Why Belt and Road opportunity outweighs China risk

Investors are understandably wary of big-money Chinese projects, given a history of missteps. But its new Silk Road programme offers outstanding prospects ... if you're patient.

Since it was announced in 2013, the Belt and Road Initiative has promised an infrastructure bonanza for countries across southeast and central Asia. The vast programme offers ambitious road, pipeline, telecoms, rail and port projects that aim to super-charge intra-regional connectivity and facilitate more commerce between China, the rest of Eurasia, and Africa. In the shorter term it also promises a construction boom.

But prior Chinese projects have encountered serious challenges and investors watching the eye-watering sums being invested are wondering how to get in on the action whilst avoiding the potholes.

Chinese internal economic development slowed to a sedate 6.6% of GDP in 2016 and Beijing is looking beyond China’s borders for opportunities to invest, trade and secure vital energy supplies. It may also be looking to bolster China’s international standing by stepping into the vacuum created by a more inward-looking US.

Belt and Road is its big idea to achieve those aims. The terrestrial “Belt” – which largely covers Central Asia – and the (oddly-named) maritime “Road” will stretch all the way from Eastern Europe to Indonesia. 

China has spared no effort or expense in laying the groundwork. It has poured money into the new Asian Infrastructure Investment Bank (AIIB), the Silk Road Fund, and the Shanghai Cooperation Organisation (SCO), and has inked trade and investment deals with numerous countries along the initiative’s twin trade routes.

While there is no official data on the total number and value of expected Belt and Road projects, China Development Bank has already said it has reserved $890 billion for over 900 projects. The Export-Import Bank of China also said in 2016 that it had started financing over 1,000 projects in 49 BRI countries. 

Some investments are under way in East Africa and Southeast Europe, but most existing projects are concentrated in south and central Asia and, notably, in Southeast Asia, which is lapping up the chance to fund its needs. 

“[The] sharing of infrastructure reduces risk and is therefore desirable – that geopolitical perspective, backed up with a very pragmatic liking for Chinese money and decades of under-investment in key infrastructure, has created a favourable climate among [Southeast Asian] governments for Chinese investment,” said Chia Kim Huat, a senior partner at law firm Rajah and Tan in Singapore, which has negotiated several Chinese projects in the area.

So how can Western investors profit from Chinese largesse and what are the lessons to be drawn from ongoing or prior Belt and Road projects? What are the potential pitfalls and how can they be avoided?   

According to Huat, Belt and Road projects are no different to other Chinese projects but they are fundamentally different to, for example, US-led ones.

“The first difference that a Western investor needs to recognise is that, unlike the TPPI [Trans Pacific Partnership] or other trade deals, there is no [Belt and Road] document. The West likes a document first, which clearly states scope, obligations, process, legal frameworks etc. – the Chinese [do] not,” he said. 

As such, there are no published deadlines and no pre-stated rights or obligations. “Relationships first, details and contracts later, and if it goes wrong, we talk. We do not litigate,” Kim said. 

So no list of projects to bid on or numbers to phone. Instead, prospective investors must cultivate networks around the region, especially with connected intermediaries, and in preparing to engage learn about the associated risks and plan for them, he added.

Me too, please

Perhaps not surprisingly, the potential of Belt and Road is stirring interest in Southeast Asian countries where economic development is constrained by infrastructure.

One advocate is Dennis Tan, senior partner with law firm Tan Chia Min in Kuala Lumpur. “Frankly – unlike our neighbour Singapore – we have a big infrastructure deficit. We need solar plants, wind plants, a monorail system, highways and roads and are keen to leverage” Belt and Road, he said.

Tan explained how Tan Chia Min is using its China contacts, mostly law firms, to actively help Malaysian clients to find Chinese infrastructure investors who can bring in money and expertise on the basis of a JV arrangement with the Malaysian government.

“We found that our existing relationships with law firms in China gave us a head start in finding and engaging with the right people in China, and is has snowballed from there,” concluded Tan.  

Cautionary tales

Several recent projects in Europe and Asia suggest China has some way to go in learning how to build effective partnerships outside its own backyard.

In 2013 a deal was signed between China, Serbia, and Hungary to build a 350km high-speed rail line between Belgrade and Budapest — the first part of a broader project to connect the (China-run) Piraeus port in Greece with the heart of Europe.

By late last year it seemed the project was finally set to kick off – but surprisingly China had overlooked the fact that EU member countries must publicly tender large-scale infrastructure projects. Hungary could not simply grant the project to the China Railway International Corporation, and in February 2017, the project was halted for review by Brussels.

At Hambantota, in a remote area in south Sri Lanka, billions of dollars of Chinese money were pumped into building a new deep sea port, an international airport, a conference centre and supporting infrastructure.

The plan envisaged building an entire new city to energise that part of the country. But internal political strife, mountains of debt, political static from India, and heaps of negative public sentiment that on occasion boiled over into violent protest, threaten their continued existence.

However, it is in Indochina where perhaps the most insight can be drawn, believes Tony Segadelli, managing director of power engineering consultancy firm Owl Energy. Here, heavy-handed community relations and the import of Chinese workers have alienated locals on some projects and in one case led to a premature termination.

