Belt and Road: Seize the Next Wave of Growth in Eurasia
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The forum is focused on mutually beneficial strategies and investment opportunities sparked by the Belt and Road Initiative that will catalyze development and new industrial activities all over Eurasia (China, Central Asia, Middle East, Europe).
Date: November 23-24, 2017
Venue: Ca’Vendramin Calergi, Venice
Organizer: China Development Institute, The European House – Ambrosetti
Theme: Belt and Road: Seize the Next Wave of Growth in Eurasia
Financing the Development of the Belt and Road: Key Challenges
Author: Wang Jianye, Managing Director, Silk Road Fund; Professor of Economics and Director of the Volatility Institute at NYU Shanghai; recently has been selected as Rotating Secretary General of the International Working Group on Export Credits (2020-2023).
Editor’s Note: At the Belt and Road: Seize the Next Wave of Growth in Eurasia forum on November 23 in Venice jointly held by China Development Institute and The European House – Ambrosetti, Professor Wang talked on the financial issues and challenges that Belt and Road Initiative faces.
Over the three years since the launching of Belt and Road Initiative (BRI), from an investment and financing perspective, what have happened? What have we learned? What are the key challenges going forward?
What have happened?
It has almost become a cliché that the vast landmass in the Eurasia continent, with growing population and markets, has great growth potential. Investment to increase connectivity in this not well-connected region would expand the market, creating effective demand and growth. However, while officially-supported institutions increased their financing, we have not yet seen large capital flows into the developing countries in this region. Why?
A recent World Bank research is telling.1 Their data show that per capita investment growth in emerging market and developing economies has been falling rapidly since 2010, with non-BRICS commodity exporters from roughly 7 percent in 2010 to 0.1 percent in 2016. This is in contrast to the partial recovery in developed economies. By 2014, investment growth there had returned to its long-term average rate, about 2 percent. Their research points out that sluggish investment and growth in developing countries, notwithstanding record-low external borrowing costs and large unmet internal investment needs, can be attributable largely to domestic problems – worsening business environment, rapid buildup of enterprises debt, and policy uncertainty – while external factors such as major countries’ economic slowdown also played a part.
Against this background, let’s look at data from China. Three developments are worth noting from China’s international investment flow data of the last few years:
First, outward direct investment (ODI) increased dramatically in 2015-2016, driven largely by private enterprises. ODI since the global financial crisis could be divided into two periods: 2008-2013, 2014-2017. Data compiled by government and market sources indicate that private sector drove the recent outflow acceleration. ODI relative to GDP rose from 1.1 percent in 2014 to 1.5 percent in 2015 and 1.9 percent in 2016.
Second, destination markets also shifted from emerging and developing economies to developed countries. It should be noted that ODI by disclosed value and number of deals in the Belt and Road developing countries have also increased, admittedly from a very low basis. In conjunction with the rise of the private enterprises, ODI target industries experienced a shift, from primary commodities to services, high value-added manufacturing, and consumption related sectors.
Third, the recent surge in capital outflows especially in 2015-2016 reflects to certain extent masked capital flight. Unusually large and rapid buildup of foreign assets by some domestic entities through M&A or purchases in real estate and unrelated businesses became a source of concern. Some entities including in the financial industry accumulated large domestic liabilities in support their foreign spending spree, increasing balance sheet mismatches. “Errors and omissions” in the balance of payments were also indicative of such a flight, which increased from -0.6 percent of GDP in 2013-14 to about -2 percent of GDP in 2015-16.
The regulatory authorities responded by strengthening the enforcement of capital flow regulations and domestic financial prudential requirements. Starting from November 2016, irregular ODI has subsided. Recent BOP data suggest that net direct investment, which turned deficit in 2016, returned to small surplus in the first three quarters of this year.
What have we learned?
Financing the development of the Belt and Road has to be on market principles. Multiple factors affect China’s capital flows, but primarily market forces in the international arena. Our analysis points to three types – cyclical, structural, and governance drivers. Cyclical forces stem from changing expectations on domestic vs. foreign interest rates and exchange rate movements. Structural forces result from rising domestic costs—wages, land prices, tightening of environment regulations, etc. Governance factor affects SOE investment through corporate governance; it also affects private investment through its impact on uncertainty regarding taxation, regulatory treatment, and property rights protection. In opening up its financial account, China faces domestic financial stability constraint.
