22 Aug 2019
China’s implementation of a new trade network energises the global construction industry
By Oxford Business Group
From 206 BCE to 220 CE, China’s Han dynasty fostered a booming trade industry for silk, a precious commodity in high demand among the elites of the Mediterranean. The Silk Road was the moniker given to the network of trade routes connecting the East and West at the time. Later, spices and other precious cargo would be traded using the system, fostering not only economic, but also cultural links between Asia and its contiguous continents. As such, the network became the information super-highway of its time as well, transmitting knowledge and expertise across distances and cultures.
Extremely rapid economic expansion in China in the four decades since Deng Xiaoping’s reforms in 1978 has seen the country once again emerge as a global economic powerhouse. It is the biggest nation by population and is on course to become the world’s largest economy in dollar terms in the coming decades.
In recent times, China has flexed its diplomatic muscle across Asia and further afield. Upon assuming leadership in 2013, President Xi Jinping launched the Belt and Road Initiative (BRI) as a means to strategically expand China’s economic footprint and diplomatic leverage, as well as to facilitate the east-west trade on which it depends and boost its access to raw materials. In essence, the BRI is the Silk Road of the 21st century – a network of terrestrial (the “belt”) and maritime (the “road”) trade routes connecting its East Asian hinterland with Western Europe via South-east and Central Asia, the Middle East, Africa and Eastern Europe. In the Pacific, Latin America and Australasia have been included in the Chinese vision of world trade.
The BRI is multifaceted, but its cornerstone is the vast amounts of Chinese investment in hard transport infrastructure across the network. As such, it is perhaps the most significant development in the global construction sector since the beginning of the 21st century, particularly in the emerging markets where the initiative has a presence. Projects often come with financing on attractive terms provided by China’s state-run banks, with the retention of a Chinese construction company as a precondition. Infrastructure is typically transferred to local institutions or organisations following construction, although Chinese firms are also beginning to offer operation and maintenance contracts.
Breakneck economic growth in China has allowed for, and been facilitated by, enormous public investment in construction, particularly large-scale infrastructure. This has meant decreasing marginal returns on infrastructure projects in some cases, as well as overcapacity in the industrial sector, notably in steel and cement production.
In order to employ this excess capacity to productive ends, since the turn of the century Chinese firms have increasingly looked abroad. As such, Chinese companies have become a cost-competitive option for infrastructure investment for lower- and middle-income countries, while also developing increasingly sophisticated expertise in construction and civil engineering to be able to compete at a global level in terms of quality.
The BRI has had a significant impact on the global market for heavy building materials, with Chinese over-production of cement leading to price pressures internationally. According to the “Global Cement Report”, China’s overcapacity in cement production increased from 23% in 2010 to 42% in 2017. This poses challenges for domestic producers in BRI-recipient countries that import building materials from China, particularly in East Africa and South-east Asia.
Furthermore, the BRI is shaping the competitive landscape of the global construction and civil engineering sectors, accelerating some trends that began to emerge at the turn of the century. Budding Chinese players now have the scale, experience, sophistication and financial backing to compete with established rivals in the West and popular local providers. This competition is most fierce in emerging markets, where price pressures are particularly acute. Although Chinese actors provide stiff competition to local construction companies, the vast scale of BRI investment tends to minimise the disruption to the bottom line of the latter. At the same time, BRI works generate major new opportunities for local firms to partner with Chinese contractors, providing localised knowledge and manpower in exchange for specialised expertise and training.
By the Numbers
The BRI rounded out its first five years in 2018, by which time it had already grown to include some 70 countries – encompassing half the world’s population – and is ultimately forecast to cost more than $1trn. India, Russia and Indonesia are likely to be the three-largest recipients of BRI investments over the 2017-21 period, while Nigeria, Iran, Egypt, South Africa and the Philippines are also expected to be among its top beneficiaries.
China has also established more than 80 economic and trade cooperation zones in BRI countries, to which some 244,000 local jobs have been attributed. As well as direct investment, Chinese financial institutions are providing tailored resources that enable BRI countries to pay for their own infrastructure upgrades. By end 2016, five of China’s state-run banks had extended $425bn in credits and loans for BRI projects, and the rate of lending was steady in 2017 and 2018 as well.
In an October 2018 research paper, the World Bank estimated that full implementation of the BRI could yield an average reduction in global shipment times of 1.2-2.5%, with a consequent lowering of trade costs by 1.1-2.2%. These gains are likely to be concentrated in economies participating in the BRI, many of which are lower- and middle-income countries. Countries located along corridors where BRI projects are being built could see shipment times reduced by up to 11.9% and trade costs lowered by up to 10.2%.
It is hardly surprising that China’s neighbours and continental peers account for the majority of BRI investment. One of the single-largest elements of the plan is the Pan-Asia Railway Network, which will upgrade and fill gaps in the existing rail networks of Southeast Asia, eventually linking Kunming in southern China with Singapore along three axes: an eastern route via Vietnam, a central route through Laos and a western route across Myanmar. All three are to meet near Bangkok, Thailand before continuing south through Malaysia. While Chinese players are taking the lead, there are many opportunities for local sub-contractors, engineers, workers and material suppliers to reap the benefits from the investment.
