The Financial Implications of China's Belt and Road Initiative

A Route to More Sustainable Economic Growth

Piotr ?asak, René W.H. van der Linden

• Publisher: Palgrave Pivot
• Year: 2019
• ISBN:
  9783030301187
• Topic: Negocios y empresa
• Subtopic: Finanzas

This book systematically discusses the contribution of the Belt and Road Initiative (BRI) to China's transition from an emerging to an advanced economic and financial system after more than five years. From a historical perspective, it explains to what extent the BRI plan is effective enough to help China bounce back from its economic slowdown and the financial implications in a policy trilemma context. Further, it investigates both the rationale of the BRI and its pitfalls, focusing on the various options for financing the project based on the Mundell & Fleming model. The book also analyses the impact of the BRI as well as possible policy options to deal with China's policy trilemma in a structurally more balanced "new normal" economic growth model. Lastly, it reviews the financial stability issues concerning liberalization policies in China.

© The Author(s) 2019

P. Łasak, R. W. van der LindenThe Financial Implications of China’s Belt and Road Initiativehttps://doi.org/10.1007/978-3-030-30118-7_1

Begin Abstract

1. Introduction

Piotr Łasak¹ and René W. H. van der Linden²

(1)

Faculty of Management and Social Communication, Jagiellonian University, Kraków, Poland

(2)

Faculty of Business, Finance & Marketing, The Hague University of Applied Sciences, The Hague, The Netherlands

Piotr Łasak (Corresponding author)

Email: [email protected]

René W. H. van der Linden

Email: [email protected]

Abstract

In the introduction section, the Global Financial Crisis (GFC) of 2008–2009 is described as an important reason for the inevitable economic downturn in China. This possible scenario created a momentum for a grand infrastructure program called ‘One Belt, One Road’ (OBOR), intended to look like a new global economic order. This ‘Belt and Road Initiative’ (BRI) aims to ‘break the bottleneck of Asian connectivity’ and could be seen as a way of ‘helping oneselves by helping others.’ Though with the stimulus package implemented in 2010 the Chinese economy seemed to be back on track again with double-digit annual GDP growth rates, the flip side of this injection was a legacy of debt with many ‘ghost’ cities, bubbles in the housing and stock markets, a rise in ‘bad’ assets and the creation of massive excess capacity in many industrial sectors from steel to cement. Combined with the slowing economy and the sluggish international demands, it is anticipated that the overcapacity will squeeze corporate profits, increase debt levels, and make the country’s financial system more vulnerable. The biggest weakness of the system is that it lacks the ability to allocate credit according to market-conform risk assessment principles and leads to excessive debt growth. Finally as a way to reach a more sustainable growth path, this habit of debt-financed growth due to the so-called financial dependency triangle has been addressed with the implementation of a policy of ‘deleveraging ’. One of the most crucial objectives as part of this ‘new normal’ economy is to induce an economic shift that will steer the country away from a reliance on exports and investments toward growth driven by domestic consumption and innovation. The restructuring of the Chinese economy entails two essential adjustments to the financial system: first, the need to improve the efficiency of banks and financial markets and expand their services to dynamic sectors of the economy and beyond the state sector; and second, the need to avoid instability in the increasingly complex financial sector stemming from either the NPL/credit overhang problem in the banking sector, and/or a crash in the asset market, and a negative spillover from an over-expanding shadow banking sector. In this environment, it becomes increasingly important to strengthen systemic risk oversight and to further improve regulation and supervision. From this perspective, a vital part of implementing the BRI would be to enhance financial integration between countries. Although there is no agreed-upon definition for what qualifies as an OBOR project, but so far it is clear that the funding mainly comes from China’s huge, but shrinking, financial resources. Since the RMB, despite its internationalization, is still not a fully functioning global currency, the BRI largely requires dollar-denominated financial resources to fulfill its objectives. This ‘dollar-constraint’ obviously reduces the leeway for OBOR projects to be financed by China, at least in hard currency. Against this background, different financing options and implications are considered for the BRI plan within a policy trilemma context.

Keywords

‘One Belt, One Road’Asian connectivityStimulus packageDouble-digit annual GDP growth rates‘Ghost cities’‘Bad’ assetsDebt-financed growth‘Financial dependency triangle’‘Deleveraging ’‘New normal’ economyNPL/credit overhang problem Shadow banking sector Systemic risk oversight‘Dollar-constraint’ Policy trilemma context