The principles of sharing are very important for BRI financing sustainability. The BRI is not a “Marshall Plan,” and cannot be a one-actor show. To achieve “win-win” outcomes, in May 2017 finance ministries of 26 countries endorsed the Guiding Principle on Financing the Development of the Belt and Road, highlighting “equal-footed participation, mutual benefits, and risk sharing.”
Challenges going forward.
First, the leadership challenges to state-owned enterprises. As the Chinese economy is in transition, SOEs still play dominant role in some sectors and significant in others. SOEs’ return on assets and investment return have been falling in recent years, and significantly below that of private enterprises. According to the IMF, adjusted for implicit support through the use of land and natural resources, and lower implicit financing cost, SOEs’ return on equity is estimated to have become negative since 2012.2 In the industrial sector, SOEs account for more than half of corporate debt and 40 percent of industrial assets but less than 20 percent of industrial value added.
Returns on SOE overseas investments are likely to be much lower on average than private enterprises. These companies, especially their leadership, are facing daunting challenges to increase efficiency and profitability. For cross-border M&A, more important is post-acquisition restructuring and management. Strategic vision, efficient decision making and high-quality execution are vital, which require sound corporate governance, market consistent incentives and market-driven corporate culture to attract and retain talents. All are leadership demanding.
Second, the challenges for direct investment in developing economies in the Belt and Road. Many countries are low-income, small size, placing viability limit on projects that require larger market. Red tape and rent-seeking also add to the hidden costs of doing business there. Moreover, counterparty risks are high. It is often difficult to find local corporate partners with solid balance sheet and performance track record. Payment capacity is typically a concern with high risks over the longer term. Few countries or companies there are in investable credit rating. Many are vulnerable to global and commodity cycles.
Coping with these risks would require our enterprises operate on market principles, thoroughly understand local conditions, and on that basis match investors of various preferences for risks and returns with the right projects and other partners. Special attention should also be paid to social responsibilities and environmental protection. Building alliance with local stakeholders and going green would help achieve commercial success in the relatively risky segments of the market.
Third, the challenge of expanding the use of RMB in overseas direct investment. In the last several years, large ODI and other capital outflows have led to a decline in China’s foreign exchange reserves from nearly $4 trillion to slightly over $3 trillion. At this stage, maintaining a sizable official reserves before the RMB exchange rate can be freely floating is important for financial stability. Expanding ODI thus would entail the use of RMB. Although the RMB has become a composite currency of the SDR, its share in World foreign exchange transactions is still smaller than several currencies that are not in the SDR basket.
The challenges are to progressively develop the relevant infrastructure, reduce RMB funding and holding costs, build up so-called “network externality” (i.e., a greater number of users increases the value to each). Of course, international use of a currency depends ultimately on market acceptance, which could be a long process. Stable currency value and the rule-of-law institutions and governance are therefore fundamental.
Finally, the challenge to modernize governance at home in face of increasingly free cross-border mobility of capital and talents. Public sector reforms are particularly relevant in this regard. Exposing the SOEs fully to market competition through opening up protected sectors and removing implicit subsidies would force restructuring, increase efficiency, and contribute to leveling the play field for all enterprises.
Fiscal reforms to make public spending accountable, reduce uncertainty in taxation, and realign central-local fiscal relations will go a long way in instilling confidence and reducing capital flight. Reform to make the tax system more progressive will not only help alleviate income inequality, but also put the public finances on a more sustainable footing, good for internationalization of the RMB.
The recent State Council Opinion reiterated that effective protection of property rights is a cornerstone of our society. The challenge is not just in implementation, but in the difficult institutional and cultural transformation to a “rule-of-law” society.
The BRI calls for “opening-up” of the countries in the Eurasian continent. In doing so, it also creates the conditions for institutional and governance modernization in these countries. Real progress in these reforms will not only transform the business community but also the relevant society, benefiting people along the Belt and Road, creating truly “win-win” outcomes.
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1 Ayhan Kose, Franziska Ohnsorge, and Lei Sandy Ye, 2017. “Weakness in Investment Growth: Causes, Implications, and Policy Response.” Policy Research Working Paper 7990, World Bank, Washington DC.
