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12.03.2014 11:45

With New Funds, China Hits a Silk Road Stride

Initiatives that extend financial support to infrastructure projects across Asia should help China win business and influence
By staff reporter Zhang Yuzhe
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(Beijing) – China's ambitious plan to expand trade links westward into Central Asia in the spirit of the ancient Silk Road is taking shape now that the government has decided to shift foreign currency into a special fund.

The State Council will tap the nation's foreign currency reserves for about 65 percent of a new US$ 40 billion infrastructure-and-trade financing mechanism called the Silk Road Fund.

The rest of the fund's cash will come from the government's sovereign wealth fund, China Investment Corp., and two policy banks, the Export-Import Bank of China and China Development Bank Capital Co. (CDB), sources said. CIC's share of the tranche is 15 percent, while the banks will contribute 15 percent and 5 percent, respectively. Future injections may be ordered if investment demand warrants.

The Silk Road Fund project is one of four outbound investment initiatives winning strong financial support from Beijing in recent months. These projects will supplement similar multibillion-dollar funds launched by China in recent years to support development in Africa and Southeast Asia.

In July, China and its partners in the BRICS bloc agreed to contribute a combined US$ 100 billion to establish the Shanghai-based New Development Bank. The bank will help improving member countries' resilience against international financial market fluctuations and finance infrastructure projects in emerging countries.

In October, Beijing committed US$ 50 billion and organized several partner countries to form the new Asian Infrastructure Investment Bank (AIIB). The bank will target infrastructure projects across Asia, with a focus on Association of Southeast Asian Nation (ASEAN) members. The bank's goal is to raise US$ 100 billion for projects.

In November, state media reported, the Chinese and Mexican governments agreed to set up a cooperation fund targeting bilateral cooperation in infrastructure, industry, tourism and energy projects. The two countries agreed to contribute a total US$ 1.2 billion and consider doubling the fund in the future.

Several other outbound investment mechanisms are on the drawing board. Sources said that Beijing authorities are working on plans for more outbound-investment funds in which Chinese government cash would finance infrastructure and business projects in other countries.

One proposed fund would target Chinese-Arab cooperation with financing from CDB and the Abu Dhabi Investment Authority, a sovereign wealth fund in the United Arab Emirates.

According to Chinese political and financial analysts, this flurry of initiatives fits China's effort to expand outbound investment and enhance the Beijing's global influence. The funds and policy banks can offer equity, bond and credit financing.

Especially significant from the perspective of Chinese influence is the Silk Road Fund, said a financial expert who asked not to be named, because Beijing is the sole funding source. In contrast, the expert noted, stakes in the New Development Bank are shared equally by its five member-nations. And more than 20 countries from Indonesia to Singapore are AIIB stakeholders.

The Silk Road Fund grew out of a proposal voiced by President Xi Jinping in September 2013, when he floated the idea of forming a "New Silk Road Economic Belt" in a speech at Nazarbayev University in Astana, Kazakhstan. One month later, while addressing Indonesia's parliament in Jakarta, Xi made a pitch for a "21st Century Maritime Silk Road."

These initiatives quickly drew international attention in the context of last year's friction over the South China Sea and other geopolitical issues, including Asia's rebound from the 2008 global financial crisis.

Xi put the Silk Road Belt and Maritime Silk Road initiatives on the regional front burner November 4, in the run-up to the Asia-Pacific Economic Cooperation (APEC) conference in Beijing.

The president and China's top economic policymakers held a meeting where they discussed the initiatives, AIIB and the Silk Road Fund. Later, the APEC meeting gave Xi a platform for announcing the plan to funnel US$ 40 billion from China and welcome other investors to contribute to the fund, with the goal of financing infrastructure and boosting trade links across Asia.

"The Silk Road Fund will be open," Xi said, adding that the fund's managers "will welcome investors from Asia and beyond to actively take part."

Domestic Benefits

The initiatives have encouraged Chinese companies that stand to profit from overseas infrastructure projects, such as heavy equipment supplier XCMG Group and railroad builder China Railway Construction.

Analysts say the government's initiative will help absorb some of the excess capacity affecting China's manufacturing sector by giving them business tied to improving infrastructure in neighboring countries. These companies will also get a chance to diversify their client base and expand into new corners of the world.

Most regions within the scope of the two Silk Road initiatives urgently need new roads and other infrastructure development, according to the Asian Development Bank (ADB). But few countries in the region have enough capital to finance needed projects.

Combined annual GDP for countries in these targeted regions is around US$ 21 trillion, the ADB says. But these countries will need more than US$ 730 billion worth of annual infrastructure investment combined by 2020.

So much needs to be done that the ADB and World Bank – which have been financing regional projects for years – can't keep up. These institutions have the capacity to funnel only about US$ 20 billion into Asia every year, with no more than half of that amount available for infrastructure construction, according to the ADB.

The Chinese government is trying to close the region's financing gap with programs such as the Silk Road Fund, the country's largest-ever inter-government cooperation fund.

