EMEA: In-Depth: The unravelling of China’s belt and road

02 October 2018 - 12:00 am UTC

China has staked its political credibility on the Belt and Road Initiative (BRI), but – five years in – it is hitting a wall. Projects are being cancelled and China cannot carry all remaining BRI projects alone. If it is to succeed, the initiative needs international investors to buy-in. But will they? Solomon Teague and Colin Leopold report


The Belt and Road Initiative was supposed to represent China’s emergence as a regional and global superpower, funding billions of dollars’ worth of infrastructure to lift its neighbours out of poverty. Instead it is turning into a public relations disaster.

Sri Lanka has signed over its strategically located Hambantota Port to China after it could not meet BRI debt payments, sparking claims of a Chinese ‘debt trap’.

Malaysia has cancelled Chinese projects worth USD 23bn, including the East Coast Rail Link and a gas pipeline project in Sabeh, while a high-speed rail link with Singapore has been put on hold. Projects have been delayed or scaled back in Myanmar, Nepal and Pakistan, and, according to the latest reports, Pakistan’s new government wants to renegotiate more BRI investments, including an expansion of the Gwadar port, and road and rail links.

In September, the European Commission proposed its own version of BRI, targeting transport, energy and digital infrastructure links with Asia through a EUR 60bn insurance fund between 2021 and 2027, further eroding global confidence in BRI. The US has also announced a new institution able to invest USD 60bn in BRI and developing countries.

At the same time, observers are questioning whether China can honour its existing BRI commitments. China has not disclosed how much it is lending in BRI countries and estimates vary: Natixis says it is probably higher than USD 300bn – equivalent to about 10% of its reserves.

At the latest count, 103 countries and international organisations have signed 118 cooperation agreements with China on the BRI. According to its National Bureau of Statistics, China has invested USD 28.9bn, lifting trade with BRI countries to USD 5trn.

But Chang Liu, China economist at Capital Economics, observes a cooling off in BRI financing in 2018, noting a fall in the value of new projects. “Momentum has been undermined”, says Andrew Davenport, chief operating officer at Washington-based risk consultancy RWR.  The number of transactions in the first eight months of 2018 may be slightly up on 2017 but the value of these new deals is only about half, he says, citing data from China’s Ministry of Commerce.

China Overseas Direct Investment (ODI) to Belt & Road countries 


Belt comes loose
The 2018 figures could demonstrate greater difficulty carrying out large-scale BRI investments in the face of new government screening issues or that BRI is hitting a buffer with international support – financial and political.

According to Moody’s at the end of last year, BRI is reliant on Chinese financial institutions to the tune of more than USD 750bn including loans and guarantees. The figure for international finance institutions including the Asian Infrastructure Investment Bank, the Asian Development Bank and the World Bank was just over USD 200bn.

The large funding from China’s policy banks – China Exim (USD 90bn) and the China Development Bank (USD 110bn) – to BRI countries with a high implementation risk “could lead to asset quality erosion at the banks and increase contingent liabilities for the Chinese sovereign over time”, Moody’s said at the time.

Alicia Garcia Herrero, chief economist for Asia Pacific at Natixis, says BRI recipient countries expect US dollar funding, which China is reluctant to provide since it began rebuilding its foreign reserves in 2015.

Chinese firms involved in BRI are also looking to reduce their interest and exchange rate risk associated with long-term loans, particularly in countries regarded as high risk, notes Deloitte, in an Insight report looking at BRI. “We expect Chinese banks will continue to be more cautious about funding requests, leading companies to seek out other financing options,” the report states.

To make BRI work, China needs the international investor community to get on board. But there is little geopolitical will, if any.

In January UK prime minister Theresa May declined to endorse the initiative amid concerns it was not meeting international standards. In August US senators wrote a bipartisan letter to US Treasury Secretary Steve Mnuchin calling for the US to block IMF moves to bail out countries caught in “China’s debt trap diplomacy.” [extra:pullquoteleft:boxoutcopy=1]

Specifically, the letter highlighted that China’s behaviour as a creditor “has not been subject to the disciplines and standards that other major sovereign and multilateral creditors have adopted.”

Private sources of international capital have additional concerns – from pricing and sustainability to political, currency and cancellation risk.

On the face of it, the case for Western investors joining BRI en masse is weak. While most base decisions on risk adjusted returns, key BRI funders such as China’s Export Import Bank typically secure loans on terms agreed between China and the host government.