2 International Monetary Fund, Staff Report for 2017 Article IV Consultation, paragraphs 18-19, http//www.imf.org.
Experience of London Financial Centre
Author: Mark Yeandle, Associate Director, Z/Yen Group Limited
Editor’s Note: At the China Industrial Finance Forum 2017 on November 17 in Jinan held by CDI, Mr. Mark Yeandle shared his views on the experience of London financial centre. Here are excerpts from his speech:
Firstly, was the city of London constructed or did it grow? What keeps it as an important center? Secondly, is there any lesson we can learn from the development of Canary Wharf from scratch? Thirdly, if there is any lesson for China’s financial centres?
London was not planned as a financial centre. It developed as a trading centre of a very successful empire. The British people always had a long history of international trading. Then we had the industrial revolution and the building of financing as an industry which had a massive impact on the country. It became a very logical sequence if you carry on building financial centres. Big bang in 1980s was a deregulation of financial services which freed up the market and allowed the UK and London in particular to grow and thrive. The invention of modern finance, the industrial revolution and the Big Bang are the three great steps of innovation.
Obviously, London is a big city in terms of the size and population. Interestingly, long-term decline of sterling actually helped Britain more international. Investment managers could make good returns in investing purely in UK instruments simply because the value of sterling was dropping. Constant innovation, the development of institutions over the years, being one important centre in the European time zone which enables London to speak to Asia and America in the same working day, English language, skilled people, general reputation of trustworthiness, all sort of things all helped London develop.
Why does London stay on top? Time zone and English language are still important. Liquidities of market are now so strong. London has become a leading centre for stocks, shares, bonds, foreign exchanges, derivatives, insurance, etc. It got all the intuitions like the Lloyds insurance market and the Baltic Exchange. Innovation, like Fintech, also helps London stay on top.
How on earth did Canary Wharf come about? It is now a leading financial area and 30 years ago it was still part of the London Docklands. The London Docklands actually died in the earlier part of this century. Thames were tidal so you always got ships up and down. The harbours basically died because long ships were just too big and deep for the city. So, we ended up with Canary Wharf as an industrial wasteland very close to the City of London. The City of London is one square mile and it is just contained within the old Roman Walls, so it is very limited in space. The old financial development tried to take place there but there was simply not enough room in the City. The buildings were very old and unsuitable and quality of office environment in London was poor. So, the Docklands development organizations went to the City of London and asked: “are you happy with your office premises or do you see the need to do something dramatic?” The answer is that we have to do something dramatic.
Canary Wharf was not planned. It was there because it was demand. I have been to many financial centres where premises have been built early in the process. They have very lovely glass towers, very shining and impressive. Unless you plan early on how to fill them, they will become embarrassment when you leave them empty there. Canary Wharf was filled basically before it was built, because there was so much demand there. The development worked very closely with London about transport links because Canary Wharf is still far away from the City. They spent huge amount of money on transport, like Jubilee Line, City Airport, Docklands Light Railway, London River Services and Helipad.
What perhaps China’s financial centres can learn from this? Building a financial centre, you start with business environment and sufficient infrastructure. Only when you get those two things, skilled people want to move in and financial sectors begin to develop here. Eventually, it will lead to the reputation as a strong financial centre. The generalities of financial centres also give some advice. You cannot be an international centre without international people. Successful people want to live in successful cities. People want to live in cosmopolitan places and gravitate to cluster of their industries. Reputation of the centre is vital because it takes 20 years to build a reputation and five minutes to ruin it. Trust is the glue that holds all relationships together. People will not come to and invest in the city, unless they trust that they will be treated fairly no matter where they come from.
Dr. Qu Jian Attends Sino-Kuwait Strategic Cooperation Seminar
Sino-Kuwait Strategic Cooperation Seminar was held on November 27, 2017 in Kuwait, hosted by Embassy of the People’s Republic of China in the State of Kuwait, in hope to strengthen Sino-Kuwait relationship and facilitate strategic and pragmatic cooperation between the two countries. During the seminar, Dr. Qu Jian presented on “The Economic Transformation and Diversification Through Developing Special Economic Zone”, and analyzed the highly cohesive development strategies of China and Kuwait, as well as the implication of China’s experience in Special Economic Zone development on Kuwait. A total of over 140 participants attended the seminar, including personages from Kuwait government, academia, companies and social organizations.
China Industrial Finance Forum 2017
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The forum gathered experts from China, Germany and the UK and explored ways how finance can better serve the real economy.
