Mega Trends of China (3): The Belt and Road Strategic Planinstitutional.bnpparibas-ip.com/wp-content/uploads/2016/01/Chi_Lo... · railway between Jinhong in Yunnan and Vientiane in

For professional investors | 13 January 2016 – 1

However beautiful the strategy, you should occasionally look at the results.

Winston Churchill

SUMMARY

China’s Belt and Road strategy aims at achieving long-term economic and political objectives. Its east-

west land route will enable China to access huge natural resources reserves and exert influence on the

world’s oil production and consumption regions. But this route is fraught with difficulties.

The north-south route will link China to South and SE Asia by land and sea. The land route will most

likely take priority for implementation due to favourable economic and political factors, with the Mekong

sub-region likely to be the first to benefit.

China’s Yunnan province will be the gateway linking the rich SE China with the Mekong sub-region and

the rest of SE Asia. This linkage will also extend China’s influence to the Indian Ocean and the South

China Sea. But there seems to be no coordinated effort on implementation, despite the grand vision.

Beijing’s Belt and Road (BAR) initiative is a “one stone kills three birds” strategy that will help China achieve international, domestic and political objectives in the long-term by opening up new trade and investment opportunities that will reshape the global balance of economic power. It will build:

1) an economic land belt (called the Silk Road Economic Belt) that includes countries on the ancient Silk

Road through Central and West Asia, the Middle East and Europe, and

2) a sea route (called the 21st Century Maritime Silk Road) that links China’s port facilities with the African

coast through South and SE Asia, moving up through the Suez Canal to the Mediterranean.

Chi on China

Mega Trends of China (3): The Belt and Road Strategic Plan


What is it in for China1? Domestically, BAR aims at helping export China’s excess capacity by creating new markets for Chinese construction firms and capital goods makers. This should enhance domestic investment returns and stabilise GDP growth. The project envisages building roads, railways, pipelines and industrial corridors across some 67 countries, requiring billions of tonnes of steel and cement, hundreds of thousands of workers, tens of thousands of cranes and diggers, and dozens of new dams, power stations and power grids. Internationally, it should unleash an infrastructure boom by connecting China with Asia, Europe and Africa by land and sea, and boost renminbi internationalisation by encouraging its usage in both trade and financial transactions. Politically, Beijing hopes to use BAR to secure foreign trade relationships to counteract major trade pacts, such as the Trans Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP)2, that have excluded China, and to breakout of the US “pivot Asia” policy that blocks China’s expansion eastward. The strategic importance of BAR BAR aims at building a massive network of trade and infrastructure for China to expand into countries in Asia, Central Asia, the Middle East, Europe, Africa, America and even Latin America (Map 1). It should also go a long way to deepen renminbi internationalisation. The oil-producing Middle East region, which lies on the east-west route of BAR, is of particular strategic importance to China due to its links with the major oil-consuming regions. Establishing a major influence in the Middle East will enable China to exert influence on trading with the major energy consumption regions (Map 2). Meanwhile, the majority of China’s oil imports (which cover about half of its oil demand) come from the Middle East and Africa. The oil is transported by sea with 80% passing through a 600-mile Malacca waterway that connects the Indian Ocean to the west and the Pacific Ocean to the east (Map 3). This makes the security of sea channels a strategic priority for China and has led to speculation that it wants to build a “string of pearls” of ports around South and SE Asia to allow its navy to secure its sea lanes (see below).

1 For our earlier research on BAR, please see:

“Chi on China: The AIIB, Reviving China’s Investment-led Growth or Rebalancing towards Consumption?” 13 May 2015.

“Chi on China: China’s One Belt One Road: One Stone Kills Three Birds, (Part 1 of 2)”, 24 June 2015.

“Chi on China: China’s One Belt One Road: The Land and Sea Strategies, (Part 2 of 2)”, 8 July 2015

2 TPP is a 12-member Asian regional trade agreement, initiated by the US, including major Asian trading nations such as South Korea,

Japan, Singapore, Vietnam and Malaysia. The TPP bloc accounts for 38% of world GDP. TTIP is a proposed US-EU free-trade

agreement that governs market access and cooperation. Both TPP and TTIP exclude China, which means that their trade regulations

could adversely affect China’s trade relations with these markets.


