Emerging Markets: China’s New Silk Road Big on Ambition, But is Anything Happening?

Emerging markets, IMF editions, October 2015

For two years now, evocative maps of ancient trade routes have been doing the rounds, filled with arrows and channels sweeping from China into Central Asia and beyond. Since 2013, when China first announced its plans for a new silk road – it goes by various names, most commonly One Belt, One Road – people have been trying to work out just what it will look like, and what it will actually do.

There are two components being developed in tandem: the Silk Road Economic Belt, which roughly follows the original Silk Road trading route through Central Asia, West Asia and the Middle East to Europe; and the Maritime Silk Road (sometimes called the 21^st Century Maritime Silk Route Economic Belt), bringing together Southeast Asia, the Indian Ocean, Oceania and parts of Africa.

It’s a grand vision, and from a trade perspective, makes sense. “This is definitely a very smart move by the Chinese government in terms of branding what is in their own back yard and trying to lead it,” says Agatha Lee, head of global trade and loan products business in Asia Pacific for JP Morgan. “It is reinforcing history, and creating a new economic growth agenda where most people along that route will benefit.”

Lee says there are multiple aims. “Economically, it will drive new industries, create new infrastructure, create new trade routes and the new markets will benefit,” she says. “Socially, it will create employment, awareness for some more isolated countries, and will raise standards of living. And politically, it will drive closer partnership alliances and cooperation. These projects cut across several countries and cultures.”

Fine. But is anything actually happening yet? Two years on, has any physical progress been made?

“The short answer is no,” says Minggao Shen, head of China research at Citi. “There are many projects labelled One Belt One Road, but these are projects that would have had to happen anyway. Additional investment generated from the Silk Road project is still very limited. This is not a short term plan, this is a long-term plan.”

That said, maybe this is the ideal moment to get things rolling. “There is plenty in the pipeline, and now that China’s domestic economy is slowing it makes sense to bring it forward,” says John Zhu, economist at HSBC. “Let’s not forget that a lot of the Silk Road is in China, so it is not all foreign outbound investment. A lot is in the less developed central and western parts of China.

“We fully expect infrastructure investment here to pick up in the next couple of quarters, which makes sense as a short-term countercyclical policy within the framework of One Belt One Road.”

Initial investment is likely to be on the transport side: chiefly rail, but also inland ports along the river, and highways. But it can be difficult to get anyone to name a single individual project in China that is underway as part of the broader Silk Road initiative, rather than just talking in broad conceptual terms. “For a major project like this, inevitably it takes a while to get going,” says Lee. But in her view, it’s just a question of time. “Corporates, especially state-owned enterprises, have embedded this One Belt One Road in to their business strategies, especially those that are in infrastructure industries.”

In order to make progress, there first needs to be funding, and this is perhaps where the real work has been done so far. China has three chief sources of funding for the silk road projects, diverse in approach and structure.

One is the Silk Road Fund, a US$40 billion development fund whose formation was announced by Xi Jinping in November 2014. Notably, its first major investment, announced in April, was not in China but in Pakistan, and was not a road or railway but power infrastructure: a hydropower plant on the Jhelum River. The Karot Hydropower Project is to be built by a subsidiary of China Three Gorges Corp, and was one of just 51 agreements worth US$46 billion that were signed during President Xi’s visit to Pakistan that month. Thirty of those agreements related to a vital chunk of the overall Silk Road initiative, an economic belt and trade corridor from China’s Xinjiang Uygur region to Gwador Port on the Arabian Sea.

Then there is the Asian Infrastructure Investment Bank (AIIB), founded in 2014 as a new multilateral with the participation of 56 other countries. This is a development bank focused on supporting infrastructure development in the Asia Pacific region, and a large part of its mandate will be related to the Silk Road initiatives.

Also relevant is the New Development Bank, the formal name for the BRICS Development Bank. Headquartered in Shanghai, this bank’s mandate is far broader than just China or the Silk Road countries, but given that its stated goal is to “mobilize resources for infrastructure and sustainable development projects in BRICS and other emerging economies and developing countries,” it will clearly have a role to play.

