China's just-completed conference touting its Belt and Road initiative certainly looked like a triumph, with Russian President Vladimir Putin playing the piano and Chinese leaders announcing a string of potential deals and massive financial pledges. Underneath all the heady talk about China positioning itself at the heart of a new global order, though, lies in uncomfortable question: Can it afford to do so?
Such doubts might seem spurious, given the numbers being tossed around. China claims nearly $900 billion worth of deals are already underway, with estimates of future spending ranging from $4 trillion to $8 trillion, depending on which Chinese government agency is doing the talking. At the conference itself, Chinese President Xi Jinping pledged another $78 billion for the effort, which envisions building infrastructure to link China to Europe through Asia, the Middle East and Africa.
From no other country in the world would such pledges be remotely plausible. Yet even for China, they'll be difficult to fulfill without clashing with the country's other objectives.
The first question is what currency to use for all this lending. Denominating loans in renminbi would accelerate China's stated goal of internationalizing its currency. But it would also force officials to tolerate higher levels of offshore renminbi trading and international price-setting. So far, they've shown little appetite for either.
Additionally, countries along the Belt-and-Road route would need to run trade surpluses with China in order to generate the currency needed to repay such loans. In fact, as Bloomberg Intelligence economist Tom Orlik has noted, China ran a $250 billion surplus with Belt-and-Road countries in 2016. It will be mathematically impossible for Sri Lanka and Pakistan to repay big yuan-denominated loans when they're running trade deficits with China close to $2 billion and $9 billion, respectively.
Financing projects in dollars is no panacea either. Unless China conducts U.S. dollar bond offerings to fund these investments, it'll have to tap its official foreign-exchange reserves. Those now hover around $3 trillion.
That sounds like a lot. But outside estimates suggest anywhere from a few hundred billion to nearly $1 trillion of that money is illiquid. China needs nearly $900 billion to cover short-term external debt and another $400 to $800 billion to cover imports for three to six months. Pouring additional billions into Central Asian infrastructure projects would only tie up money China needs to defend the yuan.
And, borrowers would need to run significant dollar surpluses in order to repay dollar-denominated loans. Obviously, not every country can do so, or undervalue its currency to try and build up a surplus.
Beyond the specific mechanisms, it's unclear whether China has the financial capacity to lend at these levels to borrowers of dubious creditworthiness. As French bank Natixis S.A. has noted, in order to finance $5 trillion in projects, China "would need to see growth rates of around 50 percent in cross-border lending.” This would wreak havoc on Chinese creditworthiness and raise external debt from a “very comfortable" level (around 12 percent of GDP) to "more than 50 percent" if China can't bring in other lenders.
There are a couple ways around these difficulties. First, China could use this as an opportunity to liberalize the renminbi fully, allowing yuan to flow out of the mainland into countries targeted for investment. However, given Chinese leaders' worries about a plunge in the currency and the impact on a rickety domestic financial system, this seems unlikely.
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Second, China could opt to bring in other countries and multilateral institutions to share in the task of financing projects. Chinese leaders say they support this (just as they favor internationalizing the yuan); Xi has even welcomed involvement by rival Japan. But in the past they've refused to co-finance projects with international institutions such as the Asian Development Bank and have been prickly about working with other countries, even supposed friends like Russia, on overlapping projects.
Meanwhile, European countries refused to sign the final statement at last weekend's conference after it omitted language on corruption and governance; the U.S., too, has been standoffish. Enticing Western countries and banks to finance projects that haven't been suitably analyzed and vetted will be an uphill task.
There are two more likely, if less appealing outcomes. China could stretch public finances even further to fund projects its leaders admit will likely lose money. For the moment, they seem willing to lend in dollars even if it ties up hard currency.
But it's almost certain that the amount of money that makes its way into Belt-and-Road projects will be significantly lower than advertised. Grand in ambition but short on details, Xi's sweeping initiative may be better thought of as a “philosophy” or “party line," rather than a fixed commitment. One thing's for sure: It's going to be a lot harder than putting on a conference.
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