“The Chinese are economically dominant in Laos and Cambodia and the hydro-electric projects in Cambodia, for example, have been Chinese-funded and in every case that I know of they have brought their own contractors,” said Segadelli, who has been involved in more than 100 power generation, transmission, and distribution projects across Asia.

Sometimes that causes unrest, he said, as in Myanmar in 2010 when the Chinese $3.6 billion Myitsone dam project was stopped. “The Chinese Power Investment Corporation (CPIC) managed the project, did exactly what they wanted and took no notice of local feeling and this resulted in a big push-back. 90% of the power had been intended for China and was taken from the Irrawwady, so not only was it displacing people and affecting resources like fishing – the locals were seeing no direct benefit,” Segadelli said.

“There were critical consequences – the Myanmar regime was bruised by the social response and decided to let in the West. Significantly, there have been no new projects at all since civilian rule.”  

Tony Regan, an energy expert at Data Fusion, an oil and gas consultancy based in Singapore, believes that the Chinese tend to base their approach to large projects on their prior Asian experience.

“Working government to government has been okay in much of Asia,” Regan said. “But increasingly negotiating a large infrastructure project requires aligning multiple parties – politicians, financial institutions, NGOs.” Politicians are not (he states) widely trusted and western companies are much better at managing these complex negotiations and keeping multiple parties happy.

Some Southeast Asian Belt and Road projects also appear to be very costly or to make little economic sense. 

“Take the much-ballyhooed Kra Canal,” Marcus Hand, a global shipping expert based in Singapore, told FinanceAsia

 “It was first proposed in 1677 by Thai King Narai. It would cross Burma and Thailand and allow cargoes to avoid the Malacca Straits, reducing sailing time and incidentally posing a major threat to Singapore’s container port.” 

Hand’s team estimate the total project costs at a colossal $28 billion, which on the face of it could provide significant opportunities for investors and contractors. But not only must the 102km canal traverse a southern Thai region prone to civil conflict, Hand said, it is also hard to see how the economics stack up for the global shipping industry, its putative customers.

In contrast to the Panama and Suez canals, which enable ships to avoid circumnavigating entire continents, “bypassing Peninsula Malaysia and Singapore via a new Kra Canal would save just 1,200km, about three days sailing, and yet to cover the capital cost ... and provide a decent return, tolls would need to be far higher than the fuel costs and time saved,” Hand said.

Quality issues

Chinese infrastructure projects have been known to have suffered from quality and resource issues too, Segadelli said, citing Chinese-designed buildings that have been blown over by typhoons in the Philippines and solar installations that have collapsed, making it harder for operators to get insurance.

“The Chinese often design based on their own history and irrespective of codes and standards. They seem not to care, or do not understand that there is a difference,” he said.

In general, his view is that the Chinese are not great at international project management. They try to flood the site with their own people to minimise scrutiny and because they are used to making do. Outside China they do not know how to get the right people, which results in a mix of languages, skills and, above all, cultural attitudes, which requires far more supervision to ensure good outcomes, Segadelli said.

In the Philippines GNpower’s Mariveles coal power plant in Bataan, built in 2013, took three years to get up beyond 50% to 60% output because of bad design and poor construction.  As a result owners in general are now looking at lifecycle costs and assuming lower performance from Chinese-run projects. 

Segadelli believes that most project principals now accept that when they do business with a Chinese contractor they need to plan in greater project-management resources and budget for 50% more man hours. “Even with this additional cost Chinese contractors have tended to be significantly cheaper than anyone else,” said Segardelli.

“However” he cautions “this cost gap is closing as the Chinese get wiser and start to scale up project management and oversight appropriately.”

One consequence is that principals are falling back on the Koreans – who have been active in the region for years, are the next cheapest and have far more on-the-ground experience in Southeast Asia than the Chinese.

Patience Please

Still, potential investors troubled by prior Chinese missteps in Europe and Southeast Asia also know the Chinese are here to stay and that the value of patient collaboration goes well beyond today’s project, seeing as Belt and Road could ultimately be worth trillions. 

“Investor patience is critical,” Huat said. “As the implementation of [Belt and Road], and challenges related to it, become clearer, there will certainly be new opportunities for Western firms to engage with Chinese partners seeking to mitigate local risk.” 

It follows that those able to demonstrate a strong track record in countries affected would be best placed to become powerful partners to Chinese investors.

Encouragingly, Segadelli sees evidence the Chinese are also beginning to recognise the importance of greater rigour in contracting and accept that they have to bend more to Western models of governance, especially outside Asia. 

“For putative partners, though, cultivating the right relationship (rather than trusting lawyers) will still pay dividends in the longer time, though it may seem slow and frustrating now,” he said. 

Expect challenges in terms of compliance, operating standards, and work practices, be wary of departures from code or from plan, driven by ignorance or by a desire to cut costs and a poor understanding of the consequences, and invest in project management, advised Hand, who describes China abroad as “a work-in-progress”.

“There is a clear reputational risk in being associated with projects which fall foul of these issues – but, on the other hand, there is an obvious opportunity to bring new ways of thinking to your partnership with the Chinese, if you have the right relationship,” he told FinanceAsia.

That’s how Segadelli sees it too; evident weaknesses in Chinese project management and technical skills should be regarded as an opportunity, rather than a threat. 

“Go in with your eyes open, there is money to be made,” he said.

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