Venue: Shandong Hotel, Shandong, China
Organizer: CDI, and the Financial Office of Jinan Municipal People’s Government
Theme: Industrial Finance to Support Real Economy
CDI International Report on Economics of the Anthropocene
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CDI invited professor Carsten Herrmann-Pillath from Max Weber Centre for Advanced Cultural and Social Studies at University of Erfurt to share this ideas on the principles and consequences for policy design from the perspective of anthropocence and have discussion on how to strike a balance between energy consumption and economic growth to achieve a sustainable development.
Venue: Room 101, CDI Mansion, Shenzhen
Host: CDI
Theme: Economics of the Anthropocene: Principles and Consequences for Policy Design
The 13th Shanghai-Tianjin-Shenzhen Forum
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Three issues were discussed during the forum including "Urban Renewal and Development", "Urban Management and Development" and "The Bay Area Economy and Development ".
Venue: Social Sciences Innovation Base, Shanghai, China
Host: CDI, Shanghai Academy of Social Sciences, Binhai Research Institute in Tianjin
Theme: Urban Renewal and Bay Area Economy
Experience of the German Economy
Author: Peter Bofinger, Professor for Monetary and International Economics, Würzburg University, and a Member of the German Council of Economic Experts
Editor’s Note: At the China Industrial Finance Forum 2017 on November 17 in Jinan, Professor Peter Bofinger shared his views on the successful experience of the German Economy. Here are excerpts from his speech:
Germany is among the top ten economies in the Global Competitiveness Report provided each year by the World Economic Forum. In this ranking, Germany is especially high in terms of innovation and business sophistication. Germany has one the lowest unemployment rate among the OECD countries and sound public finances compared with other advanced economies.
Why is the German economy so successful? Germany has a specific economic model which was shaped by Ludwid Erhard, the father of Germany’s market economy, after the WWⅡ. His concept can be labeled in his motto that is “prosperity for all”. The idea was that in order for a country to prosper it means that growth has to be shared by all. Growth is important, but growth has to be widely shared.
How can the concept be translated into the German economic system? What really matters when you decide an economy is the relationship of government influence and market force. For example, the Anglo-Saxon countries have low government influence and strong market influence, and in the Scandinavian countries, market influence is relatively small compared with government. Germany is in the middle, not too much government, not too much market, and it is a very balanced approach. It explains why Germany is so successful.
The approach also explains the success of a German model that provides workers with relatively high security. Unemployment protection of workers in Germany is rather high. Good protection of workers is not something negative for growth and it is a positive feature. Workers and employers see themselves as partners; there is no confrontation but cooperation between them. It is really helpful for Germany. The intuitional framework is called co-determination which means the boards of large companies compose of 50 percent of workers’ representatives and 50 percent of shareholders’ representatives. It is important for the solid environment of the German economy, especially in recessions.
Germany also has a special industrial landscape which is rooted in the German history. Until the beginning of 19th century, Germany was composed of independent small states, so Germany is a much decentralized country. It is also reflected in the industrial structure. Germany has many companies spread across the country. Some of them are even global leaders but they are in the countryside. Why can these family companies adjust themselves over time and still remain successful? The family model is very helpful, because they have long-term perspective. They do not depend on short-term capital market, but they have their long-term vision of how to be successful.
What is the financial system for this decentralized structure of Germany? It is called a three-pillar system which is very robust in times of crisis. One pillar is private banks. The second one is savings banks which are owned by the local authorities and spread all over the country. This decentralized banking system really helps small enterprises get the money. In addition, we have corporative banks which are owned by small investors and mainly exist in major cities. Both saving banks and cooperative banks are not listed on the stock exchange. The three pillars make up a stable system, because it is diversified and it is on the local basis that money is provided for the local companies.
Is Germany really so good? The biggest test for the German economy is the German unification in 1990. When the Berlin Wall came down, we suddenly have 60 million East Germans with an economy that was extremely not completive, while the West German economy was really able to provide social security and infrastructure investment. The unification has been successfully managed, which is a sign of strength of the German economy.
The German economy’s strength is obvious if you look at how we manage the globalization. Germany has benefited from the rapid process of globalization because we have the right products that are needed for industrialization. Compared with other advanced economies, the German economy is very open and has successfully managed the challenge of globalization, which shows the strength of our economy.
Germany has been able to retain the manufacturing base and it is still one of the very strong manufacturing economies. Manufacturing matters.
We have also realized the potential of digitalization. We are one of the economies which intensively use industrial robots. Digitalization is not something afraid of and it does not destroy jobs but provide new opportunities.
