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Ryan Lam, CFA
Senior Economist
April 2015
China’s ‘Belt and Road’Initiative: Assessingthe Opportunities
• Good infrastructure connectivity is just a starting
point for creating a Eurasian economic corridor.
The Chinese leadership will likely use the ‘Belt
and Road’ initiative to push forward with its ‘Go
Global’ strategy.
• We have identified several areas in which Hong
Kong has the potential to capitalise on the
opportunities presented by the initiative.
• Infrastructure revenue bonds are a natural choice
for financing. As the leading offshore renminbi
bond market in the world, Hong Kong has a lot to
offer in terms of supporting renminbi-
denominated bond sales.
• In addition to its role as a trading platform, Hong
Kong can also play a proactive role as a provider
of capital. The newly established Future Fund
could benefit from the stable returns and inflation
protection that infrastructure assets can provide.
• Regardless of the nature of the build-operate-
transfer or build-own-operate agreements put in
place, conflicts of interest often build up between
investors and governments over issues such as
ownership, control and profit sharing. There is a
great deal of room for negotiation in contractual
arrangements. Backed by world-class legal
professional services, Hong Kong could serve as
a convenient location for liaison in terms of
holding conferences and undertaking contract
negotiations.
• With area for improvement in logistics and limited
supply of proper construction materials in host
countries, Chinese developers may choose to hire
external parties to develop project-specific
logistics facilities that will help streamline delivery
of major equipment and building materials from
the Mainland. Hong Kong's logistics and maritime
advantages put the city in a strong position to
seize such opportunities.
2April 2015
Forging a new path
In 2005, then US Fed Chairman Ben Bernanke gave a landmark speech in which
he drew attention to the issue of rising global imbalances. A growing number of
economists have since come out in support of Bernanke’s argument that a “global
savings glut”, emanating in large part from emerging economies, had fuelled the
credit boom and greater risk-taking in advanced economies. Based on this view,
a rebalancing of the global economy requires high-saving countries to spend
more so that advanced economies can rebuild their savings and reduce their
trade deficits.
Parking large amounts of savings into US Treasury securities is no longer an
optimal policy in economic terms. This reality is a major driving force behind the
Chinese Government’s recently announced plans to reallocate its savings away
from financial instruments and towards the development of much-needed
transport and energy infrastructure throughout Eurasia.
The ‘Belt and Road’ (BAR) initiative, which aims to bolster trade with Europe and
build infrastructure across Asia, is comprised of two key elements – a land-based
‘belt’ and a maritime ‘road’. The ‘Silk Road Economic Belt’ encompasses three
routes that will connect mainland China with Central Asia, Russia and Europe; the
Persian Gulf and the Mediterranean Sea through Central and West Asia; and
Southeast Asia, South Asia and Indian Ocean. The ‘21st Century Maritime Silk
Road’ will include two routes that will link the Mainland to Europe through the
South China Sea and the Indian Ocean, and to the South Pacific through the
South China Sea.
There are three distinctive features of the BAR initiative:
• China’s Ministry of Commerce estimates that the countries along these routes
encompass a population of 4.4 billion people and have a collective GDP of
USD21 trillion, an amount equivalent to 29% of the global economy. While
there is currently little information regarding how bilateral negotiations will
proceed, there is a strong commitment on the part of Chinese Government.
• The BAR initiative’s main tool for releasing untapped growth potential in the
region is the development of an array of transport and logistics corridors to
xxxx
3April 2015
draw Central and South Asia into a unified transport network. The focus on
removing transportation bottlenecks is not accidental. Delivering goods on
time and at a low cost has been a crucial part of Emerging Asia’s1 integration
into the global production chain.
• Good infrastructure connectivity is just a starting point for creating a Eurasian
economic cooperation zone. The Chinese leadership likely views this as a
gateway step to facilitate moving forward with its ‘Go Global’ strategy. We
expect more detailed plans focusing on the creation of a Eurasian economic
corridor to be laid out at the provincial level.