One London-based project finance banker says the whole concept of the initiative raises serious red flags. “It’s the principles of infrastructure development gone all wrong,” he says. “Decisions should be taken by these [BRI country] governments themselves with transparent procurement and proper cost/benefit analysis. [BRI] drives a coach and horses through all those basic concepts.”

Ironically, developing countries accepting BRI loans could actually reduce their number of infrastructure projects in the long run, warns the Center for Global Development, as domestic spending on infrastructure and social services is sacrificed to service debts.

Of 63 countries receiving BRI investment, it says 23 countries are “significantly or highly vulnerable to debt distress.” The USD 6bn cost for a planned railway line between Laos and China represents almost half of Laos’ GDP, it notes, and the government there will be under considerable pressure to cover any losses.

China’s due diligence approach has led to questions about the economic case for BRI projects. Few Western observers saw Sri Lanka’s Mattala Rajapaksa International Airport as economically viable but China agreed to finance it. The airport has not operated a flight in months, leaving many questioning the benefit for Sri Lankans.

Risky road
For Western investors BRI projects come with political and cancellation risks, says Adrian Wong, partner at CMS Cameron McKenna Nabarro Olswang in Singapore.

“The development of projects may be affected by a change of administration in the recipient country, as was seen in Malaysia,” he says. “However, it is possible to argue that this may be more of a ‘China issue’ than a ‘BRI one’, with the new administration feeling its predecessor was too dependent on China.”

Even conceptually, BRI poses a problem for the international investment community given there is no single definition for the initiative, say people spoken to for this article. But this ambiguity may be by design, says Mattia Romani, managing director for economics, policy and governance at the European Bank for Reconstruction and Development (EBRD).

“China did not want the BRI to be strictly defined and driven by top down decisions,” he says. “China is good at top down decision making, if it wanted the BRI to be clearly defined it would be.” The fact it isn’t shows China wants BRI to be more inclusive, attracting foreign banks and investors, he says.

But who are these investors and what role will they have in BRI?

Garcia Herrero says international infrastructure funds may be more likely to allocate capital to BRI companies and projects than banks, as their degree of project feasibility can often be less restrictive. That suits China, she says. “China might not be so interested about PPP financing as it seems but rather more with portfolio inflows to finance projects that Chinese corporates run on their own.”

But a second European infrastructure banker says portfolio investment could be difficult to attract.

“Infrastructure funds tend to have a relatively narrow focus – you don’t see many private sector funds with a [truly] global investment remit. A few do, but even those in practise tend to focus on OECD countries that have investment grade ratings and offer some political stability,” he says.

Meanwhile, some international banks have been quietly adopting a different approach to BRI.

Davenport at RWR says large banks and even some governments have been establishing new divisions to target business opportunities emerging in the roll-out of BRI. [extra:pullquoteleft:boxoutcopy=2]

Despite project due diligence and political risk concerns, European lenders have found ways to benefit from the massive BRI marketing drive, says Commerzbank, in a whitepaper looking at the BRI entitled “Changing the behaviour and perceptions of Corporate China”. In April the bank acted as joint global coordinator, joint bookrunner and joint lead manager on a EUR 700m bond to support BRI projects, alongside Bank of China, Citigroup, Crédit Agricole and ING.

In July the bank signed a MoU with the Industrial and Commercial Bank of China to deliver USD 5bn of BRI-related business to the German lender in five years, in project financing, capital markets and trade finance. South Africa’s Standard Bank and ICBC are working together in Africa given the latter’s 20% stake in the bank. 

A particular opportunity is emerging for Western banks that can provide the complete suite of financing options across their international banking networks. They may be better placed to serve smaller companies that lack the scale or experience to attract the interest of Chinese state-directed banks. Western banks also believe they can provide financing more quickly than Chinese institutions and can introduce them to a larger pool of international investors.

Although Chinese banks can provide cheap funding in RMB and short tenor corporate backed facilities, relative USD funding costs make international banks competitive in term funding. Neither can Chinese banks offer the same local currency financing solutions that some international banks can, while their inexperience in structuring and executing complex transactions such as project financing can put them at a disadvantage, says the second European banker.

