silk road paper

One Belt, One Road

Assessing the Economic Impact

of Chinas New Silk Road

July 2, 2015 | www.bloombergbriefs.com

INSIDEChinas Modern Marco Polos Bring No Novelties Westward p.2Mapping Chinas One Belt, One Road Ambitions p.3Chinas Road to Africa Closes Infrastructure Gap, Adds Debt Risk p.4One Belt, One Road Wont Move Dial on 2015 Growth: Simpfendorfer p.5Chinese Steel Capacity May Go West p.6Asean and Central Asian Cement Markets Show Promise of Growth p.7Improved Infrastructure to Streamline Shipping for Exporters p.8

AS THE NAME suggests, Chinas One Belt, One Road plan has two compo-nents. One Road is a maritime Silk Road stretching from Fujian on Chinas coast, through the Malacca Straits, around the horn of Africa, and ending in Venice. One Belt is an overland route stretching across central Asia, through the Middle East before ending in the heart of Europe.

Thats a lot of territory, not all of it partic-ularly enticing. The hope for Chinas leaders is that such an ambitious project will help achieve multiple objectives. Pouring cement for ports and roads and laying steel rails for trains could use up excess industrial capac-ity. Regional infrastructure with China at the center would facilitate trade and increase Bei-jings strategic heft.

Its the impact of infrastructure spending on absorbing industrial overcapacity that has sparked the most immediate interest. Since November 2014, when the government pledged $40 billion in support of the project, shares in firms such as Sany Heavy Industry and China Machinery Engineering outpaced even the wild rally on the Shanghai bourse.

In the short term, that looks too optimis-tic. Excess capacity in Chinas steel, cement and other major industries is vast. Even if the amounts pledged so far were spent immedi-

One Belt, One Road Chinas Modern Marco Polos Bring No Novelties Westward

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It took Italian merchant Marco Polo 24 years to get from 13th century Italy to China and back. The payback: he returned a wealthy man. In Chinas 21stcentury vision, the modern version of this trade route is about to get a little smoother. But will returns on the new Silk Road be so high?

ately and exclusively on made-in-China prod-ucts, they wouldnt bring all the blast furnaces and cement kilns back to life.

Looking longer term, the potential demand is enormous. The Asian Development Bank estimates infrastructure needs for the region at $750 billion a year through 2020. Chinas policy banks could put substantially more funds to work than the $40 billion available from the Silk Road Fund. Even so, difficult negotiations with host countries on which projects are priorities and whose national firms win construction contracts mean Asias infrastructure needs are unlikely to solve Chi-nas overcapacity problems.

Enhancing trade links has the potential to make a lasting impact. The area covered by the One Belt, One Road initiative includes about 50 percent of the worlds GDP and roughly the same share of global trade. Re-duced transport costs should increase trade flows, bringing the benefits of greater compe-tition and efficiency that come with it.

The trouble is that while Marco Polo re-turned from China with his bag stuffed with oriental novelties, Chinese goods are already old news for customers on the new Silk Road. China is the top trade partner for close to half of the countries on the route. That doesnt mean there isnt scope to do more. It does mean the benefits from increased trade will likely come as a slow burn, not a quick blast.

Finally, with all the roads in the region lead-ing to the Middle Kingdom, and many of them paid for with their checkbook, Chinas leaders hope that they will gain enhanced strategic influence. In that sense, One Belt, One Road falls under the same heading as the Asian Infrastructure Investment Bank and island building in the South China Sea.

All represent Chinas attempt to expand its influence over everything from shipping routes for crucial oil imports to decision making in the global financial system. How that plays out remains to be seen. Strategic influence comes with economic weight if One Belt, One Road and the governments other efforts dont re-verse the deceleration in Chinas growth, its strategic ambitions could be tough to realize.

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China Machinery EngineeringSany Heavy IndustryShanghai Composite IndexChina Railway Construction

Source: Bloomberg

Series rebased to 100 as of Nov. 3, 2014

BY TOM ORLIK AND FIELDING CHEN, BLOOMBERG INTELLIGENCE ECONOMISTS Originally published on June 4.

Construction Shares Rise on Infrastructure Spending Hopes

July 2, 2015 bloombergbriefs.com Bloomberg Brief: Economics Asia 3

BloombergBriefs.comSource: Bloomberg

% Share in China Total Trade (2014)

% Share in World Total Trade (2014)

Mapping China'sOne Belt, One Road Ambitions

One Belt starts in Xian in central China. Opening trade routes for China's inland provinces is intended to accelerate catch-up to the more developed coast.

President Xi Jinping announced the One Belt initiative in Kazakhstan. Beijing and Moscow vie for influence in central Asia, a region rich in natural resources.