Map 1: Belt and Road infrastructure network

Sources: Wikipedia, BNPP IP (Asia)

Map 2: Strategic importance of the Middle East



Map 3: Strategic importance of the Straits of Malacca


The politics of the east-west route The east-west route (Silk Road Economic Belt) aims to link China to Europe (Map 4) through Central Asia by creating a land-transport network that cuts thousands of miles off the traditional sea routes from China’s east coast for transporting oil and gas and other natural resources imports. Domestically, Beijing hopes to use better economic links to enrich its underdeveloped border regions through the creation of new trade zones so that it can keep ethnic tensions at bay, especially in the volatile region of Xinjiang.

Map 4: The east-west route



However, this route which goes through Central Asia is fraught with difficulties. First, infrastructure projects in this region face unforgiving terrain through tall mountains, as well as threats from armed militants. Second, the BAR initiatives to integrate the Central Asian economies with China could put Beijing on a collision course with Moscow, which has been lobbying neighbouring countries to join its Eurasian Economic Union (EEU)3 (Map 5).

Map 5: The Eurasian Economic Union


Due to its bigger network, many central Asian countries may find China’s BAR more attractive than Russia’s EEU. But politics may still stand in China’s way. As China expands its influence into parts of the former Soviet Union, Central Asia could become the focus of tensions between China, Russia and possibly Iran, Turkey and some western countries. Even though China has quietly become the preeminent economic power in the region over the past two decades with trade with the region surging (Chart 1), and even though western interest in Central Asia has receded with the military drawn down from Afghanistan and Russia’s ambition curtailed by its economic difficulties, it will not be smooth sailing for BAR implementation. Central Asia has traditionally felt greater affiliation with Russia (due to its inclusion in the former Soviet Union) and Turkey, and many politicians there do not trust China. Russia has also been sceptical of China’s economic expansion in the region, which Moscow sees as its own backyard housing the world’s largest natural coal and gas reserves.

3 The Eurasian Economic Union (EEU) is an economic union of states located primarily in northern Eurasia. A treaty establishing the

EEU was signed in 2014 by the leaders of Armenia, Belarus, Kazakhstan, Kyrgyzstan and Russia, and came into force on 1 January

2015.


The north-south land route Under the BAR plan, the southwest province of Yunnan is designated as an economic bridgehead for expansion into the Mekong Basin (Map 6). Chinese companies are building power lines, roads and dams, and investing in property, agriculture and mines in the area. A USD4 billion highway now runs from Kunming, Yunnan’s provincial capital, to Bangkok. There are plans for building a USD7 billion high-speed railway between Jinhong in Yunnan and Vientiane in Laos, financed by China’s Exim Bank.

Map 6: Stretching into the Mekong Basin



A proposed Bangladesh-China-India-Myanmar (BCIM) economic corridor will link Kunming and Kolkata4 in India with highways and other infrastructure means, including oil and gas pipelines (Map 7). There are already oil and gas pipelines and highways running between Kunming and Kyaukphyu, a port city of Myanmar. Developing this section of the land route will extend Beijing’s influence to the Indian Ocean.

Map 7: Extending into Myanmar


The north-south sea route By sea, the “21st Century Maritime Silk Road” will enable China to boost trade and influence along Asia’s sea transport lanes and, by extension, across the South China Sea (Map 8). China has already financed new ports in the Indian Ocean in Bangladesh, Pakistan and Sri Lanka. While China’s primary focus is commercial, it is also building up naval power (running in parallel to the US Navy) to protect its trade routes.

Strategically, this sea route will enable China to exert control over the China Seas, many parts of which are also claimed by other SE Asian nations. Beijing appears to be focusing on economic expansion, while keeping an “uneasy peace” by slowly asserting its influence in the waters. This approach has created geopolitical tension, with some Asian countries suspecting China of pursuing a strategy of encircling Asia with a “string of pearls” – a network of ports connecting China’s eastern coast to the Middle East – to boost its strategic clout and maritime access (Map 9). India, among others, asserts Beijing is designing such a “string” to make China the hub of a new order in Asia and the Indian Ocean. It worries that by establishing dominance along major trade routes, China is trying to redraw Asia’s geopolitical map.