Belt and Road Projects with Western Investors
Project Country Sector Transaction Size Financial Close Financing
Las Viborillas 127.5MW Solar Park Mexico Solar PV USD 231m Mar-18 Chinese developer JinkoSolar makes use of an international consortium of lenders. Six banks comprising BBVA, Intesa Sanpaolo, SocGen, SMBC, MUFG and Natixis provided USD 208m in senior debt.
Pampa 100MW Wind Farm Argentina Onshore Wind USD 177m Mar-18 China Engineering Corporation (CEEC) and Swiss investor GoldenPeaks Capital agreed to invest in a 100MW wind project in Argentina. CEEC will hold a 50.01% share, GoldenPeaks while hold 20%, and other partners are to hold the remaining 29.99%.
Sirajganj 220MW Unit 3 Combined Cycle Power Plant Bangladesh Energy Generation USD 246m Feb-17 EPC awarded to a consortium of China National Machinery Import and Export Corporation (CMC) and Fujian Electric Power Survey and Design Institute (FEDI).The project was co-financed by Siemens Bank and Standard Chartered Bank on an 80:20 basis, with the lenders arranging a USD 197m financing package, and Bangladeshi state-owned developer Northwest Power Generation Company providing the equity.
Maamba 300MW Coal Fired Power Plant Zambia Energy Generation USD 828m Jul-15 Standard Chartered and Barclays Bank joined forces with regional and Chinese lenders to provide USD 515m in senior debtfor the coal-fired power plant in Zambia. 
Source: Inframation 

Banking on BRI
HSBC has conducted a number of BRI roadshows in China’s major cities for the last two years, though it declined to give specific details. It says the roadshows were designed to support its customers in China that want to engage with BRI, as well as its international clients wanting to do business in China.

The bank also declines to disclose how much money it is investing in BRI, either in terms of marketing spend or actual financing, but says it is currently supporting a number of BRI projects. These include the Sinosure-backed financing of an airport redevelopment project and train locomotive imports in Sri Lanka. It has also financed a repowering project in Bangladesh, an industrial power project in Indonesia and renewable energy in Australia.

James Cameron, managing director and co-head of infrastructure and real estate group for Asia Pacific at HSBC, also references the bank’s support for Chinese investments in Malaysia, New Zealand, Brazil and the UK, using products involving performance bonds, receivable financing, corporate loans and capital markets facilities.

The bank applies the same credit and relationship criteria as it would in any other situation, he says. “Given our presence in China and the scale of our relationships there we see BRI as a big opportunity to add value for our clients.”

US banks are also quietly playing a role. Citi held its own BRI client forum in Beijing for bank clients at the end of last year, where bank executives in BRI target countries discussed opportunities the initiative throws up. Separately, in April 2018 it agreed to support local lenders Bank of China and China Merchants Bank in their BRI investments and projects. Citi declined to comment on how much cash it is investing in this area, but it is unlikely to be huge amounts. It says so far cooperation is mainly on the advisory side, through hedging, cash management and trade – though it has also been involved in capital markets work.

JP Morgan, meanwhile, is currently in the process of hiring a new BRI lead. The bank did not respond to requests for more information about the hire, or the size of the team or the specific nature of the work it would be engaged in. But it reflects a broader desire to participate in Chinese deals.

In June the bank said it would increase its investment bank headcount in China by up to 50%, specifically to secure more deals in the technology sector. And in May it was reported to have applied to China’s regulator to set up a new securities company.

But apart from trade finance opportunities and supporting Chinese clients, international banks have so far taken a back seat on the nuts and bolts of BRI project financing. [extra:pullquoteleft:boxoutcopy=3]

The head of Asian infrastructure finance at a Europe-based bank says lenders will have to “overcome concerns around political risk and economic viability, with many projects having a low or sub-investment grade rating.”

Standard Chartered is reported to have won at least 20 projects linked to BRI over the past four years across Africa and Asia but its head of Greater China and North Asia said earlier his year that international BRI investors may have to be patient.

“People excessively focus on whether there needs to be project financing,” he told the FT in February, “but in reality there is a lot of that and bit by bit, step by step, guarantees, FX, escrow accounts, etc — all those things — are very important to these Chinese players.”

When the time comes, Cameron at HSBC says, BRI project financing risk can be mitigated by working with local companies or those with experience in that country – thus sharing risk management and maintaining non-recourse balance sheet exposure.