Some are encouraged to see this intention to use multilateral sources of funds rather than just China going it alone. “AIIB has a lot of representation from other investors and countries, and hopefully that should mean a great deal of oversight and scrutiny of the project,” says Zhu. “The worry is that they are going to waste the money and make bad decisions; the fact that they are willing to go through a multilateral route, when frankly they’ve got the money to do it themselves, is positive. It means the project will be done more professionally and with better risk controls.”

It is tempting, as a stock market crash unfolds and China’s economic growth model is under uncommon scrutiny, to look at the Silk Road initiative and think: is that the answer? An economy boosted by trade and specifically exports, as the domestic economy slows?

“This project will be a new source of trade and economic growth to counter the slowing domestic economy in China,” says Lee. “The Chinese emphasis on domestic spending is still there. But at the same time, if you look at how China wants to grow, it can’t just be the domestic economy.”

The idea is, though, that it’s not enough just to create the means for Chinese goods to get to Central Asia more easily; for it to be a true success, it also has to spur those neighbouring economies so that they have more money with which to buy those exports.

“One Belt One Road will help with Chinese export growth on two conditions,” says Shen. “One, can you put infrastructure there to help create a positive spillover to growth, and two, the timing, because it may take years.”

Shen notes that year to date, Chinese export growth was negative 1.3% for the first eight months. However, China’s market share of G20 economies in export terms grew. “These two numbers together suggest external demand is extremely weak. So unless One Belt One Road puts in infrastructure that helps other countries to grow their economies better, then if China exports more now, it just means China is eating other people’s cake.

“My understanding is that One Belt One Road will start with infrastructure projects, as Chinese leaders believe this the bottleneck for growth in other emerging markets.”

Zhu at HSBC says the project “will almost certainly increase trade flows, both in terms of increasing linkages and reducing trade costs,” but also notes the nuance about creating strong markets to sell to in the first place. “This is also a way to boost external demand for China’s own export industries. It’s not charity or aid: China wants to make an investment that will make a reasonable return over time and also boost demand globally.”

We should not overestimate the immediate impact these projects might have on the economy. Shen notes that even if AIIB were to spend $100 billion of capital [China’s initial contribution to AIIB’s funding base] in a single year and put the whole lot into a high speed rail project, the additional demand for steel would still only equate to 2% of China’s steel supply. In the short term, instead, the bigger impact is likely to be a movement of development into relatively new parts of China, rather than overseas. “There is a great deal of investment that needs to be done in the poorer parts of China,” says Zhu. “For the most part, people still live in the countryside or in the very poorly connected central or western parts of China.”

There are other interesting knock-on effects coming out of the project too. Shen highlights the question of Special Drawing Rights (SDRs). “Whether RMB is included in SDRs is a critical issue for the One Belt One Road strategy,” he says. “Domestic media report that AIIB could be partly funded by RMB if it is agreed as an international currency; that could also reduce the pressure on the Chinese currency when Chinese firms invest overseas.”

One thing that’s particularly unclear about the Silk Road initiatives is timing. “There is no clear timeframe,” says Shen. “If you look at Chinese plans around reforms, urbanization plans and SOEs, the government is talking about 2020 as an important deadline. AIIB and One Belt One Road should have a similar timetable. The next five years will likely be the critical period for it to be successful.”

But the truth is – and this is unusual for China – timing is, for once, not in the leadership’s own hands. “The timeframe is very contingent on what happens overseas,” says Zhu. “Domestically they have more control, but along the Silk Road – both on the land belt across Central Asia through the Middle East and into Europe, and the sea route through Asia and onwards – there are so many variables.”

Take that Pakistan investment, for example, the very first piece of spending by the Silk Road Fund. There are few less stable major world powers, in security terms, than Pakistan. Zhu argues the security question is “a case of hopefully getting the price right. Of course there is going to be risk; the issue is whether you price it correctly.” But no matter how much money China has, and how adept its political influence, there are many elements that it simply cannot control. Shen says: “It’s not just hard power – money – that matters, but soft power too.”

Despite the challenges and a lack of any visible progress, economists tend to be united on two things: that this is a very long-term project that cannot sensibly be judged yet, and that in principle, it’s worth doing. “It makes sense economically for China,” says Zhu. You clearly have a big stock of foreign reserves in China which have been recycled into US treasuries and are yielding a negative return in real terms. Far better to invest in something which, in the long term, will earn better returns.”