A strategy with incentive compatibility
Despite the growing optimism that is being reflected in recent asset prices, there
is no shortage of examples to demonstrate that policies with good intentions often
lead to unexpected or less-than-desirable results. The keys to successful policy
formulation are recognising the constraints of participants and designing an
incentive-compatible strategy. Under the post-World War II Marshall Plan, for
example, the US provided funding for recovery initiatives, but required the
Europeans themselves to be the driving force and assume responsibility for
drafting the reinvigoration plans.
Considering the long lock-up periods and significant up-front capital requirements
of infrastructure investment, the BAR initiative stands little chance of success if
any of the participants suspect that other players will not fulfil their roles. The
good news is that the BAR plan appears to be mostly incentive compatible and is
therefore likely to remain as a keystone of development policy for the long term.
The key points in this respect are as follows:
• The Mainland is currently facing challenges of overcapacity, particularly in the
steel, cement and shipbuilding sectors. For Chinese firms, capacity cut in
these sectors has proved harmful to short-term business performance.
Exporting excess capacity would be a possible way to ease the pain of
adjustment.
• The engineering expertise and risk management skills of Chinese companies1
Emerging Asia as includes most economies in East Asia, Southeast Asia and South Asia, excluding Japan, Hong Kong,Singapore, South Korea and Taiwan
4April 2015
• For the Mainland authorities, the BAR plan promises several significant
benefits. First, enhancing regional transport infrastructure will reduce the
country’s exposure to commodity supply disruptions. Second, stronger ties
between the Mainland’s interior provinces and its western-frontier neighbours
should help narrow regional income disparities. Third, project financing will
enhance the renminbi’s role as an international settlement currency.
Increased overseas use of the yuan will, in turn, force domestic financial
institutions to embrace market forces and facilitate further financial
liberalisation.
BAR riding high on official agenda
The determination of the Chinese Government to push forward with the BAR
initiative is reflected in the rapid pace at which it is rolling out its plans (Exhibit 2).
The vision of a more closely integrated Eurasian continent was first put forth by
President Xi Jinping in September 2013. The BAR initiative was again discussed
in the March 2014 Government Working Report and, just a few months later in
July 2014, the New Development Bank was established with a starting capital of
Exhibit 1: Chinese-led Overseas Railway Projects
Country/Region Project Investment Estimated Completion Date
US California High-Speed Rail USD68.0bn 2030
South America Peru – Brazil Pacific Atlantic railway USD60.0bn 2024
India Delhi-Chennai High Speed Rail Over USD30bn -
Southeast Asia Pan Asia railway USD30.4bn 2025
Russia Moscow – Kazan High-Speed Rail USD25.0bn 2030
Nigeria Nigeria railway USD13.1bn 2025
Southeast Asia Kuala Lumpur – Singapore High Speed Rail USD12.0bn 2022
Kenya Kenya railway USD3.8bn 2020
Eastern Europe Belgrade-Budapest High Speed Rail USD2.9bn -
Source: Hang Seng Bank
could prove valuable tools for host nations looking to play a bigger role as
‘factories’ and ‘granaries’ for the world. Equally important, Chinese operators
are generally aggressive bidders - with prices often as little as half of those of
their global rivals. One indication as to the success of this strategy is provided
in the number of Chinese-led railway projects with multibillion-dollar price tags
that are already underway in many nations (Exhibit 1).
5April 2015
Hong Kong – assessing first-mover advantage
As the initiative is in still in its infancy, conventional wisdom would suggest that
Hong Kong should act promptly and capture first-mover advantage. This
assumed advantage, however, is far from guaranteed. Not every first-mover will
end up setting the tone of the game and much depends on the circumstances in
which any advantage is sought. With this in mind, we have accounted for a
number of region-specific features and characteristics of infrastructure
investment in our identification of several areas in which Hong Kong has the
potential to capture some of the many opportunities presented by the BAR
initiative.