In the energy space, in addition to the flagship 3666-km gas pipeline connecting Gedaim on the Turkmenistan-Uzbekistan border to Horgos at China’s border with Kazakhstan, the BRI entails multiple localised energy projects across Asia. This has given rise to many power plant construction opportunities with local partners, including hydropower (as in Indonesia), coal-fired (like in Mongolia and Bangladesh) and nuclear (as in Pakistan). In turn, such new generation capacity necessitates ancillary infrastructure.
In December 2015 King Mohammed VI of Morocco spoke at that year’s Forum on Sino-African Cooperation of the strategic role the initiative will play in strengthening European, Asian and African ties. Morocco became the first African country to officially become a member of the BRI, following the signing of a memorandum of understanding (MoU) with China in November 2017. That same year, it was announced that Chinese firms would be linchpin investors over the course of the next decade in the planned $10bn Mohammed VI Tangier Tech City, although the initial stages of the project have moved slower than hoped. Algeria, for its part, became a member of the BRI in September 2018, with the flagship project being the $3.3bn Port of El Hamdania, to be constructed over a seven-year period by two Chinese firms.
The strengthening economic relations between sub-Saharan Africa and China are also well documented. China has played a leading role in developing infrastructure across the continent for decades, and remains a crucial destination for African raw materials exports, while acting as a significant source of financing. Indeed, China accounts for over 70% of the external debt of Cameroon and Kenya, while the figure rises to 80% in the case of Djibouti. China even established its first military base on foreign territory in Dijbouti in 2017, at the southern Red Sea gateway to the Suez Canal.
Notable projects include the 472-km Nairobi-Mombasa rail line in Kenya, and the 756-km electrified railway linking landlocked Ethiopia with Djibouti and its port infrastructure. These entered into service in mid-2017 and early 2018, respectively.
Latin America & The Caribbean
China’s economic links with the Latin American and Caribbean region have greatly expanded over the past two decades, with many countries exporting raw materials to China and the latter investing in infrastructure projects before the conception of the BRI. High-profile examples of Chinese involvement include the Belgrano Cargas Railway in Argentina and the Central Bi-Oceanic Railway linking the Atlantic to the Pacific via Brazil and Peru. Bolivia, Panama, Trinidad and Tobago, and Antigua and Barbuda had all signed formal BRI cooperation agreements with China as of August 2018, with more expected to do so in the future.
While Iran, Iraq and Pakistan were regarded as pivotal to the BRI from the outset – and are expected to be core recipients of further investment – it was not clear in the early years that ambitions would extend to the Gulf, despite its location astride important shipping routes. As the size and scope of the BRI increased, however, it came to encompass the Gulf in a significant way.
One of the first major projects announced in the region came in 2016: the $10.7bn transformation of Duqm, a small fishing village in Oman, into a major port and transit-oriented industrial city. Located within the Duqm Special Economic Zone, this new “Sino-Oman Industrial City” is eventually expected to have an oil refinery and methanol plant, in addition to factories producing automobiles as well as oil, gas and solar energy equipment. That same year also saw China’s Cosco Shipping Ports selected for a 35-year concession to operate Khalifa Port Container Terminal 2 in Abu Dhabi. In December 2018 Cosco announced an investment of $200m to expand the terminal, having already invested some $300m in the facility and $130m in a nearby container freight station.
Furthermore, in late 2018 China signed a MoU to participate in the $86bn development of Kuwait’s new Silk City initiative. This 250-sq-km project is to be phased in over a 25-year period and is expected to ultimately house up to 700,000 people. It will be linked to Kuwait City by the Jaber Al Ahmad Al Sabah Causeway, which was under construction as of early 2019 and is forecast to be the world’s fourth-longest bridge upon completion.
One concern that has been raised about the BRI is the possibility of lower-income countries contracting infrastructure projects that considerably increase their debt burden without having the capacity to repay loans. Moreover, China has been criticised for requiring that public assets be pledged as collateral in the event of non-payment. One highly publicised example is that of Sri Lanka, which in December 2017 transferred control of the new Chinese-built Hambantota Port to a Chinese state-run port operator on a 99-year lease after it failed to fulfil its repayments commitments.
Countries considered by the non-profit Centre for Global Development to be particularly at risk of not being able to service their debts as a result of the BRI include Dijbouti, Laos, the Maldives, Mongolia, Montenegro, Pakistan, Kyrgyzstan and Tajikistan. Even before the launch of the BRI, China wrote off an undisclosed amount of debt owed by Tajikistan in exchange for 1158 sq km of disputed border land.
Tools of the Trade
The rollout of the BRI highlights the dual role of Chinese FDI as both an economic proposition and a tool of diplomacy. Beyond construction and financing, government-backed firms have also begun offering contracts to operate and maintain new infrastructure, a trend that has some worried about China’s lingering influence in BRI-recipient countries and the resulting lack of skills transfer and local job creation. How China handles debt defaults will also be watched closely by the international community going forward.
The above is extract from “The Report: Indonesia 2019” published by Oxford Business Group. Please click to read full report.