The Belt and Road:

Great for Trade but Who is Going to Pay?

IEMS and BRUEGEL

May 2017

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1. Positive impact on trade beyond China

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Working Paper: China’s Belt and Road initiative: can Europe expect trade gains?

By Alicia García-Herrero and Jianwei Wu

Bruegel, September 5, 2016

3

Most investment in on the “road” not on the “belt”

• Estimated reduction in road/railway transportation nearly 50% (only 10% for shipping)

• China will look more like Europe in terms of trade transportation

3

Air, 22%

Road, 19%

Rail, 0%

Maritime, 59%

Others, 1%

Source: China Customs

Share of Chinese trade by transportation mode

Air, 0% Road, 8%

Rail, 70%

Maritime, 19%

Inland Water, 3%

Source: Eurostat

Share of EU's trade by transportation mode

4

Transportation cost reduction is win-win for trade creation

• Gains larger in Europe, followed by Asia, as land route undergoes larger savings

4

-1

0

1

2

3

4

5

6

7

EU Non EU Asia Rest of World

Sim

ula

ted c

hange o

f tr

ade (

%)

Source: Bruegel

Regional trade impacts of the reduction in

transportation costs

5

By country, Eastern and Central Europe gain more: Some losers but very small losses, and therefore generally win-win

5

7.6

7.8

8.0

8.2

8.4

8.6

8.8

9.0

9.2

9.4

9.6

Belg

uim

Ne

therl

and

Slo

ven

kia

Austr

ia

Hu

ngu

ry

De

nm

ark

Mo

ldova

Germ

any

B&

H

Pola

nd

Source: Bruegel N.B. B&H stands for Bosnia and Herzegovina

Panel A: Top 10 winners in trade

-0.16

-0.14

-0.12

-0.10

-0.08

-0.06

-0.04

-0.02

0.00

Mo

rocco

Ma

li

Lib

ra

Alg

eria

Sie

rra L

eon

e

Fiji

Seych

elle

s

Ch

ad

Vanu

atu

Japa

n

Source: Bruegel

Panel B: Top 10 Losers in trade

EU Non-EU Asia Rest of World

6

However, if China opts for a trade deal (instead of focusing on infrastructure), Asia becomes the largest winner

6

-2

0

2

4

6

8

10

12

14

EU Non EU Asia Rest of World

Sim

ula

ted c

hange o

f tr

ade (

%)

Source: Bruegel

Impact of a free trade agreement on trade

by region

7

2. How to finance the Belt and Road?

7

8

8

14.7

26.2

8.4

2.3

0.8

0 10 20 30

Water & Sanitation

Telecom

Transport

Power

Total

Asia: Investment Needs by Sector (2016-2030, USD tr)

Source: Natixis, ADB N.B. Climate-adjusted estimates

China 59%

South Asia 24%

Southeast Asia 12%

East Asia ex China

3%

Central Asia and Pacific

2%

Asia: Investment Needs by Country (2016-2030)

Source: Natixis, ADB N.B. Climate-adjusted estimates

Huge infrastructure investments needed in Asia

9

9

0

10

20

30

40

50

60

70

80

Russia Other Asia ASEAN Africa Europe

Belt & Road Investments by Country (USD bn)

Energy Rail Industrial Park Materials Port Road

Source: Natixis *Both confirmed and highly likely projects included.

USD 5 trillion!: Size of investment in the next 5 years by official

source

Road 2%

Port 3%

Materials 5%

Industrial Park 6%

Rail 41%

Energy 43%

Belt & Road Investments by Industry

Source: Natixis *Both confirmed and highly likely projects included.

How much so far in the Belt and Road?

10

10

Table: China lending to the world

Announced Potential Notes

China Banks - At least 137

USDbn*

Total cross border lending as much as 1,574

USDbn (at least 9% in OBOR)

Development Bank (China Development Bank/EXIM) - 415 USDbn*

Based on actual lending to LatAm by China

Development banks (125 USD bn) and the

relative share of LatAm versus OBOR in

cross-border lending

Bank of China 20 USDbn -

Capital Announced Disbursed Notes

Multilateral banks 240 USDbn 17 - 23 USDbn > 3.1 USDbn

Asian Infrastructure Investment Bank (AIIB) 100 USDbn 10 - 14 USDbn 1.7 USDbn

New Development Bank (NDB) 100 USDbn 5 - 7 USDbn 1.4 USDbn

Silk Road Fund 40 USDbn 2 USDbn -

Source: Natixis * Estimated from the proportion of cross border lending (excluding Europe) to OBOR / Total lending

