Eyes Too Big

China’s Belt and Road Initiative (BRI) has captured headlines around the world, but a hefty debt burden is forcing Beijing to rethink how it finances the grandiose undertaking.

In an April brief, the US Center for Strategic and International Studies forecast China’s 65-country plan could cost between $1 trillion and $4 trillion, calling it a “broad and ever-expanding construct.” That and similar analyses are fueling expectations China may finally seek more participation from Western financial institutions—not just for funds, but for expertise.

So far, foreign banks haven’t gotten to share much in BRI cross-border project finance deals, and a vagueness about Beijing’s plans has stoked skepticism among some bankers. The reluctance by politicians to endorse the project and the threat of a protracted US-China trade war are adding uncertainty, but pressure to deleverage China’s banking is tipping the balance.

Whether BRI is a vehicle to get a better return on China’s vast foreign-exchange reserves or merely a geopolitical power play is open to debate, but one thing is clear: The project is the brainchild of newly elevated president-for-life Xi Jinping. The extent to which foreign institutions will play a role depends on how Xi steers policy after US President Donald J. Trump’s jackknife moves on international trade, but the probability that China will diversify its funding pool has increased substantially.

Bankers hope financing will extend beyond multilateral development institutions such as the World Bank, Asian Development Bank or China’s Asian International Investment Bank to include global banks, debt and equity markets, private equity and infrastructure funds. There are grounds for optimism. China’s Securities Regulatory Commission recently permitted domestic and overseas companies, and government-backed institutions in Belt and Road countries, to issue bonds on the Shanghai and Shenzhen exchanges.

Sovereign wealth funds, particularly from the Gulf states, could also play a more prominent role in BRI. The role of Gulf SWFs in BRI is now both financial and policy-driven, analysts say.

BRI Bonanza? Don’t Bank On It

Getting in the way of a banker’s feast is China’s own banking sector, which has been engaged in some dizzying levels of BRI financing. “China is offering full package deals for infrastructure projects that do not require Western bank participation,” says David Baxter, international development navigator and PPP consultant. He says poor feasibility studies—which fail to highlight the real benefactors of projects or prove the projects are economically viable—are acting as roadblocks to deeper engagement by foreign lenders.

Still, stricter central bank controls are likely to rein in new project financing by China’s larger lenders.

Cue the Western banks? Citigroup and Standard Chartered have steadily increased staff numbers in anticipation of BRI business. HSBC, which made 75% of its 2017 profits from Asia-Pacific, recently appointed a head of BRI for the region.

According to Alicia Garcia-Herrero, a senior fellow at the Brussels-based economic think tank Breugel, China’s finite financial resources mean the inclusion of Western banks and financial institutions is inevitable if the BRI strategy is to fulfill its ambition. But that may come at a price.

“Implementation of BRI is not very transparent, and that has frustrated most banks that want to join,” she says. “If China cannot find a middle way to accommodate the Western way of doing business while maintaining its state-driven advantages, then Western involvement will be hard to realize.”

The issue isn’t just debt, but experience and cooperation. “China will need foreign institutions to help with their expertise. The EU has been the largest creditor to Belt and Road countries, so it is natural for China to cooperate with the EU,” Garcia-Herrero adds. Until there is more clarity, it looks as if foreign banks might be confined to subsidiary financing, typically in areas including custody services, trade finance and cash management.

But James Cameron, co-head of Infrastructure and Real Estate at HSBC, argues that a global footprint could help banks get in on BRI projects. HSBC’s footprint covers 50% of BRI countries across 44 markets. For less globally inclined institutions, infrastructure financing in BRI countries that delivers “bankable” projects for users, investors and procurers could be a difficult trick to pull off.

Still, despite the torrent of reservations over execution, Cameron doesn’t doubt the potentially transformative nature of the BRI: “It will generate a wealth of opportunities for local and international investors, and stimulate capital-market development in many Asian markets where bank lending still tends to dominate financing.”

Sovereign Wealth Funds

With assets under management that grew 13% this year to reach $7.45 trillion, according to alternative-assets data provider Preqin, sovereign wealth funds (SWF) are financial leviathans, and their pursuit of alpha is pushing them toward higher-yielding assets. State-owned investment funds have quickly become comfortable investing in emerging and frontier markets; BRI projects increasingly meet those conditions. Abu Dhabi-based SWF Mubadala recently created Mubadala Infrastructure Partners, an independent fund in partnership with General Electric and Credit Suisse. MIP describes its mandate as focusing on infrastructure investments in emerging markets. Preqin calculates that 64% of global SWFs are vested in infrastructure, of which 33% are based in the Middle East.

Elliot Hentov, head of policy and research at State Street Global Advisors, says Chinese backing can benefit projects by covering aspects that require sovereign support. “BRI is helping create financial opportunities that were previously not accessible to foreign investors.”

Hentov says Gulf SWFs are increasingly taking a strategic view, beyond pure portfolio considerations. Some have been explicit that SWF-to-SWF or SWF-to-government partnerships are desirable, particularly if they deepen interactions in the energy sector. “BRI initiatives that improve relations with China or create interdependencies, projects that build out supply lines for Gulf hydrocarbons, or projects that improve trading routes to the Gulf fall under that [strategic] category.”

With so much capital in hand, SWFs are undoubtedly one of the most influential investor groups. Hentov says SWFs participating in BRI raise the credibility of projects and help attract other investors.

Show Me the Money

“Tell me, I forget. Show me, I remember. Involve me, I understand.” This proverb could describe the lack of engagement between China and foreign financial partners. But the size of the funding gap—recently estimated by Wang Yiming, deputy head of the Development Research Centre of China’s State Council at $500 billion a year—hides the narrow financing channels that Western banks and financial institutions face. Transparency remains central to garnering the buy-in of international financiers, but how China achieves that with the sheer number of countries involved is a stretch even for the hugely ambitious leadership of Xi Jinping.

Yet, China could soon face a backlash, with critics accusing Beijing of “creditor imperialism” and of creating a debt trap for poorer nations. In December, Sri Lanka turned over a controlling stake in the port of Hambantota on a 99-year lease to a Chinese company, to ease the country’s debt burden after it fell behind in repaying a Chinese loan to build the port.

With growing suspicions over the strategic objective of BRI, it is even more important that China harness international expertise. But until the financing risk of countries along the BRI is addressed, China’s grandiose scheme could stumble—and might even fail.