Can China afford its new trillion-dollar Silk Road?

TGIF Series 2 #4: Han Dynasty-Like Surpluses Will Fund China’s Global Expansion

As the U.S. retreats from the world stage, China is concocting a powerful policy cocktail to boost global trade and security in its favor. Behind China’s trillion-dollar One Belt, One Road initiative is a lending program of unprecedented breadth and investment opportunities are opening up in everything from transportation and industrial manufacturing to healthcare and telecommunications. But can China afford it? Absolutely. 

Over its 5,000 year history, China has seen extreme periods of wealth. One of those periods was during the Han dynasty.

“The granaries in all the towns are brimming with reserves, and the coffers are full with treasures and gold, worth trillions,” wrote Sima Qian, a Chinese historian living in the 1st century BC. “There is so much money that the ropes used to string coins together rot and break, an innumerable amount. The granaries in the capital overflow and the grain goes bad and cannot be eaten.”

He was describing the legendary surpluses of the Han dynasty, made possible by China’s global trade expansion via the ancient Silk Road, which stretched from central China as far as ancient Rome.

Fast-forward 2000 years, and China has reached similar Han dynasty-like wealth.

With the exception of the last few years, China’s monthly foreign exchange reserve has steadily increased over the past decade, making it the world’s largest.

China’s US$3 trillion foreign reserve stockpile plus its US$550 billion external loans, its US$350 billion in and portfolio debt equity and its US$125 billion from reserve-like assets (PBOC’s other foreign assets) altogether form a US$4 trillion pot of capital that can be used to fund expected annual OBOR spending of US$100-$200 billion.

Where will the riches go?

To maintain the country’s surplus generating machine (its export-oriented economy), Beijing is again looking beyond its borders for investment opportunities and trade, recreating the Silk Road trade routes with a maritime component.

One Belt, One Road (OBOR) is China’s 21st century transcontinental trade route. A vast network of highways, railways, ports, pipelines, industrial zones and energy storage facilities are under construction, with the intention of connecting over 60 countries across Asia, Africa and Europe. It’s estimated that Beijing has already financed US$890 billion worth of OBOR infrastructure projects. Over the next several decades, trillions could flow into OBOR projects.

Release the funding floodgates

OBOR is being financed in two ways: outflow direct investment (ODI) – that’s when Chinese firms expand into foreign countries – and lending from China’s enormous policy banks.

As of last year, China’s Outward Direct Investment (ODI) increased 24.5 percent, reaching a total of US$217.2 billion, as you can see in the graph below.

(Overseas lending from two of its policy banks added another $100 billion. This level of lending is sustainable as long as China continues to run current account surpluses in the range of 2 to 3 percent of GDP. As of 2016, China’s current account surplus dropped to 1.8 percent of GDP, which is worryingly low but not unmanageable.)

Most of China’s outward investment goes to Asia, as shown below.

Hong Kong sees the vast majority of these outward capital flows. The autonomous region is a popular “launching pad” for mainland enterprises expanding overseas and investing offshore. Hong Kong also serves as the ideal service platform outside the mainland for most Chinese enterprises looking to tap into OBOR opportunities.

What’s the point China’s lending spree?

By deploying capital abroad, China seeks to soften the country’s economic slowdown and vulnerabilities.

First, OBOR infrastructure projects will provide a new market for China’s dying state-owned sector (much of which is involved in industrial construction). And second, the areas connected to OBOR’s network of cross-continental trade routes will see a boost in economic growth. Richer emerging markets mean more consumers of cheap Chinese goods, reversing the country’s slowing export growth.

So far, the results have been positive.

Since OBOR officially began in 2013, China net exports have increased dramatically, growing 40.2 percent in 2014 and 78.2 percent in 2015, as you can see in the graph below. Despite a global economic downturn in 2017, China’s exports remained high, only decreasing 9.7 percent from the previous year’s high. Growing exports will strengthen China’s account trade surplus – key to continued OBOR financing.

At this point, you know Beijing’s grand plan, the intricacies of the OBOR initiative, how OBOR will revitalize China’s state-owned economy and how the project will be financed. Next time, we’ll tell you which entities get to play with all of the money flowing from the dragon’s surplus.