Ryan Lam, CFA Senior Economist [email protected]April 2015 China’s ‘Belt and Road’ Initiative: Assessing the Opportunities • Good infrastructure connectivity is just a starting point for creating a Eurasian economic corridor. The Chinese leadership will likely use the ‘Belt and Road’ initiative to push forward with its ‘Go Global’ strategy. • We have identified several areas in which Hong Kong has the potential to capitalise on the opportunities presented by the initiative. • Infrastructure revenue bonds are a natural choice for financing. As the leading offshore renminbi bond market in the world, Hong Kong has a lot to offer in terms of supporting renminbi- denominated bond sales. • In addition to its role as a trading platform, Hong Kong can also play a proactive role as a provider of capital. The newly established Future Fund could benefit from the stable returns and inflation protection that infrastructure assets can provide. • Regardless of the nature of the build-operate- transfer or build-own-operate agreements put in place, conflicts of interest often build up between investors and governments over issues such as ownership, control and profit sharing. There is a great deal of room for negotiation in contractual arrangements. Backed by world-class legal professional services, Hong Kong could serve as a convenient location for liaison in terms of holding conferences and undertaking contract negotiations. • With area for improvement in logistics and limited supply of proper construction materials in host countries, Chinese developers may choose to hire external parties to develop project-specific logistics facilities that will help streamline delivery of major equipment and building materials from the Mainland. Hong Kong's logistics and maritime advantages put the city in a strong position to seize such opportunities.
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China’s ‘Belt and Road’ Initiative: Assessing the Opportunities · 2015-04-23 · Forging a new path In 2005, ... The ‘Silk Road Economic Belt’ encompasses three routes
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Source: Asian Development Bank, Hang Seng Bank Source: Hang Seng Bank
Registered
capital
Loan to
equity
ratio
Loan
repayment
period
Annually
available
funding
Asian Infrastructure
Investment BankUSD100bn 1.5 8 years USD18.75bn
New Development
BankUSD100bn 1.5 8 years USD18.75bn
Silk Road Fund USD40bn 2.0 8 years USD10bn
Total USD240bn - - USD47.5bn
Exhibit 5: Current Account Balance of Emerging Asia (% of GDP)
Source: IMF, Hang Seng Bank3
Current account balance is equal to national savings minus domestic investment
already committed sizeable sums of capital to found or co-found various
institutions aimed at supporting infrastructure financing, but our estimates
suggest that the funding gap remains significant (Exhibit 4). Closing this gap will
require a greater commitment from the private sector.
7April 2015
4Financial Fragility and Economic Performance, The Quarterly Journal of Economics, 105(1), 87–114, Bernanke and Gertler
(1990)
Perhaps more than any other factor, Asian savers shy away from infrastructure
projects because of the difficulties in risk assessment and diversification. In
many countries in Emerging Asia the financial instruments needed for sound risk
assessment are simply not in place. Because perceptions of risk, not just interest
rates, determine the supply of credit4, a shortage of credit persists amid lingering
concerns over credit risks. The mispricing of risk is an important factor in the
relative backwardness of infrastructure in Asia, in our view.
Hong Kong could play a pivotal role in releasing credit constraints. The city’s
financial system could shape risk perception through pooling risk (aggregating
savings so that each investor shares the risk of infrastructure projects), hedging
risk (creating financial instruments to transfer part of the risk to other interested
parties) and diversifying risk (grouping the infrastructure investment into large
portfolios of assets).
More specifically, financial history suggests that debt obligations are more likely
to be honoured than equity obligations. The infrastructure revenue bonds (IRB)
secured by cash flows of the infrastructure projects would likely receive stronger
market interest. As the leading offshore renminbi bond market in the world, Hong
Kong has a lot to offer in supporting renminbi-denominated IRB sales to fund the
BAR plan.
Of course opportunities do not usually come without challenges. Other AIIB
founding members also aspire to capitalise on the rolling out of the BAR initiative.
London in particular has emerged as a leading centre for project finance and
infrastructure asset management. Over the years, the city has developed well-
integrated trading platforms for insurers and pension funds to assess the risk of
construction delays and cost overruns of infrastructure projects. For the Hong
Kong Government, measures to improve the regulatory and tax framework to
attract alternative investment fund managers looking to relocate deserve specific
attention in this regard.
In addition to its role as a trading platform, it is also worth considering whether
Hong Kong can take a step further and act as a capital provider. In 2014, over
50% of sovereign wealth funds (SWFs) with assets totalling between USD1bn
8April 2015
Seeking local partners
Large-scale infrastructure projects have characteristics of natural monopolies
and are particularly vulnerable to political risks. While public-private partnerships
(PPP) are a popular financing vehicle for mitigating such risks, profit-sharing
arrangements with governments could become a liability if there is regime
change. Even in advanced economies such as Australia and the UK, such
partnerships have been criticised for delivering high returns to foreign investors
without a commensurate delivery of benefits to local users.
An alternative form of financing is to sell debt or equities to local investors in host
countries. Although Dubai and London are currently at the forefront of the
Islamic finance market, Hong Kong’s deep pool of financial professionals and its
extensive experience in creating diversified financial products give the city an
edge in helping Chinese firms to secure overseas funding – but more needs to
be done to strengthen its potential role as the gateway for Islamic finance in East
Asia. One crucial first step is to give meaningful consideration to how Hong
Kong might attract international experts in Islamic finance to help build the
necessary financial infrastructure and advise on religious and regulatory matters.
Exhibit 6: Proportion of SWFs Investing in Infrastructure(by Assets Under Management)
Source: 2014 Preqin Sovereign Wealth Fund Review
and USD9bn included an infrastructure allocation (Exhibit 6). Hong Kong’s public
finances are currently robust enough to support infrastructure spending in the
region. We contend that the newly established Future Fund could benefit from
the stable returns and inflation protection that infrastructure assets can provide.
9April 2015
Contract consultation
Regardless of the nature of the build-operate-transfer (BOT) or build-own-
operate (BOO) agreements that are usually put in place, conflicts of interest
often build up between investors and governments over issues of ownership,
management control and profit sharing. In the ideal scenario, ownership, control
and financial flows should be packaged in ways to satisfy investors’ need for
control while at the same time addressing the political concerns of host
countries. There is a great deal of room for negotiation in the contractual
arrangements that govern infrastructure deals. Backed by world-class legal
professional services, Hong Kong could act as a convenient location for liaison
in terms of holding conferences and undertaking contract negotiations.
Project logistics
Another major opportunity lies in the logistics sector. Chinese infrastructure
developers have traditionally used and managed their own supply chains. In
recent years, however, it has been more common for infrastructure developers
to seek third-party logistics support for their oversea projects. With area for
improvement in logistics and limited supply of proper construction materials in
host countries, Chinese developers may seek to hire external parties to build
project-specific logistics facilities to help streamline the delivery of major
equipment and building materials from the Mainland. Hong Kong‘s logistics and
maritime advantages put the city in a strong position to grasp such opportunities.
The Hong Kong authorities may therefore wish to revisit the city’s port capacity
and facilities to examine whether upgrades or expansion might prove a valuable
investment over the longer term as activity under the BAR initiative picks up
momentum.
10April 2015
Hong Kong Economic Monthly Statistics April 2015
Note: (F) ForecastSource: Census and Statistics Department of HKSAR, Hong Kong Monetary Authority , Rating and ValuationDepartment, Hong Kong Tourism Board, CEIC, Hang Seng Bank