China’s Belt and Road Initiative: A new silk road and its contentions
China’s Belt and Road Initiative: A new silk road and its contentions
Invesco Fixed Income explores contentions over the Belt and Road Initiative.
The Belt and Road Initiative (BRI), promoted by the Chinese government, is based on an idea to replicate and expand the Old Silk Road. It seeks to create a “new” Silk Road – a trade route to echo old glories and remind us of Marco Polo and Venice, of silk and merchants. Its main aim is to expand the market for goods, making it global and consequently creating a push for consumable goods.
However, critics of the BRI state that it is actually a coercive “debt-trap diplomacy” conducted by China in disguise to exert control over the countries that join its transnational infrastructure investment scheme. In this article we explore these arguments and show how developing economies and consumers can stand to benefit from the BRI.
A supposed debt trap?
Long before the initiative, many of the regions involved, alongside their companies, already had large debt burdens, and China was not a main creditor. New projects under the BRI thus offered these economies the ability to generate appropriate, healthy and market-oriented external debt which would then facilitate the economic development of the countries under the BRI. Indeed, ratings agency Moody’s writes that, beyond the challenges of the initiative, the judgement on the credit front is positive1.
The size of the total bond market of the countries crossed by the BRI exceeds one trillion dollars2. In such a competitive environment, economies or companies that are able to attract funds certainly have an advantage over others. This is especially true for companies with a great deal of potential based on their funding needs.
The bond market under the BRI is expected to remain vibrant and large. Companies have a growing need for financing, and we think this can result in an average of one to three new bond issues per day of trading3. If we add to these factors the commitment of the companies affected by the BRI to get involved in the initiative, we can understand to what extent the broad range of new issues is likely to persist.
Looking at new bond issues might be favorable as this type of bond is inherently efficient. Its low transaction costs are due to the lack of trading commission and the lack of differential between demand and supply in the primary market, where new issues are subscribed to. Also, these instruments enable hedging in segments relating to reliable companies (or investment grade, if you wish), with a higher yield (compared to counterparts by sector or by rating, but sold on the secondary market). Alternatively, they can be sold within two months to increase liquidity (exploiting the price differential during purchase and sale, generating a capital gain).
Case study: Kazakhstan’s experience in uranium to renewable energy to oil
Uranium is a niche-market raw material, often overlooked and undervalued by global investors. However, investor perception has changed in recent months. Last year, the radioactive element was the best performer in the commodities market. According to Bloomberg data, in one year – 2018 – over 95% of all asset classes had negative returns4.
What does this tell us? As is often the case, when investor interest awakens, there is a decline in the supply in these times of geopolitical tensions and growing demand. Uranium is a good example of this issue, attaining a peak of US$152 per ounce in June 2007. It then fell by 87% over the next ten years to a nadir of US$19.75 in May 2017. It now hovers around US$29. It is clear how increased production levels of this and other raw materials, based on infrastructure investment and construction, is not just important but of major significance.
Investors therefore see an opportunity in the Kazakh Route, part of the wider BRI. This does not only involve the territory of Kazakhstan alone; it includes the numerous international corridors connecting it to the rest of Eurasia. Kazakhstan should therefore benefit from existing trade (for example, over US$1 billion between China and Europe, not to mention Russia’s trade with China and the Middle East, together totalling almost US$90 billion per year)5.
For this reason, the New Silk Road can also benefit from raw materials through continuous investment in infrastructure. For example, there is immense potential in terms of renewable energy, but that is not all. The plans for the BRI’s northern and southern corridors are countless.
The Caspian Pipeline Consortium is perhaps the most significant of these, with its course of over 1,500 kilometres from the Tengiz oil field to its Black Sea terminal at Novorossiysk. These pipelines date back to the Soviet period. Work to improve infrastructure like this has led to an increase in flow rate to 1.4 million barrels per day. Also worth a mention is the Kazakhstan–China oil pipeline, the Uzen-Atyrau-Samara line, and a third linking Baku with Tbilisi and Ceyhan.
The boom in consumption
Under the BRI, 71 countries are involved, representing more than half of the global population, it is worth noting. It throws up exciting investment opportunities in the consumer sector6. For example, in the massive Chinese market, rising incomes are carefully watched by the big e-commerce companies that focus on the growing Chinese middle class.
China has what’s called “Singles’ Day” on November 11 – created by a major Chinese e-commerce firm based on the idea that if you haven’t found your soulmate yet, the e-commerce platform will offer day full of amazing discounts. On November 11 last year, the company took in sales of US$31 billion, which was hailed as a record by the Chinese press the next day. The products on sale also included European and American brands, many of which are sought after by the new Chinese middle class as status symbols or aspirations.
Similarly, a high-end Italian sports carmaker launched its first SUV in China in 2016 via another e-commerce website. One hundred units of the car were sold online in only 18 seconds.
These examples show that the potential of a middle class whose desire for consumable goods continues to rise. At the same time, investors should not underestimate the small consumable-goods markets in countries that currently lack infrastructure development, but will soon be linked to the rest of the world by the BRI.
^1 “China’s Belt and Road Initiative is credit positive overall, but challenges evident,” Moody’s, published Sep. 19, 2017.
^2 Bloomberg, HSBC, JPMorgan, Invesco, as of Aug. 10, 2018.
^3 Invesco, as of Aug. 10, 2018.
^4 Bloomberg, as of April 30, 2019.
^5 Invesco, as of April 30, 2019.
^6 Invesco, as of March 31, 2019.
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The opinions referenced above are as of August 9, 2019. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.
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