How to finance this huge investment effort? Key funding source so far not multilaterals but Chinese banks

10

11

11

But there is a limit to what China can finance (especially in USD): the world is looking at China’s forex reserves

-500

-400

-300

-200

-100

0

100

200

300

400

-500

-400

-300

-200

-100

0

100

200

300

400

10 11 12 13 14 15 16 17

Natixis China Capital Flow Tracker (Quarterly, USD bn)

Natixis China Capital Flow Tracker

BOP Flow

Source: Natixis

11

5.6

5.8

6.0

6.2

6.4

6.6

6.8

7.0

7.2

2,800

3,000

3,200

3,400

3,600

3,800

4,000

4,200

11 12 13 14 15 16 17

Reserves and Currency

Reserves (USD bn) USDCNY (rhs)

Source: Natixis, Bloomberg

12

Three options to mitigate problem First option: RMB financing

• More financing of infrastructure projects in RMB as host countries’ exports invoiced in

the same currency and providers/infrastructure companies are mainly Chinese

• However, it is now more difficult due to RMB steady depreciation

12

0

5

10

15

20

25

30

35

0

500

1,000

1,500

2,000

2,500

12 13 14 15 16 17

China's cross-border trade settled in RMB

RMB settlement (bn) RMB settlement share (rhs)

Source: Natixis, CEIC

0

10

20

30

40

50

0

10

20

30

40

50

11 12 13 14 15 16 17

USD EUR GBP JPY CNY

Source: Natixis, Bloomberg, SWIFT

Share as international payment currency (%)

13

13

232%

181% 176%

66% 56% 53%

0%

50%

100%

150%

200%

250%

14 15 16 Q3

NPL Coverage Ratio (%)

NPL Coverage Ratio Adjusted NPL Coverage Ratio

Source: Natixis, CEIC, WIND

0

1

2

3

4

5

6

7

14 15 16

Stressed Loan Ratio (%)

Non Performing Loan

Non Performing Loan + Special Mention Loan

Source: Natixis, CEIC

5.8

6

1.7

6

1.0

4

3.5

4

Related research:

China Banking Monitor 2016: From lending to investing in order to survive

But not sustainable given the worsening asset quality of Chinese banks

14

0

50

100

150

200

250

300

350

400

450

HK SG

14

Second option: More offshore financing

• More external financing would increase China’s external debt (from a low level)

• Opportunities for Hong Kong to intermediate the financing of B&R

Hong Kong Market Size USD tr

Bank Assets 2.45

Market Cap 4.11

Bond 0.39

Source: Natixis, World Bank, Bloomberg, CEIC

0

20

40

60

80

100

120

140

CN IN PH KR TH TW ID VN MY NZ JP AU

External Debt (2016)

Source: Natixis, CEIC N.B. Vietnam as of 2015 (rhs)

15

15

0

5

10

15

20

25

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

International Claims (USD tr)

Total Europe China

Source: Natixis, BIS NB Locational statistics used for China, available from 2015 Q4

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Borrowing countries (USD tr)

Developing countries OBOR

Source: Natixis, BIS

EU, 55%

Rest of

World, 45%

Total 1,739 USDbn

EU 953 USDbn

Loan to OBOR countries

European banks relevant part of the equation Largest cross border lenders globally but also for OBOR so far

15

• USD 5 trillion would increase China’s debt by 50% of GDP

• Equity market needs further development and openness to foreign investors

16

Beyond banks, capital markets should be tapped but, again China cannot take all that burden by itself

0

50

100

150

200

250

300

350

China(Unilateral

B&RFinancing)

EU US China

Source: Natixis, BIS

Debt-to-GDP Ratio (%)

17

Third option to mitigate problem: More host co-financing

• More co-financing by host country and/or co-financing by other beneficiaries (especially European Union)

• Host country co-financing already happening but the limit is quite clear for many countries (hard to take more debt)

• Already initiatives to attract EU financing in exchange of China’s financing of Juncker Plan

• Also China EU Commission connectivity platform to co-finance transnational transportation projects

17

18

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The way forward

• The Belt and Road is indeed a grand plan which will take decades

• The approximate 5 trillion USD financing for next five years is just the beginning. This is a 20 year end game.

• China’s reduced reserves and saddled banks are making financing the key constraint for Xi’s grand plan.

• Trade gains are large for host countries, and even European Union

• It is, thus, in EU’s interest to finance the current version of the Belt and Road.

• European banks well placed to do so as major cross-border lenders

• Hong Kong has a role to play in intermediating external financing as key off-shore center in the region

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