“We are seeing increasing interest from both international and local clients in working with Chinese clients, and increasing interest from the Chinese side too, on this basis.”

Instruments are also emerging to reduce risk and allow financing to take place without sovereign guarantees – which are usually less bankable when issued by a developing country.

Romani at the EBRD talks about using a similar model to the Turkish hospital PPP projects (not part of BRI), where bonds were upgraded to investment grade credit rating because of EBRD’s credit enhancement facilities and the political risk insurance provided by the World Bank’s Multilateral Investment Guarantee Agency.

Signature Belt & Road Projects
Project name Country Estimated Cost Description
Gwadar Port Pakistan USD 1.02bn A prominent project in the China-Pakistan Economic Corridor (CPEC). The port, which is operated by China Overseas Port Holding Company, is operational and its 2nd phase is currently under construction. The surrounding Gwadar Special Economic Zone is also currently being developed
Khorgos Gateway Kazakhstan-China  USD 250m Located on the border of China and Kazakhstan in China’s Xinjiang Uyghur Autonomous Region, it is the world’s largest dry port and handles trans-Eurasian freight trains.
Yiwu-London Railway Line China-UK  – One of several long-distance freight trains from China to Europe. The Yiwu-London journey takes 18 -20days to complete, a significantly shorter time than large cargo vessels.
Kyauphyu-Kunming Oil & Natural Gas Pipeline Myanmar-China  USD 2.5bn A dual gas & oil pipeline which at full capacity can supply almost 6% of China’s crude oil imports, while reducing dependence on slower maritime  routes
Kunming-Singapore High-Speed Railway Network China-Singapore  USD 2bn An initiative that precedes the BRI, but is given new impetus by it. If completed, this high-speed railway network will connect China, Vietnam, Laos, Cambodia, Thailand, Myanmar, Malaysia and Singapore
Source: Inframation 

Reimagining relations
If multilaterals and international banks (see box below) can find their place in BRI project financing, there may be unexpected results for how Chinese banks and sponsors do business over the long-term. The perceived disparity between Chinese environmental standards and Western bank lending criteria may even tighten.

“International investors have country quotas and concerns around environmental factors or ethical compliance,” says Wong. “China knows that, so in some cases it may finance a project without lobbying for any reforms. But it will also be supportive of this if partners are needed to help with the financing.”

According to the Green Finance Initiative, a lobby group within the City of London Corporation that advocates for the enhancement of the green finance sector worldwide: “A clean coal project in Pakistan which is invested in by a Chinese multilateral development bank (MBD), policy bank or commercial bank… would be considered Green by Chinese Catalogue standards [which determine what is considered a green bond in China], but would not be considered Green under international standards.”

The China City Development Foundation is keen to develop Green Infrastructure Finance Accreditation (GIFA) principles, modelled on Australia’s Infrastructure Sustainability rating scheme. GIFA promotes sustainable infrastructure and is a mechanism that could be used to align standards on BRI projects. But these are still specific to China and would need to be aligned with the Equator Principles, the standards which apply in the majority of international project finance debt, in both developed and emerging markets.

Increasing foreign competition in BRI is already driving an alignment of standards generally, says Romani: “The larger Chinese companies are often already implementing these higher standards. It may take a while for the smaller and provincial Chinese companies to catch up, but they will.” And indeed, international financial advisers may have a role to play in supporting them.

In due course China will naturally come to adopt the higher investment standards demanded by international investors, claim the optimists. There are even new university courses offering training on public-private partnership schemes, which are clearly part of China’s attempt to instil more investment discipline into the process, says one of the European infrastructure bankers.

“Environmental and sustainability concerns have become a far bigger issue for Chinese clients in the last few years,” says Cameron, “certainly for the government, and therefore for our clients too.”

But until Western banks and investors start allocating funds to BRI projects in greater numbers, many will see the recently observed year-on-year fall in investments, and project cancellations, as the beginning of the end for BRI.

“Of course the wheels are starting to come off. It’s only going to continue if China’s soft financing continues,” says the first European infrastructure banker.

On the other hand, if the Western MoUs and roadshows translate into more actual project financing, BRI could yet come good.

“China started the initiative and it will always be closely associated with it, but the world is increasingly interconnected and other countries will think about how they can participate, and may have their own perspective of BRI,” says Wong.

This perspective could result in a new definition of BRI, but only if it benefits the new investors involved.  ​​​​​​