Believe the Hype?

Grand visions of China’s One Belt One Road (OBOR) infrastructure project continue to make headlines but for now portfolio manager Naomi Waistell, of Newton’s emerging and Asian equity team, is curbing her enthusiasm.

In May 2017 China’s President Xi Jinping officiated at the largest event to take place in Beijing since the 2008 summer Olympics. Delegates from some 130 countries attended, as did 29 heads of state – including Russia’s Vladimir Putin and Turkey’s Recep Tayyip Erdo?an. The heads of the United Nations, the International Monetary Fund and the World Bank were also in attendance. The agenda: the official launch of a latter-day Silk Road – a vast infrastructure project spanning three continents linking China with Europe, central Asia, the Middle East and Africa by road, rail, sea and air.

In his speech marking the launch, President Xi Jinping drew comparisons between the historic Silk Road (think camels laden with silks and spices winding their way through vast steppes and deserts) and the modern One Belt One Road (OBOR) project. The development, he said, will "unleash new economic forces for global growth, build new platforms for global development, and rebalance economic globalisation so mankind can move closer to a community of common destiny".

So much for the history and current ambitions but for investors a key question is will the hype match the reality? Will the grand visions encompassing everything from power stations to gas pipelines, technology hubs to motorways reach fruition or – like so many centrally mandated infrastructure grand projects of the past – fizzle out in the face of hard facts?

For Newton portfolio manager Naomi Waistell, it’s an important question. On the one hand, she describes the initiative as stunning in its scope. With an estimated price tag of some US$900bn, she says the scheme has rightly drawn comparisons with the Marshall Plan, the monumental US economic support effort that helped rebuild Western Europe at the end of the Second World War. "OBOR is nothing if not ambitious," she says. "It accounts for roughly 60% of the world’s population and around 30% of its GDP. It has the potential to create enormous prosperity for the people living in the countries it affects."

At the same time, though, she says it makes sense to stand back and take a considered view of what the project stands for and what it could achieve. For one thing, and like the Marshall Plan before it, OBOR is about more than just economics: it also serves a set of wider geopolitical and strategic ends.

Crucially, she notes, OBOR should help to reduce China’s dependence on the Straits of Malacca, the narrow sea lane separating the Malay Peninsula from Sumatra, through which most of its imports and exports flow. "Around 80% of China’s oil imports pass through this strategic choke point too," she says, "which makes Chinese prosperity immensely vulnerable to any form of maritime embargo."

Hence, a new port alongside rail and road links in Pakistan provides direct access to the Indian Ocean and the Gulf, while pipeline agreements such as the Central Asia-China natural gas pipeline, which runs from Turkmenistan through Uzbekistan and Kazakhstan to Western China, will allow unrestricted overland transhipment of oil and gas. Russian exports of coal, oil and energy to China are also expected to rise as rail links and pipelines between the two countries improve.

OBOR fulfils another strategic goal too, according to Waistell: namely the soaking up of China’s vast excess industrial capacity. She notes that Chinese companies are expected to dominate the construction phase of many of the larger infrastructure projects and so will likely import Chinese materials to support that process. "This should take the pressure off domestic overcapacity in sectors such as steel, cement and aluminium – and China’s heavy industry sector should see direct benefits as a result."

While the strategic rationale of OBOR might make sense for China, there are still question marks over how much of what has already been announced will actually come to pass, according to Waistell. In railways, for example, high speed projects associated with OBOR in Libya, Mexico, Myanmar, Venezuela and Indonesia have either been cancelled or are facing major delays. According to an investigation by the Financial Times, cancellations and delays account for at least 25% of the combined US$143bn value of overseas high speed rail schemes initially announced as part of OBOR.

Challenging projects
The One Road maritime strategy has been far from plain sailing too. Even though China has secured contracts to build a port in Myanmar, a deal with Bangladesh fell through in 2016 when Dhaka opted for an offer from Japan instead. A US$1.1bn deal to construct Hambantota Port in Sri Lanka was scaled back after it sparked protests – and other projects from Europe to Africa have been met with differing degrees of suspicion as to China’s true intentions.

Here, says Waistell, is an important sticking point. Neither Japan nor the US are directly involved in OBOR. India – a key regional player – was also notable by its absence from the May launch event in Beijing. Partly this was a response to China’s involvement in the US$62bn China-Pakistan economic corridor, which exacerbated regional tensions, says Waistell, not least because part of the development is in the disputed border region of Gilgit-Baltistan. "China has done an incredible job of moving from a predominantly agricultural economy to its current status as the manufacturing hub of the world," says Waistell. "But if it wants its grand vision to be a success, part of its strategy will need to be about addressing the concerns of countries like India, the US and Japan who can be said to be ambivalent about OBOR at best."

Notwithstanding these considerations, recent data highlights how at least some parts of OBOR seem to be gaining a head of steam. During the May launch event, for example, China signed 270 cooperation deals, covering telecommunications, infrastructure development, trade promotion and finance. Year to date, Chinese acquisitions in the 68 countries officially linked to OBOR totaled US$33bn, surpassing the US$31bn tally for the whole of 2016. This rise is all the more remarkable given that it came against a 42% fall in overall outbound mergers and acquisitions from China.

At first sight, the numbers are impressive but here too other factors could be at play, says Waistell. She concludes: "We know China has cracked down on foreign investment, tightening capital controls and raising restrictions on foreign M&A – but this doesn’t seem to have staunched the enthusiasm for investment in OBOR projects. For us, this raises the question: Is investment by Chinese firms in the New Silk Road simply capital flight by another name? If so could we simply be looking at a gross misallocation of capital?"