Breathing new life to BRI
On 15 July we held a CxO lunch to discuss the current status and outlook of the ‘Belt and Road’ Initiative (BRI), and the actions that can be taken to increase its quality and sustainability. Below I have summarized the key takeaways for your convenience.
1. A challenging landscape
BRI was once regarded as the project of the century. One that would bring prosperity to a world that was facing subpar growth; generate business opportunities to companies along and beyond the ‘Belt and Road’, including from developed markets; and lead China into a new stage of high-quality opening-up.
However, the Initiative has accumulated much criticism over the past years and international enthusiasm about it has dropped. Business confidence surveys, news reports and anecdotal evidence indicate a lack of visibility on existing ‘Belt and Road’ project opportunities, and of information on how foreign firms can participate in them. There is also evidence of several issues in these projects due to a lack of appropriate due diligence, feasibility, financial and impact assessments; and the use of ineffective risk management processes. Moreover, troubled projects such as the Hambantota Port have galvanized public opinion against the initiative.
The Covid-19 pandemic has also led to a very challenging landscape for the ‘Belt and Road’ Initiative:
- The fiscal situation in every country has deteriorated. The last time public debt was so high was at the end of World War 2. Easy financing conditions over the past decade drove an unprecedented buildup in public debt across many countries, a trend that has intensified during the Covid-19 pandemic as a result of governments’ stimulus measures.
- Financial systems are vulnerable to an increase in interest rates. Central banks are betting that the rise in inflation we are seeing is transitory. But there is a risk that this might not be the case, in which case monetary authorities, and especially the US Fed, might be forced to raise interest rates. This would make it more expensive to service debt and could trigger a ‘tapper tantrum,’ leading to capital outflows from developing markets – The Economist recently published an excellent article on this here.
- There are fewer new projects added to the pipeline. On the one hand, this is because of quarantine and travel restriction measures which prevent technical staff from travelling onsite to assess potential projects. On the other hand, the stimulus measures of the Chinese Government have shifted state-owned EPCs’ attention from overseas to the domestic market. Attention to outbound infrastructure investment will come back but not in the short-term, making it harder to fill in the pipeline of BRI projects.
- The deterioration of geopolitical dynamics is making it harder to participate in international infrastructure projects. Tit for tat sanctions and export controls mean that sponsors and capital providers suddenly have to worry about who the engineering, construction and procurement (EPC) firms are, and where the materials come from.
- Requests to China for debt suspension and restructuring will continue increasing, and the way China responds to them will impact its international image significantly. I did a bit of research and found a recent study by UNDP which identifies 72 developing countries with sovereign debt vulnerabilities. China owns 50% or more of the publicly and public guaranteed debt for five of them, and from 30% to 49% for 15 of them. As these countries struggle with servicing their debts, media headlines about ‘debt traps’ are likely to increase.
- Risks are on the rise:
- As explained by one of the guest speakers, capital providers have realized that they have been too optimistic about risks in emerging markets – especially legal risks. These risks were unappreciated in an environment of relative stability, easy financing conditions and strong market demand. But the impact of the pandemic and increasing geopolitical volatility have changed this. Even if laws are in place and project participants have a perfect set of documents which include sovereign guarantees, will these ultimately be enforced?
- The risk of stranded assets has increased. The world is ‘greener’ than the pre-Covid-19 era. The pandemic’s disruption of supply chains has increased attention on the criticality of resilience and sustainability for infrastructure assets. Coupled with this, governments across the world are stepping up their efforts to green their economies. As a result, less and less capital providers will be interested in financing heavily polluting assets, such as coal-fired power plants, because they have no idea if anyone will buy electricity generated by coal in 20 years.
- One of the attendees also mentioned currency risk. Projects might be doing ok, but capital providers are getting hit by the depreciation of currencies in developing markets. This is a risk that is very difficult to hedge, as a result of which investors are now more interested in seeking US dollar revenue based assets or assets with inflation indexation.
2. Against this backdrop, what can be done to breathe new life to BRI?
One of the attendees noted that, despite the challenges, the reality is that BRI is “the only game in town” for developing markets. International development aid efforts have mostly been unsuccessful in driving growth across the developing world, whereas BRI gives the hope of replicating China’s development success.
And as explained by one of our guest speakers, while there are still issues that need to be addressed, the quality of Chinese-led infrastructure projects has improved significantly in recent years. Previously there was a large number of white elephant projects being financed by China’s state capital, but there is now a growing number of sophisticated SOEs with international experience that prefer international capital – thus avoiding the need to provide parent company guarantees to get financing from Chinese policy banks, which negatively impacts their balance sheets.
This in itself is a solution for some of the issues facing BRI projects. Increasing the participation of renowned international capital providers in these projects would help raise their profile vis-à-vis the international community because this works as a seal of guarantee. These capital providers would not participate in projects without conducting rigorous due diligence and feasibility assessments which indicate they are high-quality assets with attractive risk profiles.
For this to happen, Chinese firms need to incorporate international best practices and standards in the way they go about investing and developing infrastructure overseas. This includes making these projects more transparent. As mentioned above, there is a lack of information on current opportunities and on how foreign firms can participate in them – a fact that was emphasized by a number of the attendees. As well projects need to be structured in a way that clearly allocates risks amongst all participants.
But perhaps the key challenge for China is preventing a few troubled projects from coming to define the whole of BRI going forward, an increasingly difficult task given geopolitical volatility and growing negative perceptions about China in other nations. As one of the guest speakers mentioned, China has actually done a lot of pioneering work in terms of renewables in ‘Belt and Road’ countries for which it is not getting credit.
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