by Francis Maindl
The ‘One Belt One Road’ enthusiasm
The ‘One Belt One Road’ infrastructure megaproject has attracted worldwide attention since the year 2013 when Xi Jinping first mentioned it during visits in central and south-east Asian countries. The project consists of building land and maritime transportation infrastructure between China and several countries in Africa, Asia and Europe. The initiative is seen on one hand as an attempt to extend China’s influence in Asia, Africa and the Middle East and to fight for regional leadership in Asia. It is on the other hand also aiming at encouraging growth at a time when the economy in China is growing at a 30-year low GDP growth rate.
On May 14-15th, officials from a total of 57 countries gathered in Beijing for the first ‘One Belt One Road’ summit. A lot of questions still remain on how this megaproject will be financed. So far, China committed to a $124 billion investment to the project, but with its rising level of debts, China won’t be able to bear by itself the costs of a project that has been advertised as a $1 trillion project.
In order to attract the eyes of the world to the One Belt One Road initiative, Chinese production companies posted over the last month propaganda-like music videos (all of very questionable taste) on platforms unavailable in Mainland China like Youtube and Facebook. The videos praise the project and present it as an opportunity to bring growth and peace to the world. The whole operation is a not very subtle way of trying to attract foreign investment participation to support China’s and the Asian Infrastructure Investment Bank’s effort in financing the infrastructure project.
Moody’s slap in the face
A week after the One Belt One Road summit was held, Moody’s decided to downgrade China’s credit rating from Aa3 to A1. The agency explained their decision on the basis that China’s current aggregate debt levels and lowering growth led them to anticipate a possible erosion of China’s financial strength over the coming years. It was the first time since 1989 that Moody’s downgraded China’s credit rating.
Although the effect of a credit rating downgrade would typically mean heightened borrowing costs on international financing markets and negative pressure on the local currency, China’s high foreign reserves ($3 trillions), low external debt (12.7% of GDP) and its recent policy that makes it harder to get the Chinese Yuan (CNY) out of China suggests that the downgrade might have limited effects on the Chinese economy. For this reason, the lower credit rating could then just be a mere indication that the Chinese economy is seen as increasingly vulnerable.
China’s booming debt and shrinking growth
Following the 2008 global financial crisis, the Chinese government avoided the negative effect of the crisis by rising its debt and investing in infrastructure projects on their territory. The problem is that the public spending didn’t stop. China overall debt level went from 170% of their GDP in 2008 to over 280% a decade later.
‘Shadow banking’ has also been a factor in the heightening levels of debt. In absence of healthy financial institutions typically provided by a competitive banking and public equity markets, China saw the rise of a financial black market that functioned outside of the country’s financial regulations. This generally resulted in the misallocation of capital and the rise of bad debt.
Facing the lack of investment opportunities in mainland China, individuals tended to invest in real estate on the national level and in foreign housing markets. This created a housing bubble in China’s Tier-1 cities like Beijing, Shanghai and Shenzhen and contributed to rising housing prices in major cities in countries like Canada, the U.S. and Australia.
All in all, those financial irregularities resulted in inefficient allocation of investment in the corporate sector and led to a net loss in foreign direct investment of about $2.5 trillion over the last decade. In terms of its GDP, China saw its annual growth go down from 9.6% in 2008 to 6.7% last year.
Could this be the end of the Chinese miracle?
China hopes that its massive infrastructure project ‘One Belt One Road’ will spark increased GDP growth through highest volumes of trade with countries in Asia, Africa, Middle East and even Europe.
The challenge the Middle Kingdom faces revolves mainly about controlling the rising debt and making sure that the capital is allocated in an efficient way. China’s financial woes suggest that they won’t be able to put forward their project on their own. So the question is… will they get the support they need?
Predicting the ‘collapse’ (or the slowdown to put it more mildly) of the Chinese economy has been a popular business in recent years. Journalists and media commentators like Gordon Chang and Michael Pettis have made media careers on forecasting China’s imminent economic collapse. So far, they have all been wrong.
Whether or not now is the time when the Chinese miracle comes to an end remains to be seen. But there is no doubt that China currently faces its greatest challenge since the country implemented liberalization policies and joined the world economy three decades ago.