Blog Post

China cannot finance the Belt and Road alone

The One Belt One Road initiative holds great promise for the global economy, but will need a huge amount of finance. Initial presumptions that China would be able to provide all the finance are now unrealistic. Other partners should consider providing finance for some aspects, especially Europe - which has a lot to gain from the project.

By: Date: May 12, 2017 Topic: Global Economics & Governance

There is no doubt that Asia needs infrastructure. The Asian Development Bank (ADB) recently increased its already very high estimates of the amount of infrastructure needed in the region to 26 USD trillion in the next 15 years, or 1.7 USD trillion per annum (Chart 1). The great thing about the China driven Belt and Road initiative is that it aims to address that pressing need, especially in transport and energy infrastructure. But this is easier said than done. The a-priori is that the financing will be there thanks to China’s massive financial resources.

chart 1

chart 2

Chinese authorities have come up with their own estimates of the projects that will be financed. The numbers start at USD 1 trillion and go all the way to USD 5 trillion in only 5 years. In the same vein, the official list of countries does nothing but increase over time to more than 65 countries today.

but there is a limit to how much China can finance

Such a-priori was probably well taken when China was flooded with capital inflows and reserves had nearly reached USD 4 trillion and needed to be diversified. In the same vein, Chinese banks were then improving their asset quality if, anything, because the economy was booming and bank credit was growing at double digits.

The situation today is very different. China’s economy has slowed down and banks’ balance sheets are saddled with doubtful loans, which keep on being refinanced and do not leave much room for the massive lending needed to finance the Belt and Road initiative.

This is particularly important as Chinese banks have been the largest lenders so far (China Development Bank in particular with estimated figures hovering around USD 100 billion while Bank of China has already announced its commitment to lend USD 20 billion). Multilateral organizations geared towards this objective certainly do not have such a financial muscle. Even the Asian Infrastructure Investment Bank (AIIB), born for this purpose, has so far only invested USD 1.7 billion on Belt and Road projects.

As if this were not enough, China has lost nearly USD 1 trillion in foreign reserves due massive capital outflows. Although USD 3 trillion of reserves could still look ample, the Chinese authorities seem to have set that level as a floor under which reserves should not fall so that confidence is restored (Chart 3). This obviously reduces the leeway for Belt and Road projects to be financed by China, at least in hard currency.  Against this background, we review different financing option for Xi’s Grand Plan and their implications.

chart 3

How to finance the Belt and Road?

The first, and least likely, is for China to continue such huge projects unilaterally. This is particularly difficult if hard-currency financing is needed, for the reasons mentioned above. China could still opt for lending in RMB, at least partially, with the side-benefit of pushing RMB internationalization. However, even this is becoming more difficult.

First, the use of the RMB as an international currency has been decreasing as a consequence of the stock market correction and currency devaluation in 2015 but still some of the Belt and Road projects could be financed in RMB in as far as the borrowing of a certain host country would be fully devoted to pay Chinese construction or energy companies (Chart 4). This quasi-barter system can solve the hard-currency constraint but poses its own risks to the overly stretched balance sheets of Chinese banks. In fact, their doubtful loans have done nothing but increase during the last few years, which is eating up the banks’ room to lend further (Chart 5).

chart 4

chart 5

A second option is for China to intermediate overseas financial resources for the Belt and Road projects. The most obvious way to do this, given the limited development of bond markets in Belt and Road countries as well as the still limited size of China’s own offshore bond market is to borrow from international banks. Cross border bank lending has been a huge pool of financial resources, especially in the run up to the global financial crisis. Since then they have moderated but the stock of cross border lending still hovers above 15 USD, out of which, nearly half is lent by European banks. Out of the USD 15 trillion, about 20% is already being directed to Belt and Road economies, with European banks being again the largest players (Chart 7).

Still, in order to finance the USD 5 trillion targeted in Xi’s grand plan for the next five years, you would need to see growth rates of around 50% in cross-border lending. While such a surge in cross-border lending is not unheard of (in fact, it happened in the years prior to the global financial crises), the real bottleneck would be the rapid increase in China’s external debt, which would go from the currently very comfortable level (12% of GDP) all the way to more than 50% if China were taken on the debt, or something in between if co-financed by Belt and Road countries.

chart 6   chart 7

A mix of option 1 and 2 lies on the use of multilateral development banks to finance the Belt and Road projects. In fact, China is a major shareholder of its newly created multilateral banks (AIIB and New Development Bank) but less so in existing ones (such as ADB, EBRD or the World Bank). This means that the financing burden can be shared (to a lesser or larger extent) with other creditors, while still keeping a tight grip on the construction of such infrastructure (at least in China-led new organizations). While apparently ideal, the problem with this option is that the available capital in these institutions is minimal compared to the financing needs previously discussed (Table 1).

Tabler 1

It seems that China cannot really on its banks alone – no matter how massive – to finance such a gigantic plan. The key source of co-finance would logically be Europe at least as long as bank lending dominates, which will be the case for quite some time in the countries under the Belt and Road. In fact, European banks are already the largest providers of cross border loans to these countries so it is only a question of accelerating that trend. Furthermore, the geographical vicinity between Europe and some of the Belt and Road countries could make the projects more appealing (Chart 8 and Chart 9). In addition, the European Union has its own grand plan for the financing of infrastructure – among other sectors – namely the Juncker Plan, which could serve as a basis to identify joint projects of interest to both EU and China.  In this vein, EU-China connectivity platform was launched by the European Commission in late 2015 exactly to identify projects of common interest for the Belt and Road and the EU connectivity initiatives, such as the Trans-European Transport network. All of this bodes well for Europe to become an active actor in China’s Belt and Road initiative, not only to provide the financing but also to identify projects of common interest.