Securing funding
There is much evidence to indicate that infrastructure investment is in high
demand in Asia’s emerging economies. In the 10 years between 2010 and
2020, the Asian Development Bank projects that infrastructure in Emerging Asia
will require investment of over USD800bn a year2 (Exhibit 3). The Mainland has
xxxxxxxx2Infrastructure for a Seamless Asia, Asian Development Bank and Asian Development Bank Institute (2009)
Exhibit 2: Major policy initiatives related to the BAR initiative
Time Details
September 2013President Xi proposes the construction of a ‘Silk Road Economic Belt’ whiledelivering a speech in Kazakhstan
October 2013President Xi calls for creation of a ‘21st Century Maritime Silk Road’ while deliveringa speech in Indonesia
March 2014 Inclusion of BAR initiative in Government Working Report
July 2014 New Development Bank established with starting capital of USD100bn
September 2014 Establishment of first phase of Railway Development Fund
October 2014 Asia Infrastructure Investment Bank co-founded with 56 countries
November 2014 Establishment of Silk Road Fund with USD40bn endowment
March 2015‘Vision and Actions on Jointly Building Silk Road Economic Belt and 21st CenturyMaritime Silk Road’ unveiled
Source: Hang Seng Bank
of USD100bn. Less than a month following the set up of The Asia
Infrastructure Investment Bank (AIIB) in October 2014, President Xi green-lit a
Silk Road Fund with an endowment of USD40bn. This rapid progress
compared with the pace of strictly domestic reforms highlights how much is
riding on the BAR plan in the eyes of the Mainland authorities.
6April 2015
On its own, however, the presence of funding gap does not warrant private
sector participation. Commercial viability is crucial if projects are to attract
private partners. It is important to note that Emerging Asia as a whole has run a
current account surplus since the late 1990s (Exhibit 5). What this essentially
means is that national savings are more than enough to finance domestic
investment needs3. In other words, even in the face of an exceptionally low
funding cost of the US dollar, domestic firms currently feel no need to borrow
abroad.
Exhibit 4: Funds AvailableExhibit 3: Infrastructure Investment Needs(2010-2020, USD billion)
Source: Asian Development Bank, Hang Seng Bank Source: Hang Seng Bank
Registered
capital
Loan to
equity
ratio
Loan
repayment
period
Annually
available
funding
Asian Infrastructure
Investment BankUSD100bn 1.5 8 years USD18.75bn
New Development
BankUSD100bn 1.5 8 years USD18.75bn
Silk Road Fund USD40bn 2.0 8 years USD10bn
Total USD240bn - - USD47.5bn
Exhibit 5: Current Account Balance of Emerging Asia (% of GDP)
Source: IMF, Hang Seng Bank3
Current account balance is equal to national savings minus domestic investment
already committed sizeable sums of capital to found or co-found various
institutions aimed at supporting infrastructure financing, but our estimates
suggest that the funding gap remains significant (Exhibit 4). Closing this gap will
require a greater commitment from the private sector.
7April 2015
4Financial Fragility and Economic Performance, The Quarterly Journal of Economics, 105(1), 87–114, Bernanke and Gertler
(1990)
Perhaps more than any other factor, Asian savers shy away from infrastructure
projects because of the difficulties in risk assessment and diversification. In
many countries in Emerging Asia the financial instruments needed for sound risk
assessment are simply not in place. Because perceptions of risk, not just interest
rates, determine the supply of credit4, a shortage of credit persists amid lingering
concerns over credit risks. The mispricing of risk is an important factor in the
relative backwardness of infrastructure in Asia, in our view.
Hong Kong could play a pivotal role in releasing credit constraints. The city’s
financial system could shape risk perception through pooling risk (aggregating
savings so that each investor shares the risk of infrastructure projects), hedging
risk (creating financial instruments to transfer part of the risk to other interested
parties) and diversifying risk (grouping the infrastructure investment into large
portfolios of assets).
More specifically, financial history suggests that debt obligations are more likely
to be honoured than equity obligations. The infrastructure revenue bonds (IRB)
secured by cash flows of the infrastructure projects would likely receive stronger
market interest. As the leading offshore renminbi bond market in the world, Hong
Kong has a lot to offer in supporting renminbi-denominated IRB sales to fund the
BAR plan.