Linking Asian nations "is not merely about building roads and bridges, or connecting different places," Xi said at the APEC meeting. "More importantly, it should be a three-way combination of infrastructure, institutions and people-to-people exchanges, and progress in five areas including policy communications, infrastructure connectivity, trade links, capital flow and understanding among peoples."

Sources said that the Silk Road Fund will be managed like the CIC. The fund's first chief executive will be Jin Qi, 59, who also serves as the assistant to the governor of the central bank.

Zhao Changhui, chief state risk analyst at the Export-Import Bank of China, said the fund is unlike CIC. The wealth fund is a for-profit institution with "a clear goal to serve the interests of China" that bases investment decisions on profitability, he said.

On the other hand, the Silk Road Fund "is multilateral and cannot only serve China," Zhao said. Its project selection requirements will be stricter than CIC's, and every decision must be based on a member-country consensus.

"Although China is the lead country, it has to negotiate with other members," Zhao said. "Because local government support is fundamental to a project's operation.

"China must have a framework for operating the fund that considers everyone's interests, while creating external demand (for Chinese companies) and boosting the domestic market."

Meeting Challenges

About a dozen overseas financing mechanisms preceded the recent initiatives. In general, sources said, China's investment funds were designed to back projects with high rates of return – up to 20 percent – and encourage bilateral ties between China and any country receiving financing.

These early funds weathered a variety of challenging situations that managers of the latest initiatives hope to avoid.

Among the largest funds are the China-Africa Development Fund (CADF) founded by CDB in June 2007, and the China-ASEAN Fund launched in April 2010 by the Exim Bank in partnership with several financial institutions such as CIC, Bank of China and the International Finance Corp. under the World Bank.

CADF, the world's largest Africa-focused investment fund, has invested about US$ 2.4 billion of US$ 5 billion under management, according to fund President Liu Hao. It's also met all targets and posted profits of "several hundred million yuan" annually for the past seven years, according to a Ministry of Commerce official.

But a bank source said the CADF's investment pace has been slower than expected, as only half of its funds have been put to work. Moreover, the source suggested, the fund has struggled to win support from local governments in Africa.

Meanwhile, sources said, although the China-ASEAN Fund set a goal of US$ 10 billion, it's raised only US$ 1 billion to date.

Managers of the Silk Road Fund should take lessons from China's experiences with funds in Africa and the ASEAN region by approaching investment proposals with caution, said a source at the China Export & Credit Insurance Corp.

Most countries within the regions slated for Silk Road financing are politically stable. But some are not which, according to the source, points to the risks fund managers will have to consider when deciding which countries and projects qualify for financing.

Several experts on overseas financing initiatives have offered specific suggestions to help the funds reach their goals.

Huang Jianhui, vice director of the CDB research center, recommended Silk Road Fund managers draw from international experience by creating a market-oriented business structure. He said they should back joint-venture companies, combine resources from developing and developed countries, and control risks by balancing high-profit resource projects with low-profit infrastructure projects.

An investment office employee at the CADF recommended that Silk Road Fund managers draft a general strategy, specialize and then take advantage of opportunities specific to each country where the fund operates.

"There are diverse risks, legal environments and tax policies in different countries," the source said. "As an inter-governmental fund, the Silk Road Fund can look for special arrangements in terms of market entry and administrative requirements."

What kinds of projects will attract Silk Road financing? Huang said developing countries can expect China's help with power and railroad construction, for example.

Finding worthy projects, however, will not be the biggest challenge for the Silk Road Fund. What fund managers will likely struggle with, say experts, is the need to balance political aspirations and economic performance.

Li Haihui, a credit department official at the central bank, wrote in a recent essay that the Maritime Silk Road and Silk Road initiatives are tied to a Chinese plan to build an Internet of things system linking countries across Asia. But the plan won't succeed, he said, unless China can build trust in the targeted countries and successfully deal with other international financial institutions in the region.

Huang Yiping, a professor at Peking University National School of Development, said Silk Road Fund managers should approach projects cautiously at first, without worrying too much about how their decisions might impact excess capacity among Chinese manufacturers or China's economy. Instead, he said, they should focus on a long-term strategy and win support from other countries.

"If the first step is a misstep, things will be more difficult in the future," Huang said.

These new outbound initiatives have given China a chance to combine foreign investment policies with measures that encourage competition among Chinese companies, said Huang Shaoqing, an economics professor at Shanghai Jiaotong University.

Some experts have voiced concerns about the funds' ability to balance political strategies and pro-market operations. But the Silk Road Fund and other funds could manage projects in ways that reward the most competitive companies with contracts for overseas projects, Huang said.

Also not to be overlooked, if the Silk Road Fund and similar platforms are to succeed, is staffing. One expert said what they need are professionals familiar with each target country who can juggle diplomatic tasks along with international financing.

"The Silk Road Fund has a grand strategic roadmap," said the CDB executive. "But the success of its first step will depend on how well its team is formed, and whether proper incentives and restraint mechanisms are in place. At least five years will be needed before everything is settled."

(Rewritten by Han Wei)

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