What are the lessons for China?
Social protection is a blessing not a curse, because it provides motivation for workers. Good labor relations matter for the performance of firms.
Small can be beautiful. Small and medium-sized companies are successful because they are more flexible and transparent and have low transaction and information costs.
Stock markets are good, but we must be careful. What matters for successful economies is long-term vision, while dependence on stock markets nurtures short-termism.
Globalization and digitalization are beneficial for the wealth of nations, but they do not generate prosperity for all. We need government to use them in the right way so as to produce prosperity for all.
China’s Internet Finance: Risks and Regulation
Author: Fan Gang, President, CDI
Editor’s Note: Internet finance, while injecting new vitality into economic development, has also brought with it inevitable risks, which calls for new models of internet finance regulation.
Online shopping, internet finance and telecommunication technologies have brought various benefits to the Chinese economy, such as fueling the development of the manufacturing sector, providing financial support for small and medium enterprises, and promoting consumer finance. Compared to developed countries, China’s internet finance is developing well. There are several reasons for this. First, the relative backwardness of China’s commercial and financial industries in the past created a huge space for the emergence of internet finance. Second, Chinese consumers’ awareness of privacy protection is not as high as their counterparts in western countries. Third, the Chinese government has adopted a tolerant stance towards innovation, entrepreneurship, the application of new technologies, as well as new business patterns and models, facilitating the growth of internet finance. In addition, China’s vast consumer market has provided excellent opportunities for growth.
The development of internet finance has pros and cons, which, while creating benefits, has also brought negative impacts such as phishing and fraudulent activities, etc., all of which have made regulation on internet finance highly relevant. We need to adopt a mixed supervision system which can penetrate into different industries related to internet finance. Moreover, the partnership between governments and enterprises shall also be encouraged. Moderate and effective regulation by the government will help businesses develop better. As the regulator and the regulated share common interests, their partnership and collaboration will contribute to forming a self-disciplined regulation mechanism, which is in the interest of the long-term sound development of China’s internet, e-commerce, and electronic finance, etc.
Shenzhen to Build a New Regional Innovation System
Author: Guo Wanda, Executive Vice President, CDI
Editor’s Note: In the Guangdong-Hong Kong-Macao Greater Bay Area, Shenzhen has a unique advantage of innovation. Shenzhen shall give a leading role to innovation and strive to build a new regional innovation system.
Shenzhen is a metropolis featured with openness and innovation. Shenzhen is home to a large number of highly competitive private businesses which focus on innovative and creative industries. Moreover, the high efficiency of Shenzhen’s government, favorable business environment, large numbers of talents have all contributed to Shenzhen’s vigorous economy. Shenzhen shall give a leading role to innovation for a better spill-over effect in promoting the shared development for other cities in the greater bay area. The following measures shall be taken: first, to build a regional innovation system featuring industry-academia collaboration research; second, to put in place an industrial chain incorporating venture capital, innovative technologies, and talents for innovation; third, to facilitate the aggregation of industries, talents and capital.
In the greater bay area, Shenzhen can foster benign competitive relationships with other core cities like Guangzhou, Hong Kong and Macao in the greater bay area. Open and pragmatic cooperation will be carried out between Shenzhen and Guangzhou, in particular the establishment of the Guangzhou-Shenzhen Science and Technology Innovation Corridor. Hong Kong is an international hub for finance, trade and shipping with sound basis for cooperation with Shenzhen in industries, talents and technology, etc. Macao is a global center for tourism and leisure, as well as a well-functioning platform for one-stop MICE services. To achieve mutually complementary cooperation, Macao should combine these strengths with Shenzhen’s strengths in internationalization.
Moreover, integrated industrial chains have been formed among Shenzhen, Dongguan and Huizhou, and the collaborative development capitalizing on the advantages of the three cities is sure to exert positive influence on the growth of the greater bay area as a whole. The division of city functions among the three cities, together with close collaboration and partnership among industries, will help promote the Shenzhen-Dongguan-Huizhou city group. Differences in cost have made them highly complementary to each other in industrial division and city functions. A better coordination mechanism among Shenzhen, Dongguan and Huizhou will serve as an role model for other cities in the greater bay area. With the further improvement of transportation networks in the Guangdong-Hong Kong-Macao Greater Bay Area, there will be higher mobility of different economic factors, enabling Shenzhen to reach out further in the overall development of the greater bay area as a regional growth engine.