Of course opportunities do not usually come without challenges. Other AIIB
founding members also aspire to capitalise on the rolling out of the BAR initiative.
London in particular has emerged as a leading centre for project finance and
infrastructure asset management. Over the years, the city has developed well-
integrated trading platforms for insurers and pension funds to assess the risk of
construction delays and cost overruns of infrastructure projects. For the Hong
Kong Government, measures to improve the regulatory and tax framework to
attract alternative investment fund managers looking to relocate deserve specific
attention in this regard.
In addition to its role as a trading platform, it is also worth considering whether
Hong Kong can take a step further and act as a capital provider. In 2014, over
50% of sovereign wealth funds (SWFs) with assets totalling between USD1bn
8April 2015
Seeking local partners
Large-scale infrastructure projects have characteristics of natural monopolies
and are particularly vulnerable to political risks. While public-private partnerships
(PPP) are a popular financing vehicle for mitigating such risks, profit-sharing
arrangements with governments could become a liability if there is regime
change. Even in advanced economies such as Australia and the UK, such
partnerships have been criticised for delivering high returns to foreign investors
without a commensurate delivery of benefits to local users.
An alternative form of financing is to sell debt or equities to local investors in host
countries. Although Dubai and London are currently at the forefront of the
Islamic finance market, Hong Kong’s deep pool of financial professionals and its
extensive experience in creating diversified financial products give the city an
edge in helping Chinese firms to secure overseas funding – but more needs to
be done to strengthen its potential role as the gateway for Islamic finance in East
Asia. One crucial first step is to give meaningful consideration to how Hong
Kong might attract international experts in Islamic finance to help build the
necessary financial infrastructure and advise on religious and regulatory matters.
Exhibit 6: Proportion of SWFs Investing in Infrastructure(by Assets Under Management)
Source: 2014 Preqin Sovereign Wealth Fund Review
and USD9bn included an infrastructure allocation (Exhibit 6). Hong Kong’s public
finances are currently robust enough to support infrastructure spending in the
region. We contend that the newly established Future Fund could benefit from
the stable returns and inflation protection that infrastructure assets can provide.
9April 2015
Contract consultation
Regardless of the nature of the build-operate-transfer (BOT) or build-own-
operate (BOO) agreements that are usually put in place, conflicts of interest
often build up between investors and governments over issues of ownership,
management control and profit sharing. In the ideal scenario, ownership, control
and financial flows should be packaged in ways to satisfy investors’ need for
control while at the same time addressing the political concerns of host
countries. There is a great deal of room for negotiation in the contractual
arrangements that govern infrastructure deals. Backed by world-class legal
professional services, Hong Kong could act as a convenient location for liaison
in terms of holding conferences and undertaking contract negotiations.
Project logistics
Another major opportunity lies in the logistics sector. Chinese infrastructure
developers have traditionally used and managed their own supply chains. In
recent years, however, it has been more common for infrastructure developers
to seek third-party logistics support for their oversea projects. With area for
improvement in logistics and limited supply of proper construction materials in
host countries, Chinese developers may seek to hire external parties to build
project-specific logistics facilities to help streamline the delivery of major
equipment and building materials from the Mainland. Hong Kong‘s logistics and
maritime advantages put the city in a strong position to grasp such opportunities.
The Hong Kong authorities may therefore wish to revisit the city’s port capacity
and facilities to examine whether upgrades or expansion might prove a valuable
investment over the longer term as activity under the BAR initiative picks up
momentum.
