Nomura

The Belt and Road Initiative: Globalization, China style

  • A potential win-win initiative for China and the recipient countries economically. China to gain geopolitically as well. We identify key beneficiaries in South Asia and Southeast Asia
  • How to invest on the BRI theme: We expect China and ASEAN equity proxies in infrastructure, financing and consumption sectors to benefit. BRI should also support longer term RMB appreciation
  • Risks: For China, high local leverage and low financial returns are a risk. For recipients, debt burden, sovereignty issues, balance-of-payment risks, execution delays and geopolitical tensions are the risks

The Belt and Road Initiative (BRI), China’s infrastructure push spanning over 80 countries and worth over USD1.5 trillion over ten years, will have significant economic, geopolitical and investment implications for China, but likely even more so for BRI-recipient countries.

The fundamental economics underpinning the BRI is the theory of comparative advantage, where industrialized and developing countries own different resources and thus enjoy the advantage as a consequence in international trade. The BRI is a combination of the land-based Silk Road Economic Belt, which encompasses six economic corridors, and the ocean-crossing 21st Century Maritime Silk Road.

Six economic corridors (the belt) and the Maritime Silk Road (the road)

From China’s perspective, there are both economic and geopolitical gains:

  • GDP booster: The BRI can help China address its manufacturing over-capacity issues and uplift exports, which will also boost China’s real GDP growth by at least 0.1pp annually over the next decade
  • Stepping up the global value chain: The BRI offers China a platform to relocate its low-cost manufacturing to other low-cost countries, while upgrading its production to high value-added products.
  • Foreign policy soft power: As the US turns more inward-looking, the BRI has enabled China to emerge as the new champion of free trade. It is a projection of its rising foreign policy “soft power” and an open bid for global leadership.
  • Geostrategic advantages: The new economic corridors through Pakistan and Central Asia create alternate routes for China to source commodities, reducing its reliance on South China Sea routes for trade.

From the perspective of recipient countries, the BRI is an opportunity to leapfrog via increased investment, trade, tourism, and greater integration. These benefits are specifically true for Pakistan, Bangladesh, Malaysia and the Philippines:

  • Regional trade integration and large FDI inflows: Greater regional trade integration is likely, as manufacturing shifts to these low-cost economies. They would be expected to attract large FDI inflows, becoming an integral part of the global value chain.
  • Boost potential growth: It provides the developing economies with economic growth via large physical infrastructure investment and by fast-tracking them towards the digital economy.

A win-win initiative for China and the recipient economies, but where do the risks lie?

  • Financial risks: China’s financial sector has a weak starting position, with high domestic debt levels. Infrastructure projects may face long payback periods, uncertain returns and potential default risk due to regulatory or political risk in the recipient economy.
  • Debt sustainability: For smaller BRI economies, large loans taken at a commercial rate for a project that does not generate sufficient returns could result in debt distress.
  • Public backlash & sovereignty: Use of Chinese funding, construction materials and workers raises questions over the direct benefit of such projects to the recipient economies. Along with sovereignty concerns, this could trigger public backlash.
  • Balance-of-payment risks: A sharper rise in imports from China than exports to China (worsening trade deficits), along with debt repayments and repatriation of profit (capital outflows) could result in balance-of-payment pressures.
  • Geopolitical tensions: Tensions with India could escalate, threatening the Bangladesh-China-India-Myanmar (BCIM) trade corridor. Tensions in the South China Sea could resurface after Philippines President Duterte’s term expires in 2022.

However, we believe these are manageable risks as China’s own investment-led development has taught it valuable lessons, and via new multilateral funding institutions, the focus will be on promoting best execution of public-private partnerships and the role of market forces.

How to invest on the BRI theme – Identifying the countries and sectors

In our view, the biggest beneficiaries in South Asia are Pakistan and Bangladesh, while among major ASEAN countries, Malaysia and the Philippines stand to benefit the most. Outside of Asia, industrialized countries could benefit from increased demand for their capital- and technology-intensive manufacturing goods, while hectic infrastructure activity could benefit resource-rich economies, such as Australia and Indonesia.

In China equity, we expect infrastructure, financials and consumption proxies to benefit and have identified a basket of 10 Hong Kong/China-listed stocks with meaningful BRI exposure. BRI also supports our longer-term view of RMB appreciation, as it benefits China’s push towards RMB internationalization.

In ASEAN equity, BRI is positive for contractors, tourism, last-mile delivery and hospitals. However, strong competition from Chinese entrants into the domestic markets also means disruption of existing business models and could be negative for the likes of Philippine telecommunications companies.

Read the report here for more insights into the Belt Road Initiative.

Contributors

  • Sonal Varma

    Chief India Economist

  • Euben Paracuelles

    Southeast Asia Economist

  • Wendy Liu

    Head of China Equity Research, Chief Equity Strategist, Greater China

  • Craig Chan

    Global Head of EM Strategy

  • Trevor Kalcic

    Head of Product Management and Marketing, Asia ex-Japan

Suggested views