Caixin
Jun 17, 2015 12:50 PM

Investors Embrace China's Big Belt, Risky Road

(Beijing) – Chinese companies and banks are eager to invest in vast areas of Asia, Europe and Africa targeted for development through China's "one belt, one road" initiatives.

Financial experts are urging these and other investors to carefully consider potential risks before committing to overseas projects. But the warnings have not dampened enthusiasm for the initiative, which some say could eventually spur more than US$ 1 trillion worth of business.

The initiatives – a Chinese government effort that combines its New Silk Road Economic Belt and 21st Century Maritime Silk Road strategies – was first proposed by President Xi Jinping in 2013. It aims to strengthen economic and trade connections from China's west into Central Asia and beyond, and also into Southeast Asia toward Africa.

State banks and other financial institutions are busy preparing to provide funding for projects that would be launched through the initiative, according to sources familiar with these efforts who spoke with Caixin on the condition of anonymity.

Chinese companies that stand to profit from "belt and road"-related infrastructure and industrial projects are getting involved, too. Since late last year, according to a state-owned company executive who asked not to be named, many firms have been dusting off old project plans that were shelved years ago due to a lack of investor interest.

Banks and companies are also looking to take advantage of the internationalization of the yuan. This process is expected to accelerate as the initiative matures.

Red Flags

Experts have also urged Chinese companies to heed a variety of warning flags by carefully assessing the potential risks related to doing business abroad. A corporate banking department employee at Industrial and Commercial Bank of China (ICBC), who asked not to be named, said Chinese investors and their financiers must prepare to face complex issues stemming from diverse political, social and economic conditions in countries targeted by the initiatives.

Investors should also be aware of the differences between China's legal, environmental and technological standards and those in other countries, the ICBC source said.

Other experts have pointed to threats posed by the potential for waste. They say a short-lived burst of enthusiasm may spur overspending that leads to heavy debt burdens for borrowers and lenders.

That's exactly what happened after the government responded to the 2008 global financial crisis by overdoing it with 4 trillion yuan in stimulus spending. Some of that spending was unnecessary, officials say, and fueled debt buildup that lingers today.

Another concern, according to an employee of a Chinese joint-stock commercial bank, is that companies now racing to grab "belt and road" orders can get into trouble quickly. A company's management capacity, for example, might be overwhelmed by a flood of new orders.

Global Currency

Among the many positive consequences of the initiatives, officials say, is that new business is expected to promote the yuan. Xie Yaxuan, chief economist at China Merchants Securities, said the "belt and road" will work in favor of the yuan's internationalization sought by the Chinese government. Ba Shusong, chief economist at the China Banking Association, said the initiatives will promote the use of the yuan beyond China by expanding the country's international investment and trade activity, which in turn will circulate more yuan, more widely.

The government has already taken major steps to support the yuan through bilateral currency swap agreements with countries in the "belt and road" regions. As of January 1, the central bank had signed swaps with 10 "belt and road" countries as well as 14 governments in other parts of the world. Moreover, half of the 14 non-Chinese banks given permission to offer yuan clearing services around the world are in countries targeted by the initiative.

A central bank official said "belt and road" activities will naturally promote internationalization of the yuan. So it's appropriate that Chinese banks and the yuan are at the forefront of projects tied to the initiatives, said Zhang Hongli, an ICBC vice president.

Nevertheless, the yuan's status is unlikely to change overnight. For example, the ICBC employee said only a small percentage of his bank's overseas clients are interested in yuan-dominated credit and bonds.

"Our yuan business is still small because the rates are high and the market is small," the staffer said. "Most business is in U.S. dollars and euros."

A source at China Development Bank (CDB), a government policy bank, said the yuan will only gradually be introduced as a currency for funding Chinese companies' overseas projects. Meanwhile, he's recommending the government work toward easing financial sector concerns about the potential instability of the yuan's foreign exchange rate.

Yet overall, the "one belt, one road" effort will improve the yuan's acceptance in targeted countries, said Cao Yang, a senior financial analyst at SPD Bank. And that acceptance will likely widen use of the yuan for trade settlements, financing and foreign exchange reserves.

Financing Demand

The Ministry of Commerce reported that in the first four months of 2015, bilateral trade between China and the "belt and road" countries totaled US$ 316 billion, an amount equal to about 30 percent of China's total international trade during that period. Meanwhile, direct investments by Chinese companies in the targeted region's non-financial sector totaled US$ 3.7 billion, equal to more than 10 percent of the country's total overseas investment during that period, the ministry said.

Experts said the "belt and road" initiatives could eventually generate more than US$ 1 trillion worth of new investment. To finance such a huge figure, commercial banks and other types of creditors will be expected to join government-led financing efforts.

The government has pledged US$ 40 billion to finance some of the initiative's projects through what it calls the Silk Road Fund. Moreover, it says that up to US$ 100 billion will be made available through the multinational Asian Infrastructure Investment Bank (AIIB). Supplementary funds will come from banks such as ICBC, which as of March had opened 120 offices in 18 of the "belt and road" countries.

One of the first government-bank partnerships was finalized April 21, when China and Pakistan signed a US$ 46 billion energy and infrastructure investment pact. Financing the pact are ICBC, the Silk Road Fund, the CDB and the Export and Import Bank of China.

ICBC is extending credit to companies involved in five China-Pakistan bilateral energy and infrastructure projects. The bank employee said ICBC plans to participate in at least 130 "belt and road" projects in the transportation, mining, power and telecom sectors, to name just a few, and that are worth a combined US$ 158 billion.

Several banks are participating. Bank of China plans to support the initiatives by lending US$ 20 billion this year and more than US$ 100 billion over the next three years. And China Construction Bank plans to offer its support by opening eight new branches overseas this year.

But China's banks are also keeping an eye on credit risks. A source at a joint-stock bank said that loans are more likely to be offered to various types of equipment suppliers linked to infrastructure and mining projects, rather than the projects' main contractors. Supplier loans are considered safer and more likely to yield quick, high returns, the source said.

According to sources at several companies eyeing overseas expansions in step with the "belt and road" plans, any project-facilitating company seeking to reduce risk is likely to buy export credit insurance.

According to the state-owned enterprise executive, CDB and the Exim Bank this year have increased export credit insurance to companies tied to overseas investment projects.

"Loan and export credit insurance levels used to increase slightly every year," said the executive. "But the increases have been much greater since the launch of the 'one belt, one road' initiatives."

The ICBC source said export credit insurance can reduce a company's risks stemming from business or political conditions.

Wang Yi, chairman of the state-backed China Export and Credit Insurance Corp., said his office is evaluating applications tied to more than 180 projects related to the initiatives. This support the joint-stock bank source said, has given a lot of companies the confidence they need to expand overseas.

Also important for companies that want to limit risks is a clear understanding of legal systems in the countries where they plan to do business, said attorney Ge Xiangyang, a partner with the law firm Mayer Brown JSM.

(Rewritten by Han Wei)

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