End Abstract

The Global Financial Crisis (GFC) of 2007–2008 disrupted international capital flows, but China was able to limit the adverse effects of this credit crunch. The country boosted domestic demand through a massive stimulus package at the end of 2008 aimed largely in funding the infrastructure, and loosening monetary policies to increase bank lending. The Chinese government cleverly used its state-owned enterprises (SOEs) which formed the backbone of China’s economy during the central planning era and is used as an instrument to implement its aggressive stimulus package. In early 2010, China’s economy seemed to be back on track again with double-digit annual GDP growth rates. However, it temporarily boosted GDP and export growth, but it left a legacy of debt with many ghost cities and ‘bad’ assets that could not support the first growth injection from early 2010 until present. Despite the fact that China’s GDP growth usually exceeds target, the rate of GDP has slowed since then, declining from 10.6% in 2010 to around 6.6% in 2018 (Morrison 2018) and a forecasted 6.1% at the end of 2019. A major fall of GDP growth also occurred during the 1990s, but the turnaround came with the turn of the millennium and led to unprecedented growth with double-digit GDP figures until the start of the GFC (see Fig. 1.1). A big difference with the current decade compared to the previous decades of enormous economic growth is that the authorities now focus much more on lower growth of higher quality. Moreover, in this decade the lower growth, it accounts for one-third of global growth, has much more influence on the economies of rest of the world. China’s inevitable economic slowdown in this decade also means that it will be harder to tackle its debt problem effectively, even with the undisputed ability of the Communist Party of China (CPC) to support the economy (BBC Business 2019).

Fig. 1.1

China’s slowing economy—real GDP growth at market prices in percentages (forecast for the period 2019–2021)

(Source Adapted from IMF and World Bank)

Though the stimulus program implemented in China in general was effective, one of its lasting side effects was the creation of massive excess capacity in many industrial sectors from steel to cement. Combined with the slowing economy and the sluggish international demands, it is anticipated that the overcapacity will squeeze corporate profits, increase debt levels, and make the country’s financial system more vulnerable. Many SOEs in sectors with spare capacity borrowed heavily during the financial crisis. Most of the Chinese debt is held by SOEs, which account for just one-third of the industrial output, yet receive more than half of the credit dispensed by the Chinese largest Big Five regulated banks.¹ The rising non-performing loans (NPLs) to SOEs have put the Chinese banking system under a great deal of stress. The biggest weakness of the system is that it lacks the ability to allocate credit according to market-conform risk assessment principles. The regulated banks feel safe lending to SOEs, no matter how indebted they are, because the government implicitly guarantees their debt. As a result, the SOEs have developed a habit of debt-financed growth.² This credit overhang may not have been a problem when China’s economy was growing, but it represents a serious economic risk in times of economic slowdown. In order to restrain borrowing by local governments and SOEs, the government declared curbing SOE leverage as ‘the priority of priorities’ and warned local officials to be held accountable for building up regional debt. The implementation of the policy of ‘deleveraging ’ can be considered as one of its major tasks for the coming years (Cai 2017).

China’s economic slowdown, stock crashes, and currency realignments are highlighting the downturn of the world’s second largest economy and the main driver of global growth. The attention of global markets was focused on China’s exchange rate in August 2015 when the People’s Bank of China (PBC) announced a nearly 2.0% devaluation of the Renminbi ³ (RMB) against the US dollar (USD). Since then, China has devalued the RMB multiple times while making a transition from its 12th to its 13th Five Year plan (FYP) in which the Chinese authorities have laid out a clear and concise list of objectives as to how they want to develop their ‘new normal’ economy and to avoid a ‘middle-income trap’ in the near future. The main characteristics of this ‘new normal’ growth model consist of a slower growth level with a higher quality and more emphasis on efficiency and social security with a strong role of the government; the ability to adjust in accordance with the current market circumstances; opening-up of the financial markets and services sector as the current economy’s primary driver of growth to offset contractions in China’s traditional powerhouses of heavy industry and manufacturing. The aim is to keep a strict balance in restructuring China’s economy, i.e., making sure growth in one sector offsets slowdowns in another in order to guarantee enough employment. One of the most crucial objectives as part of this plan is to induce an economic shift that will steer the country away from a reliance on exports and investments toward growth driven by domestic consumption and innovation. This is part of China’s narrative to decrease its reliance on its global partners, a lesson learned from the GFC when China became dangerously dependent on debt-fueled investments in infrastructure, housing, and heavy industries with a significant overcapacity as a result. The restructuring of the Chinese economy entails two essential adjustments to the financial system; first, the need to improve the efficiency of banks and financial markets and expand their services to dynamic sectors of the economy and beyond the state sector; and second, the need to avoid instability in the increasingly complex financial sector stemming from either the NPL/credit overhang problem in the banking sector, and/or a crash in the asset market, and a negative spillover from an over-expanding shadow banking sector. In this environment, it becomes increasingly important to strengthen systemic risk over...

Table of contents

• Cover
• Front Matter
• 1. Introduction
• 2. China’s Four Decades of Reforms and Development
• 3. China’s New Style of Globalization as a Route to a More Sustainable Growth Path
• 4. The Rationale for the ‘Belt and Road’ Initiative
• 5. China’s Financial Deepening and Its ‘Belt and Road’ Funding Dilemma in a Global Context
• 6. Concluding Remarks and Recommendations
• Back Matter