Strategic rivalry between Asia's emerging giants could make it tough for China to realize gains from increased trade and investment with India's 1.3 billion population.

One Belt, One Road is China's answer to the U.S. and Japan's efforts to develop the Trans-Pacific Partnership, a regional free trade area.

The Strait of Malacca is a choke point for China's energy imports. By opening new routes through Pakistan, Myanmar, and Thailand, China hopes to reduce vulnerabilities.

Competing territorial claims in the South China Sea have become a flash point for tensions in the region. China's island building has raised concerns about expansionist ambitions.

Asia's infrastructure needs estimated at $750 billion a year through 2020 by the Asian Development Bank could help absorb China's industrial overcapacity.

As China's overseas population and assets increase, including in trouble spots in Africa and the Middle East, Beijing's principle of non-interference in other countries will be tested.

Beijing has promised to support companies and governments along the route if they wish to issue yuan bonds and use the proceeds to contribute to the plans.

Africa requires $93 billion in infrastructure investment a year according to the World Bank. China's tendency to bring its own materials and workers to overseas projects sometimes sparks tensions with host countries.

The One Belt, One Road initiative ends where Marco Polo's original Silk Road journey began in Europe. Sclerotic growth has made Europe receptive to Chinese investment.

The Silk Road Fund ($40 billion), Asian Infrastructure Investment Bank ($50 billion) and China Development Bank have funds to kick start spending on roads, rails and ports along the route.

Silk Road Economic Belt (Land Route)

Maritime Silk Road (Maritime Route)

West Asia &North Africa

7.4 5.4

European Union

14.5

25.1

East Europe(excluding EU members)

2.4 2.2

South &Southeast Asia

12.87.6

Central Asia1.3 0.4

Mapping Chinas One Belt, One Road Ambitions

July 2, 2015 bloombergbriefs.com Bloomberg Brief: Economics Asia4

Chinas Road to Africa Closes Infrastructure Gap, Adds Debt Risk

Chinas engagement in Africa has a long history. In the pre-reform era, it was a check-book diplomacy rivalry with Taiwan that mo-tivated Beijing. In the reform era, Chinas hunger for resources provided the drive for investment in everything from Angolan oil to Congolese copper. More recently, Chi-nas technology firms have also arrived on the scene, with Huawei and ZTE building telecom systems for Ethiopia and others.

One Belt, One Road levers existing plans for Chinese investment up the East African coast. Most notable is the $10 billion-plus Bagamoyo port in Tanzania. If realized, it would dwarf Mombasa, 300 kilometers to the north in Kenya, which currently serves as the naval gateway of East Africa. Chi-nese firms have also been awarded ma-jor contracts to build railways connecting the ports of Mombasa and Dar-es-Salaam Tanzanias commercial capital with in-land countries.

Chinas One Belt, One Road initiative promises to expand an already active engagement with Africa. Chinas deep pockets and dearth of natural resources and Africas mineral reserves and infrastructure needs make a compelling combination. Yet the misuse of increased fiscal space by some African states means Chinas investment adds to debt risks.

Its the ability of Chinese firms to bring financing to the table thats often been the deal-clincher. The bulk of investments are spearheaded by state-owned enterprises, with preferential financing supplied by the China Development Bank and Export Import Bank of China. The stock of Chinese invest-ment in Africa has more than tripled to $26 billion in 2013 from $7 billion in 2008. Chinas credit line to Africa is expected to expand substantially from the current $20 billion.

For African nations, the headline benefits are clear. The World Bank says Africa needs $93 billion in infrastructure spending a year. Chinese investment, coming at a time when many western donors and businesses are retreating, helps build the roads, rails and ports needed to kick-start development. It al-so frees up domestic resources for spending on other priorities like health and education.

Improved infrastructure has facilitated a boom in trade, underpinned by Africas

Chinas Trade Balance With Africa

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China Exports to Africa

China Imports from Africa

Source: Bloomberg BloombergBriefs.com

BY MARK BOHLUND AND TOM ORLIK, BLOOMBERG INTELLIGENCE ECONOMISTS Originally published on June 17.

comparative advantage in commodities and Chinas in low-cost manufactured goods. Africas sales to China more than doubled to $116 billion in 2014 from $55 billion in 2008. Reflecting the importance of the rela-tionship, newly elected Africa leaders often make Beijing their first port of call, snubbing old colonial ties with the U.K. and France.

There are also costs. Investment is of-ten carried out by Chinese firms using Chi-nese workers, limiting the benefits to the host country. Growing commodity exports have done little to develop the labor-inten-sive manufacturing base necessary to draw Africas rural workers into a high-productivi-ty factory sector. Indeed, an influx of cheap Chinese goods may stymie the development of Africas low-end manufacturing. Theres al-so a chance that loans turn sour especially as falling commodity prices dent income for African borrowers.