4 Kolkata was formerly Calcutta, the capital of the Indian state of West Bengal.


Map 8: The sea route: “21st Century Maritime Silk Road”


Map 9: China’s “String of Pearls” strategy



Despite the political tensions, China’s economic forces have pushed on and often included states that are not necessarily India’s friends. For example, it is financing a USD46 billion investment scheme in Pakistan, funding a 3,000 km “economic corridor” from the Arabian Sea to Xinjiang in northwest China (Map 10). The route starts in Gwadar, a Chinese-run Pakistani port near the Iran border and key shipping routes in and out of the Persian Gulf. It should improve the links between China, Asia and Europe, creating new trade routes and boosting regional growth.

Map 10: China-Pakistan Economic Corridor


The grand vision of this sea route is to build new port infrastructure that links to China’s inland transport networks, increases the number of international sea routes, improves logistics by enhancing the usage of information technology, dismantles trade and investment barriers and deepens financial integration by greater usage of the renminbi. The Mekong sub-region The Mekong sub-region is likely to be the first to benefit from BAR implementation. It includes mainland ASEAN countries, or ASEAN excluding Indonesia, Brunei and the Philippines (Map 11). BAR plans are to build extensive rail linkages with the region, which has better political relations with China than many other parts, and is geographically close to it.

Beijing has designated Yunnan a gateway between China and the Mekong sub-region, with Kunming as the base for building an international transport corridor from China to SE Asia. Yunnan will also link with the neighbouring province of Guangxi, which is sandwiched between Hong Kong and Vietnam, serving together as a hub connecting China’s rich Pearl River Delta to the east with the Mekong sub-region to the west (Map 12).


Map 11: Mainland ASEAN – Affluent and Close to China


Map 12: Yunnan/Guangxi, a gateway between China and the Mekong sub-region for both land and sea routes of BAR



Kunming plays a pivotal role in connecting China with SE Asia, with Beijing planning to make it a strategic hub stretching through the Mekong sub-region to secure closer trade and investment links with Malaysia and Singapore (Map 13). Railway links are planned to connect other parts of China via Kunming with Laos, Myanmar and Thailand. The line from Kunming through Vientiane to Bangkok appears to be one of the most promising plans, as it goes right into the economically active zones of the Mekong sub-region (Map 14). Within China, Beijing plans to develop Kunming into a transport hub over the next decade linking all major cities and provinces by road and railway networks and cutting short travel time to within 14 hours throughout the country (Map 15).

West of Kunming, BAR aims to link China with Myanmar, via the Myanmar-Thailand rail link, joining the railway networks in ASEAN countries and linking with the BCIM economic corridor (see Map 7 above), all the way down to the Andaman Sea. (Map 16). This route will enable China to send exports to Europe without the need to sail around the Malay Peninsula, thus saving substantial cost and time.

Map 13: Grand rail plans: from Kunming to Singapore

Sources: Wikipedia, press reports, BNPP IP (Asia)


Map 14: Kunming, a gateway between SE Asia and China


Map 15: Kunming’s planned domestic railway network (Travel time by 2020)



Map 16: Westward to the Indian Ocean and to Europe


Map 17: Five development zones under BAR



The BAR limits So much for the grand plans. However, there seems to be a lack of coordination for implementation. Beijing plans to divide the country into five development zones under BAR (Map 17). But every province has its own BAR investment plan, with local governments eager to jump on the bandwagon to stimulate flagging growth. The authorities talk about BAR as if they had a clearly defined implementation strategy, but in fact there is none. What actually gets built will depend on individual deals struck between Chinese firms and their foreign partners, subject to political agreements between the governments. Some of the countries participating in the BAR scheme have poor economic fundamentals, such as large fiscal and current account deficits. Beijing will be taking on greater default risk by investing in them or by providing them with capital. A wider use of the renminbi in these countries may also expose China to foreign exchange risk. Further, cultural clashes with the host countries in terms of work ethics and human rights in labour treatment could increase the risk of damaging Beijing’s political image and/or creating instability in these countries. As China expands its external activities, this could create political tensions with major regional players. However, weighing the opportunities against the risks, BAR may still likely be a positive force for global markets by fostering new trade and investment links. The key is for China to abide by international norms and rules in its initiatives.

