uncertainty over long-term projects. However, these are realities that China has to consider. Allegations of corruption and irregularities, whether confirmed or perceived, put pressure on the new leadership to scrap or renegotiate foreign-funded projects. Hence, ensuring fair and sound conditions, from initial bidding to final construction, is a form of insurance against such political headwinds.

China must also realize that it is not enough to rely on positive relations with the present government. This is especially true for democracies where other actors, such as the political opposition, local businesses, civil society, mass media, and academia wield considerable influence and are critical in supporting or effecting leadership change. One of the BRI’s five goals, the promotion of cultural exchange and people-to-people bonds, will play an important role. Cultivating long-term ties with multiple stakeholders in host countries is a crucial investment which will be key not just to the success of the BRI, but for China’s broader vision of building a community of shared future for mankind.

The fifth challenge is the need to find the proper balance between setting or modifying financial standards and a commitment to introducing new ones. China’s rise as a new aid donor unsettles long established international lending norms. While some disruptions are needed in order to update current lending guidelines, an abrupt departure from long-held standards could erode systemic safeguards against debt overexposure in less developed BRI host countries. This may imperil borrowing states and the health of development finance markets. However, China’s entry into the fray of the development finance world is supported by strong, decades-old undercurrents. For years, developing and underdeveloped countries have complained about the conditions attached to IMF-World Bank loans. Hence, China’s pledge of “no-strings attached” credit resonates well. Finally, rigid multilateral lending institutions have to date been unable to provide space for emerging economies to contribute in shaping the world aid agenda.

In 2016, possibly in response to China’s expanding aid activities, the OECD created revised guidelines for sustainable lending. Beijing may find value in reflecting on this document. For better or worse, China’s massive aid portfolio throws a spotlight on the apparent advantage of state over private capital when investing in long gestation, mid-to-high risk projects in underdeveloped and developing country markets. Thus, China compels traditional funders and private finance to rethink how to better respond to the huge infrastructure demand in the global South.

As the Belt and Road enters its fifth year, Chinese policymakers are likely to progress in their ability to manage evolving challenges to the initiative. If the BRI is a way for China to promote its reform and opening-up process, China must allow for flexibility instead of applying a cut-and-dry development formula for partner countries. In this regard, commitment to joint consultation, cooperation and mutual benefit must go beyond slogans. Finally, the BRI’s success may hinge on China’s ability to balance domestic imperatives and the interests of participating states with its desire to blaze a new trail and effect reform of global governance structures.

 

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