For some African states, easy invest-ment from China has facilitated an increase in recurrent expenditure. Taken together with stimulus packages launched in re-sponse to the financial crisis, that has erod-ed the fiscal buffers created through debt relief and put them at risks of a renewed crisis. Ghana, for example, has seen public debt double to 67 percent of GDP in 2014, from 33 percent in 2008, according to IMF estimates.

For China, there are costs in bad pub-licity when projects trigger social tensions. Theres also a chance loans turn sour, with recent reports of problems for Angola. Still, set against the gains from access to critical resources and greater strategic heft in the region, those costs look manageable. Com-pared with the paltry returns China gets on its investment in U.S. Treasuries, increased investment in Africa through the One Belt, One Road initiative looks a good bet.

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One Belt, One Road Wont Move Dial on 2015 Growth: Simpfendorfer

Q: Whats the significance of the One Belt, One Road initiative for China?A: China has captured one of the worlds most powerful brands. Everyone from Bei-jing bankers to Cairo taxi drivers knows and understands the significance of a new Silk Road. It places China at the center of the history and the destiny of the region.

Q: What does it mean for Chinas growth this year?A: One Belt, One Road wont stop GDP growth from slowing. China is simply too big. Its five largest provinces would account for five of the Silk Roads 10 largest econ-omies. The other majors are India, Turkey, Korea, Indonesia and Saudi Arabia. Some of those, like Korea, already have developed infrastructure, so the demand for more isnt great. Some of them, like India, have ten-sions with China so if there is building to be done, Chinas firms wont be first in line.

Q: What does it mean for the rest of the region?A: The impact isnt going to be substantial, but it will be material. The region suffers from a shortage of capital. The One Belt, One Road scheme and the Asian Infrastructure Investment Bank have funds. But its import-ant to remember that lack of funds is only

Chinas One Belt, One Road initiative has been painted as everything from a response to home-grown economic problems to a masterful reshaping of the regional economy. Ben Simpfendorfer, head of Silk Road Associates, hasspent 20 years working in China and the Middle East. Bloombergs Chief Asia Economist Tom Orlik asked him to help sort the genuine oasis from the speculative mirage.

one of the barriers to building better roads, rails and ports. There are also issues with bureaucracy, local politics. That means Chi-na wont be able to mirror its domestic suc-cess so easily.

Q: Where in the region do you expect to see the biggest results?A: The greater Mekong region is the lit-mus test. Trade is already taking place, but theres a significant population and scope to do much more. For countries like Cambodia and Laos, this could be a game changer. To start moving the dial for China, One Belt, One Road would have to start unlocking the potential in countries with larger populations like Pakistan, Indone-sia and India.

Q: Is there a specific project or milestone we should look to for signs the initiative is gaining traction?A: Look for projects in the regions bigger economies. Success here would be mean-ingful, especially for their near neighbors. Look also for signs that the initiative has kick-started infrastructure projects that have already spent years on the drawing board. To me, that would signal policy an-nouncements are translating into change on the ground.

Originally published on June 17.

Q: Whats the strategic significance of this initiative?A: Its a smart move by China. They are branding a change that is already taking place in the worlds center of economic grav-ity. The Silk Road is Chinas backyard. The countrys commercial influence is growing steadily, whether that applies to its oil im-ports or construction service exports. It will be hard for the U.S. to resist the change.

Q: The route passes through some troublespots in the Middle East and Africa. Whats the benefit of China to building a road into a conflict zone?A: Little benefit unless there are strategic in-terests, such as building a land route through Pakistan that provides China with access to the Arabian Sea. But its an important ques-tion as the regions security will be key to the initiatives success. History shows that the old Silk Road only flourished during periods of stability along the route.

Q: Chinas overseas investments havent always gone well. What are the risks?A: China must collaborate with foreign com-panies whether thats big multinationals or local conglomerates. Foreign partners can provide local knowledge or global expertise. In the rush to go abroad, many Chinese companies preferred to go it alone and have since struggled, especially the provincial state-owned enterprises.

Ben Simpfendorfer is founder and managing director of Silk Road Associates, a Hong Kong-based advisory. He is the author of The Rise of the New East (Palgrave: 2014) and The New Silk Road (Palgrave: 2009), and is also the former chief China economist at RBS.

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Chinese Steel Capacity May Go West With One Belt, One Road

Meeting all of Asias demand for railways, pipelines, power stations and other projects may generate demand for 272 million tons of steel through 2020, according to Bloomberg Intelligence estimates. If the program is ful-ly funded and rapidly put in place over five

The large-scale investments needed to build the One Belt, One Road plan will boost demand for steel and encourage a shift in Chinas production capacity to western countries as it becomes easier to bring in raw materials.

years it could add as much as 5 percent a year to Chinese steel demand.