10April 2015
Hong Kong Economic Monthly Statistics April 2015
Note: (F) ForecastSource: Census and Statistics Department of HKSAR, Hong Kong Monetary Authority , Rating and ValuationDepartment, Hong Kong Tourism Board, CEIC, Hang Seng Bank
Real growth
yoy (%)
2006 1,503 7.0 7.2 5.7 2,461 9.4 2,600 11.6 -138.8 4.8 2.0
2007 1,651 6.5 12.8 10.1 2,688 9.2 2,868 10.3 -180.5 4.0 2.0
2008 1,707 2.1 10.6 5.0 2,824 5.1 3,025 5.5 -201.1 3.5 4.3
2009 1,659 -2.5 0.6 -0.8 2,469 -12.6 2,692 -11.0 -223.3 5.2 0.5
2010 1,776 6.8 18.3 15.5 3,031 22.8 3,365 25.0 -333.8 4.3 2.4
2011 1,934 4.8 24.8 18.4 3,341 10.1 3,767 11.9 -426.4 3.4 5.3
2012 2,037 1.5 9.8 7.2 3,434 2.9 3,912 3.9 -477.8 3.3 4.1
2013 2,132 2.9 11.0 10.8 3,562 3.6 4,065 3.8 -502.9 3.3 4.3
2014 2,246 2.3 -0.2 0.6 3,675 3.2 4,225 3.9 -550.0 3.2 4.4
2015F 2,360 2.6 5.0 4.0 3,859 5.0 4,479 6.0 -619.8 3.5 3.5
2016F 2,506 3.2 6.0 5.0 4,052 5.0 4,747 6.0 -695.5 3.7 4.0
Q1 2014 532 2.6 4.2 4.0 818 0.7 942 2.1 -124.0 3.1 4.1
Q2 522 1.8 -7.0 -7.2 901 4.8 1,042 4.6 -140.7 3.2 3.7
Q3 580 2.7 1.6 1.6 985 5.9 1,109 5.7 -124.0 3.3 4.8
Q4 612 2.2 0.2 3.5 971 1.2 1,133 3.3 -161.3 3.3 5.1
Q1 2015 N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A
Jan 2014 N/A N/A 14.4 16.7 303 -0.4 323 -2.7 -20.0 3.1 4.6
Feb N/A N/A -2.2 -2.2 213 -1.3 267 6.8 -53.7 3.1 3.9
Mar N/A N/A -1.5 -2.5 302 3.4 352 3.2 -50.4 3.1 3.9
Apr N/A N/A -9.9 -9.6 286 -1.6 341 2.4 -55.3 3.1 3.7
May N/A N/A -3.9 -4.6 306 4.9 348 3.7 -42.4 3.1 3.7
Jun N/A N/A -6.9 -7.5 309 11.4 352 7.6 -43.1 3.2 3.6
Jul N/A N/A -3.2 -4.6 326 6.8 368 7.5 -42.1 3.3 4.0
Aug N/A N/A 3.5 2.8 327 6.4 359 3.4 -31.5 3.3 3.9
Sep N/A N/A 4.8 6.6 332 4.5 382 6.3 -50.4 3.3 6.6
Oct N/A N/A 1.4 4.3 332 2.7 382 5.6 -49.8 3.3 5.2
Nov N/A N/A 4.2 7.6 327 0.4 379 2.4 -52.2 3.3 5.1
Dec N/A N/A -4.0 -1.4 313 0.6 372 1.9 -59.3 3.3 4.9
Jan 2015 N/A N/A -14.5 -13.8 312 2.8 349 7.9 -37.0 3.3 4.1
Feb N/A N/A 14.9 18.3 228 7.2 264 -0.9 -35.9 3.3 4.6
Mar N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A
YTD N/A N/A -2.0 -0.3 540 4.6 613 3.9 -72.9 3.3 4.4
HKD bn yoy (%) RMB bn yoy (%) HKD bn yoy (%) yoy (%) ytd (%) ytd (%) '000 yoy (%)
2006 4,757 17.0 23 3.6 2,468 6.7 15.5 4.1 15.0 25,251 8.1
2007 5,869 23.4 33 42.7 2,962 20.0 20.6 25.7 14.6 28,169 11.6
2008 6,060 3.2 56 67.8 3,284 10.9 2.6 -11.1 9.2 29,500 4.7
2009 6,381 5.3 63 11.9 3,289 0.1 5.2 28.5 -9.8 29,590 0.3
2010 6,862 7.5 315 402.2 4,227 28.6 8.0 21.0 12.5 36,030 21.8
2011 7,591 10.6 589 86.9 5,081 20.2 12.9 11.1 15.5 41,921 16.4