It goes without saying that other lenders, beyond Europeans, are welcome to finance Belt and Road projects as the ensuing reduction in transportation costs and improved connectivity should be good for the world as a whole. However, Europe’s particular advantage in this project should make it a leader on the financing front bringing the old continent closer to China.

chart 8

All in all, the Belt and Road is great for supporting high demand in Asian infrastructure, but there is a limit on how much China can finance. The slowdown of the economy and the limits on the use of foreign reserves are some of the impediments. Furthermore, Chinese banks balance sheets, the largest source of financing so far, are increasingly saddled by doubtful loans, which limit their lending capacity. As for official multilateral development agencies, their funding sources remain limited for the extent of the project. Against this background, European banks-the largest cross-border lenders in the world – are well placed to step their already large financing to Belt and Rod countries. Furthermore, Europe’s proximity with some of these countries can make some of these projects more appealing for Europe as well. Thus, we should expect private and public European co-financing of Belt and Road projects to increase over the next few  years and, with it, European interest for Xi Jinping’s Grand Plan. This should bring Europe closer to China.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic More by this author

Opinion

What else China can do to support growth in the short term

Recent data shows the downward spiral in the Chinese economy has somewhat eased on a cyclical basis, but it is still too early to cheer for a full stabilization.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: April 23, 2019
Read article More on this topic

Blog Post

The next step of the Belt and Road Initiative: Multilateralisation with Chinese characteristics

The increasingly broad objective of China's Belt and Road Initiative has attracted the attention not only from the BRI members, but also from other major players such as the United States and the European Union.

By: Alicia García-Herrero and Jianwei Xu Topic: Global Economics & Governance Date: April 18, 2019
Read article More on this topic More by this author

Blog Post

Why China's current account balance approaches zero

China’s current account is projected to be balanced within the next few years. Observers disagree whether this is due to structural factors or Chinese policy. We review their assessments of the Chinese saving and investment situation and what this implies for the future.

By: Michael Baltensperger Topic: Global Economics & Governance Date: April 15, 2019
Read article More on this topic More by this author

Podcast

Podcast

Director's cut: EU-China partnership after the 21st EU-China summit

Guntram Wolff discusses with Alicia Garcia Herrero the results of the 21st EU-China Summit

By: The Sound of Economics Topic: Global Economics & Governance Date: April 12, 2019
Read article Download PDF More on this topic More by this author

Working Paper

Europe in the midst of China-US strategic competition: What are the European Union's options?

With the trade conflict between the United States and China bringing China-US strategic competition into the open, the European Union faces an urgent question: how to position itself in the competition.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: April 8, 2019
Read article More by this author

Opinion

Europe and the new imperialism

For decades, Europe has served as a steward of the post-war liberal order, ensuring that economic rules are enforced and that national ambitions are subordinated to shared goals within multilateral bodies. But with the United States and China increasingly mixing economics with nationalist foreign-policy agendas, Europe will have to adapt.

By: Jean Pisani-Ferry Topic: Global Economics & Governance, Innovation & Competition Policy Date: April 3, 2019
Read article More on this topic More by this author

Podcast

Podcast

Director's Cut: China's place in the global trading system

Bruegel director Guntram Wolff and senior fellow André Sapir discuss how potential WTO reform could better accommodate China.

By: The Sound of Economics Topic: Global Economics & Governance Date: March 28, 2019
Read article More on this topic More by this author

Opinion

Takeaways from Xi Jinping’s visit to France and Italy and ideas for the EU-China summit

The author appraises China's strategy towards Europe ahead of next month's EU-China summit.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: March 27, 2019
Read article More on this topic

Opinion

Sticks and carrots from China’s leadership to Chinese banks

The takeaway from the 13th National People's Congress (NPC) is clear: under the current economic downturn, Chinese authorities will do whatever it takes to support the real economy. Alicia García Herrero and Gary Ng reflect on the "sticks snd carrots" approach to Chinese banks.

By: Alicia García-Herrero and Gary Ng Topic: Global Economics & Governance Date: March 21, 2019
Read about event More on this topic

Past Event

Past Event

The trade crisis: good and bad scenarios and the EU's response

What role will the EU play in the resolution of the global trade crisis?

Speakers: Uri Dadush, Maria Demertzis and Denis Redonnet Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 20, 2019
Read article More on this topic More by this author

Opinion

China’s debt is still piling up – and the pile-up is getting faster

With looser monetary policy, China's policymakers hope to encourage banks to lend more to the private sector. This seems to imply a change from the deleveraging drive begun in mid-2017. Although this should be good news for China's growth in the short term, such a continued accumulation of debt cannot but imply deflationary pressures and a lower potential growth further down the road.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: March 19, 2019
Read article More by this author

Opinion

New EU industrial policy can only succeed with focus on completion of single market and public procurement

France and Germany recently unveiled a manifesto for a European industrial policy fit for the 21st century, sparking a lively debate across the continent. The fundamental idea underpinning the manifesto is a good one: Europe does need an industrial policy to ensure that EU companies remain highly competitive globally, notwithstanding strong competition from China and other big players. However, the Franco-German priorities are unsuitable for the pursuit of this goal.

By: Simone Tagliapietra Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: March 18, 2019
Load more posts