Thu, May 18, 2017 - Page 11 News List

ANALYSIS: Ambitious plan will require China to tighten its belt

By Christopher Balding  /  Bloomberg View

Chinese President Xi Jinping speaks at a news conference at the Belt and Road Forum for International Cooperation at the Yanqi Lake International Convention & Exhibition Center in Beijing on Monday.

Photo: AFP

China’s recently completed conference touting its “One Belt, One Road” initiative certainly looked like a triumph, with Russian President Vladimir Putin playing the piano and Chinese leaders announcing a string of potential deals and massive financial pledges.

However, underneath all the heady talk about China positioning itself at the heart of a new global order lies in uncomfortable question: Can it afford to do so?

Such doubts might seem spurious, given the numbers being tossed around. China claims nearly US$900 billion worth of deals are already underway, with estimates of future spending ranging from US$4 trillion to US$8 trillion, depending on which Chinese government agency is doing the talking.

At the conference, Chinese President Xi Jinping (習近平) pledged another US$78 billion for the effort, which envisions building infrastructure to link China to Europe through Asia, the Middle East and Africa.

From no other country in the world would such pledges be remotely plausible. Yet, even for China, they will be difficult to fulfill without clashing with the country’s other objectives.

The first question is what currency to use for all this lending. Denominating loans in Chinese yuan would accelerate Beijing’s stated goal of internationalizing its currency. However, it would also force officials to tolerate higher levels of offshore yuan trading and international price-setting. So far, they have shown little appetite for either.

Additionally, countries along the route would need to run trade surpluses with China in order to generate the currency needed to repay such loans.

Bloomberg Intelligence economist Tom Orlik has said that China ran a US$250 billion surplus with such countries last year. It would be mathematically impossible for Sri Lanka and Pakistan to repay big yuan-denominated loans when they are running trade deficits with China close to US$2 billion and US$9 billion respectively.

Financing projects in US dollars is no panacea either. Unless China conducts dollar bond offerings to fund these investments, it will have to tap its official foreign exchange reserves, which hover at about US$3 trillion.

That sounds like a lot. However, outside estimates suggest anywhere from a few hundred billion to nearly US$1 trillion of that money is illiquid.

China needs nearly US$900 billion to cover short-term external debt and another US$400 to US$800 billion to cover imports for three to six months. Pouring additional billions into Central Asian infrastructure projects would only tie up money China needs to defend the yuan.

Borrowers would need to run significant dollar surpluses in order to repay dollar-denominated loans. Obviously, not every country can do so, or undervalue its currency to try and build up a surplus.

Beyond the specific mechanisms, it is unclear whether China has the financial capacity to lend at these levels to borrowers of dubious creditworthiness.

As French bank Natixis SA has said, in order to finance US$5 trillion in projects, China “would need to see growth rates of around 50 percent in cross-border lending.” This would wreak havoc on Chinese creditworthiness and raise external debt from a “very comfortable” level (about 12 percent of GDP) to “more than 50 percent” if China cannot bring in other lenders.

There are a couple of ways around these difficulties. First, Beijing could use this as an opportunity to fully liberalize the yuan, allowing it to flow out of China into countries targeted for investment.

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