2012 8,297 9.3 603 2.5 5,569 9.6 11.0 25.7 7.7 48,615 16.0
2013 9,180 10.7 860 42.7 6,457 16.0 12.4 7.7 7.1 54,299 11.7
2014 10,074 9.7 1,004 16.6 7,276 12.7 9.6 13.3 4.3 60,839 12.0
2015F 11,182 11.0 N/A N/A 8,149 12.0 12.0 0.0 0.0 66,315 9.0
2016F 12,468 11.5 N/A N/A 9,168 12.5 12.5 -3.0 -3.0 71,620 8.0Q1 2014 9,189 10.0 945 41.4 6,826 19.0 12.2 -0.6 1.0 14,698 15.3
Q2 9,612 13.3 926 32.7 7,074 16.0 15.0 2.1 2.3 13,831 9.6Q3 9,920 11.4 944 29.4 7,210 12.7 12.3 8.6 3.8 16,130 11.2Q4 10,074 9.7 1,004 16.6 7,276 12.7 9.6 13.5 4.4 16,180 12.1
1Q 2015 N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A
Jan 2014 9,184 7.6 893 43.2 6,697 17.8 9.6 -0.2 -0.2 5,455 17.8
Feb 9,330 10.6 920 41.2 6,908 21.8 12.9 -0.3 0.4 4,417 9.8
Mar 9,189 10.0 945 41.4 6,826 19.0 12.2 -0.6 1.0 4,825 18.1
Apr 9,392 10.8 960 41.8 6,852 18.1 12.5 0.0 1.3 4,748 10.9
May 9,522 11.0 956 36.8 6,966 18.0 12.7 0.9 2.0 4,591 10.8
Jun 9,612 13.3 926 32.7 7,074 16.0 15.0 2.1 2.3 4,493 6.9
Jul 9,848 14.4 937 34.8 7,141 15.5 16.0 4.6 3.3 5,374 11.2
Aug 9,855 13.9 937 32.0 7,142 14.0 15.4 6.6 3.6 6,010 12.2
Sep 9,920 11.4 944 29.4 7,210 12.7 12.3 8.6 3.9 4,747 10.2
Oct 10,037 11.9 944 20.7 7,282 13.7 12.2 10.4 3.9 5,214 12.6
Nov 10,075 11.1 974 17.8 7,287 12.8 11.2 11.9 4.2 5,300 15.7
Dec 10,074 9.7 1,004 16.6 7,276 12.7 9.6 13.5 4.4 5,666 8.5
Jan 2015 10,186 10.9 981 9.9 7,366 10.0 10.4 2.2 0.3 5,610 2.8
Feb 10,152 8.8 973 5.7 7,365 6.6 8.3 N/A N/A 5,406 22.4
Mar N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A
YTD 10,152 8.8 973 5.7 7,366 6.6 8.3 2.2 0.3 11,015 11.6
Total DepositsOffice Rental
Index
GDP
Total Loans
Trade
balance
Money
supply
(Total M3)
yoy (%) HKD bn
Consumer
prices
yoy (%)
Foreign TradeRetail
sales
(volume)
% yoy (%)HKD bn HKD bn
Tourist Arrivals
Imports
RMB Deposits
Unemployment
rate (s.a.)
yoy (%)
Exports
Retail
sales
(value)
Residential
Property
Price Index
yoy (%)HKD bn
Source: CEIC, Hang Seng Bank Source: CEIC, Hang Seng Bank
Source: CEIC, Hang Seng Bank Source: CEIC, Hang Seng Bank
Source: CEIC, Hang Seng Bank Source: CEIC, Hang Seng Bank
April 2015 11
Hong Kong Retail Sales Volume Hong Kong Unemployment Rate
Hong Kong Exports Volume Hong Kong Total Loans and Deposits
Hong Kong CPI Inflation Hong Kong Property Prices(overall index, 1999 = 100)
DisclaimerThis document has been issued by Hang Seng Bank Limited (“HASE”) and the information herein is based on
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April 2015 12