BAR is a bold strategy that must be taken seriously. It may prove a long-term stimulus not only for China’s growth but also for that of the developing world, as the latter badly needs infrastructure investment (Chart 2). The Asian Development Bank and private sector investment banks estimate that Asia would need USD8 to 11 trillion of infrastructure investment between now and 2030.

Chi Lo Senior Economist, BNPP IP


DISCLAIMER

This material has been prepared by BNP Paribas Investment Partners Asia Limited* and is issued by BNP Paribas Investment Partners Singapore Limited (“BNPP IPS”)** and BNP Paribas Investment Partners Asia Limited, members of BNP Paribas Investment Partners (BNPP IP)***. The content has not been reviewed by the Monetary Authority of Singapore (“MAS”) or the Hong Kong Securities and Futures Commission. This material is produced for information purposes only and does not constitute: 1. an offer to buy nor a solicitation to sell, nor shall it form the basis of or be relied upon in connection with any contract or commitment whatsoever;

or 2. any investment advice. Opinions included in this material constitute the judgment of BNP Paribas Investment Partners Asia Limited or its relevant affiliate(s) at the time specified and may be subject to change without notice. BNP Paribas Investment Partners Singapore Limited and BNP Paribas Investment Partners Asia Limited are not obliged to update or alter the information or opinions contained within this material. Such opinions are not to be relied upon as authoritative or taken in substitution for the exercise of judgment by any recipient and are not intended to provide the sole basis of evaluation of any strategy or instrument discussed herein. The contents of this material are based upon sources of information believed to be reliable, but no warranty or declaration, either explicit or implicit, is given as to their accuracy or completeness. Investors should consult their own legal and tax advisors in respect of legal, accounting, domicile and tax advice prior to investing in the Financial Instrument(s) in order to make an independent determination of the suitability and consequences of an investment therein, if permitted. Please note that different types of investments, if contained within this material, involve varying degrees of risk and there can be no assurance that any specific investment may either be suitable, appropriate or profitable for a client or prospective client’s investment portfolio. Investments involve risks. Investments in emerging markets involve above-average risk. Given the economic and market risks, there can be no assurance that the Financial Instrument(s) will achieve its/their investment objectives. Returns may be affected by, amongst other things, investment strategies or objectives of the Financial Instrument(s) and material market and economic conditions, including interest rates, market terms and general market conditions. The different strategies applied to the Financial Instrument(s) may have a significant effect on the resul ts portrayed in this material. Past performance is not a guide to future performance and the value of the investments in Financial Instrument(s) may go down as well as up. Investors may not get back the amount they originally invested. Any reference to past performance of any market or instrument should not be taken as an indication of future performance. Neither BNP Paribas Investment Partners Singapore Limited, BNP Paribas Investment Partners Asia Limited nor any BNP Paribas Group company accepts any liability whatsoever for any loss arising, whether direct or indirect, from the use of any part of such information. A BNP Paribas Group company may, to the extent permitted by law, have acted upon or used the information contained herein, or where relevant the research or analysis on which it was based, before its publication. This material is for the use of the intended recipients only and may not be delivered or transmitted to any other person without the prior written consent of BNP Paribas Investment Partners Singapore Limited and BNP Paribas Investment Partners Asia Limited. Furthermore, any translation, adaptation or total or partial reproduction of this document, by any process whatsoever, in any country whatsoever, is prohibited unless BNP Paribas Investment Partners Singapore Limited and BNP Paribas Investment Partners Asia Limited has given its prior written consent. * BNP Paribas Investment Partners Asia Limited, 30/F Three Exchange Square, 8 Connaught Place, Central, Hong Kong. ** BNP Paribas Investment Partners Singapore Limited, 10 Collyer Quay, #15-01 Ocean Financial Centre, Singapore 049315. *** “BNP Paribas Investment Partners” is the global brand name of the BNP Paribas group’s asset management services. The individual asset management entities within BNP Paribas Investment Partners if specified herein, are specified for information only and do not necessarily carry on business in your jurisdiction. For further information, please contact your locally licensed Investment Partner.

Documents

Mega Trends of China (3): The Belt and Road Strategic Planinstitutional.bnpparibas-ip.com/wp-content/uploads/2016/01/Chi_Lo... · railway between Jinhong in Yunnan and Vientiane in