One Belt One Road (OBOR) is an ambitious project conceptualized by China in 2013 ostensibly to revive and build trade routes between China and the countries in Indo-Pacific region, Central Asia and Europe. China is trying assiduously to position it as ‘be all end all’ initiative, especially for the developing nations to end their infrastructure deficit and boost their GDP. Four years down the road, is it really turning out to be so? Here is an attempt to look at OBOR from wider perspective
What is the global infrastructure investment demand and the gap?
As per World Economic Forum (WEF) estimates, the current global infrastructure investment gap is pegged at $1tn per year vis-à-vis the annual infrastructure investment demand of $3.7tn. As per The Global Infrastructure Outlook report, which is a joint report developed by the Global Infrastructure Hub with Oxford Economics, road, electricity and rail are the major sectors with the bigger investment gaps vis-à-vis the forecast. The infrastructure investment needs are leapfrogging now because of growing world population and at the same time faster rate of urbanization. Unless these investment gaps are addressed in a robust manner, United Nations Sustainable Development Goals (SDGs) would also be at the risk of not being met.
How the investments are financed now?
Both developing as well as developed economies need significant investments to maintain or raise their economic profile. US for example spends $400bn every year and yet falls short on investment needs. All over the world the investments are being funded through private as well as public route. There are variety of choices available today ranging from financing available in multiple markets, including municipal bonds, project finance loans, dedicated federal credit programs, and private equity investments to Pension Funds, Sovereign Wealth funds to multilateral or bilateral institutions such as World Bank (through their Overseas Development Assistance), Asian Development Banks, BRICS Bank, EU Bank etc. These funds are being provided through the combination of debt and equity. Many governments have set up dedicated infrastructure financing funds e.g. Indian govt for example has set up National Investment and Infrastructure Fund (NIIF) for enhancing infrastructure financing in the country. If the cumulative infra spending needs of the nations is worth say Rs 100, then all the alternate routes put together supply Rs 73 worth of funds today. This gap of 27% in demand and supply of funds is being seen as an opportunity by China to further its strategic objectives. To that aim, China is seeking to fill this gap partly by leveraging its massive foreign exchange reserves. Enter China’s One Belt One Road (OBOR) project
What is China’s funding and execution strategy for OBOR?
China has $3.2tn foreign exchange reserves held in US dollars. The money is depreciating 2-3% a year vis-à-vis US Dollar. Also, China is getting a mere 0-1% interest on the money and sometimes even made to pay the servicing cost. Effectively the money isn’t fetching great returns for the Chinese. If they take the money back to Yuan, there are severe inflationary repercussions that they will most certainly face. On positive side, IMF’s 2016 decision to include Chinese Yuan in the basket of currencies that make up the Special Drawing Right (SDR), an alternative reserve asset to the dollar, has also come in handy. Even though only about 1% of the total foreign exchange reserves are currently being held in Yuan but it certainly offers Chinese a comfortable position and a window of opportunity.
Chinese figured out in 2013 a clever means of ensuring higher returns on its foreign exchange reserves along with attaining the strategic and geo-political objectives through OBOR project. Under OBOR, China is funding strategically important projects on maritime silk route as well as one belt region. Chinese offer loans at 6% plus of LIBOR rates vis-a-vis World Bank’s standard rate of around 3%. The other conditions attached to Chinese loans are pertaining to using min 40% of Chinese equipment, 100% of China manufactured raw material such as steel, cement etc. The projects too are executed by the Chinese companies by shipping in cheap labor from China in the host nation. OBOR is envisaged to provide an answer to China’s industrial overcapacity woes especially for its steel and cement sector. In summary, this effectively means the Chinese loan money spent on building the infrastructure in the host nation ultimately goes back to China’s own infra companies, manufacturers and the Chinese workers who are brought overseas to execute the projects.
How can these investments become a noose around host nation’s neck?
Now with this kind of costly investments and “only China” kind of execution model, if the requisite volumes are not generated quickly on the completed projects, be it air traffic for airports, container traffic for sea ports etc. it would become extremely difficult for the host nation to service the debt and Chinese investment can quickly turn into a massive burden for the host nation leading to debt trap like situation.
Normally an infrastructure project benefits the local economy in very many ways. Besides bringing in investments, it helps create jobs, pump primes local ancillary and raw material industry, creates new economic and social opportunities for growth etc. All of this results in betterment of local purchasing power, propelling growth in demand for products and services. With OBOR kind of model, the investment in the form of debt would certainly come in the host nation but because of the “unique” execution model, all the related benefits which should accrue to the local economy would instead be passed back to Chinese economy. This would stem the growth of purchasing power in the local economy. Imagine a situation where the host nation gets the infrastructure built say an airport through the debt investments but since the local economy isn’t pump-primed the new jobs aren’t created, the money hasn’t been spent with the local companies, the purchasing power of the local economy doesn’t change significantly. This means the necessary volumes needed for servicing the debt for the completed infra projects doesn’t get generated easily. The host nation then gets faced with a challenge of how to repay Chinese loan when there are no revenues from the completed project? This leads to a debt trap for the host nation.
Take the case of Hambantota airport in Sri Lanka which is also known as world’s emptiest airport. Hambantota was built at the cost of $210 mn of which around $190mn came from Exim Bank of China as a loan at 8%. This massive airport in Southern Lankan district of Hambantota has the capacity of handling 1 million air travelers a day. Four years in operation Hambantota still far away from generating enough revenues to payback the interest on Chinese debt. The airport operates only 3 flights-2 domestic and 1 international to UAE. Because of their inability to pay back, Sri Lankans govt finds itself in deep trouble and in debt trap now. Similar situation prevailed on the massive investments in Hambantota port which was recently handed over to a Chinese port management company amidst huge uproar in Sri Lanka. Similar fate awaits CPEC projects in Pakistan where economist have already raised alarms about Pakistan’s imminent default on repayments by March of 2018. The Chinese solution for this situation has been to swap the debt with an equity as also to extract huge concessions from the host nation e.g. Chinese have asked for and have been given 15000 hectors of land near Hambantota port apparently for developing other port led development projects. In case of Zimbabwe, China has agreed to cancel $40mn worth of debt and in return Harare to increase local use Yuan as a currency for foreign exchange reserve. This model is very similar to west’s economic colonialism model that they practiced earlier in Hong Kong and Macau.
How does OROB impact global economic well-being?
OBOR model of “growth” has implications for the entire global economy. Going by OBOR’s expanse (OBOR aims to cover 60 countries, 30% of world GDP & 60% of world population), a large population would be impacted by OBOR in next 2-3 decades. OBOR has a project pipeline cutting across South Asia, West Asia, Eastern Europe etc.
PM Modi speaking at WEF 2018 in Davos implicitly alluded to an alternate model of infrastructure development to Chinese OBOR, which is being promoted by India and Japan. While talking about three major challenges before humanity today, PM Modi outlined the failure of globalization due to protectionism as the third biggest challenge after environment and terrorism. Modi attributed the decline in overall global Foreign Direct Investment (FDI) to protectionism being followed by some western economies. Whilst remaining unmindful of the fact that if the overall FDI quantum reduces due to protectionism, the more number of developing nations who can’t generate enough resources internally would be compelled to seek Chinese funds. This would set many of them on the course for debt trap and faltering local economy. This will obviously have a cascading impact on the exporting nations as well as the overall consumption rates in the defaulted economies are expected to come down significantly. Thus, the 60 odd participating nations would be at risk leading to a global crisis situation where only China benefits and all the rest undergo a severe distress.