The boost to demand for Chinas firms will depend on the availability of funds and the political will to back projects, as well as ne-gotiations with foreign partners as to which

Steel Output Along the New Silk Road

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BY YI ZHU, BLOOMBERG INTELLIGENCE ANALYST Originally published on June 25.

nations firms will benefit. The short-term demand push has not yet started due to lack of clarity in investment amounts and implementation schedules.

Construction due to the plan may prompt Chinese steelmakers to build more capacity in Southeast Asia, West Asia and African countries along the new trade link, by set-ting up integrated steel mills with nearby iron-ore mines.

This could help China close capacity where it is surplus to requirements at home and ramp up operations where demand is greater overseas. That could also reduce anti-dumping cases against Chinese firms. Hebei, the largest steel-producing province, plans to send 5 million tons of capacity over-seas by 2017 and 20 million tons by 2023, according to its Go Global strategy.

The westbound connection would also push China to upgrade domestic infrastruc-ture linking its coast to the interior, gener-ating demand for high-value-added steel products to build pipelines and high-speed railways, among other things. While China is seeing a surplus of low-end steel products, it has a shortage of high-end steel offerings.

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Asean and Central Asian Cement Markets Show Promise of Growth

Developing nations in Asia will need to spend about $750 billion a year to fund infrastruc-ture projects through 2020, according to the Asian Development Bank. If fully realized, those investments may spur 580 million tons annually in cement demand based on histor-ical correlations with fixed-asset investment. That is about 25 percent of Chinas output. Average cement output per capita in south-east and central Asian nations are 380 kilo-grams and 300 kilograms, respectively. This is less than the global average of 600 kilo-grams and Chinas 1,800 kilograms, implying large potential demand.

Chinese cement companies may extend their overseas expansion, lured by a prom-ising outlook for demand and higher profit-ability than in China. For example, Myanmar, Laos and Cambodia are net cement import-ers that buy from Thailand and Vietnam. Lo-cal cement prices range from $70 to $100 a ton, compared with Chinas $45 a ton. Anhui Conch is the most ambitious of these firms, aiming to build 50 million tons a year of over-seas capacity in the next decade.

Turning the promise of expanded over-seas demand into reality will require funds for construction, political will to push through bureaucratic obstacles and the ability of Chinese firms to negotiate entry into new national markets.

Chinas cement companies that plan to expand to Asean and Central Asia should see long-term benefits from the enormous cement demand that is set to be generated by the One Belt, One Road initiative. The current capacity of these regions totals about 290 million tons, equivalent to about 10 percent of Chinas total and 70 percent of that for its largest cement producer, China National Building Materials.

Cement Output per Capita and Urbanization Rates

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Source: World Factbook, IMF, Bloomberg Intelligence BloombergBriefs.com

BY MICHELLE LEUNG, BLOOMBERG INTELLIGENCE ANALYST Originally published on June 25.

Note: Countries with lower urbanization rates, higher changes in urbanization and lower

cement output per capita tend to have more room for cement demand growth.

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Improved Infrastructure to Streamline Shipping for Exporters

As land access opens up, exporters will have the choice to optimize the various modes of shipping via air, sea, road and rail or use a modal mix. Freight movement by road may grow, especially as export-ers may increasingly use combinations of air-and-road or rail-and-road to optimize supply chains.

Rail between China and Europe current-ly takes 20-to-25 days, while sea freight takes double that time. Implementation of infrastructure projects related to OBOR may shorten lead times as high-speed rail begins to replace multiple rail gauges and as customs clearance procedures are streamlined.

In January of this year, China started the Transports Internationaux Routiers, al-so known as the International Road Trans-port, accession process. If implemented, it will enable goods to transit from origin to destination by road in sealed load com-partments. The shipments would be able to

Transport of Notebooks From Central China to Netherlands

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Source: DB Schenker, Rail Logistics & Forwarding BloombergBriefs.com

* Block Train Service

BY JOHN MATHAI, BLOOMBERG INTELLIGENCE ANALYST Originally published on June 29.

pass smoothly through customs of different countries since duties and taxes liable are covered by international guarantee. Using major EU countries under the TIR system

as a basis for comparison, TIR is likely to boost trade as customs clearance may go paperless and procedures may be whittled down to a single day.

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The One Belt, One Road program could boost shipping and cargo demand as planned infrastructure investments improve ports that dot the silk route. Some of these ports are currently constrained by depth restrictions and lack equipment capacity to handle the trend of increasingly large ships. Investments in port, rail and road infrastructure might boost cargo volumes and provide shippers more options for carrying freight.

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