Is Big Banks' Desire to Invest in OBOR Folly or Favorable?
OBOR has been criticized for increasing indebtedness among developing nations and paying too little attention to political risks.
American investors are showing interest in China's flagship project, One Belt One Road (OBOR), despite the risks. Marc Merlino, head of Citi's global subsidiaries group, recently stated that there are many opportunities for banks as well as institutional and corporate investors. Merlino believes that the risks are "well understood in the banking sector," but it is important to note that while some construction undertakings may be profitable, some OBOR projects may face too many risks to bear fruit.
Risks of OBOR projects
OBOR has been criticized for increasing indebtedness among developing nations and paying too little attention to political risks. China is relying to a great extent on funds lent to other nations to finance OBOR projects. High indebtedness within developing nations can lead to project failure, at best, or institutional collapse, at worst, if funding dries up. Even if projects succeed, developing countries taking on OBOR projects may find themselves too overleveraged to carry out regular fiscal duties, leading to a potential debt crisis. The case of Sri Lanka is often cited as a warning to developing countries investing in OBOR. In Sri Lanka, China constructed a container terminal at Hambantota. However, Sri Lanka found itself unable to repay the loan and had to transfer ownership of the port to China. This project, among others, ratcheted up Sri Lanka's debt to GDP ratio to an unmanageable 90% in 2017.
Success of OBOR projects is not guaranteed in some locations due to political risks. A whopping 71% of Chinese firms surveyed by the by the Center for China and Globalization in 2016 stated that political risks were their biggest concern. In particular, they cited concerns about "policy changes," "political unrest" and "government expropriation" as potential barriers to completing projects.
It is also unclear how profitable projects may be. Many of the projects will take at least a decade to generate returns, and there is no guarantee that returns will be positive and not negative. Just building infrastructure doesn't guarantee use of the infrastructure, a point clearly exemplified by China's many ghost towns constructed in the wake of the 2008 global crisis. The same peril is present here; just because infrastructure is present doesn't mean that it will attract the necessary human and physical capital in its surroundings to make it a hub of economic activity.
As I have noted elsewhere, China's policy banks have insufficient capacity to vet the numerous OBOR projects. The Export-Import Bank of China, for example, noted at the beginning of 2016 that it had funded over 1,000 projects. By comparison, the Asian Infrastructure Investment Bank had funded only 9 projects as of June 2017, subjecting each project to rigorous examination. If OBOR projects fail to undergo a rigorous analysis of strengths, weaknesses, opportunities, and threats, investors are probably better off parking their funds in low risk, low yield Treasuries.
Profitability of related projects
While investing directly in poorly screened OBOR projects directly may not make sense, Marc Merlino, to his credit, noted that ventures surrounding major OBOR projects provide huge potential for returns. Merino states, "it's the opportunities for micro infrastructure beyond the core projects. All the knock-on effects ...." Certainly, after OBOR plans are carries out and the success of the construction can be more easily understood, investing in micro infrastructure could be quite profitable.
Past evidence of profitability of backward linkages between major invested projects and the rest of the economy can be witnessed in China's special economic zones (SEZs). The clearest example of this is the city of Shenzhen, which was established as an SEZ in 1980, when it was a sleepy fishing village of 30,000 residents. Today, Shenzhen has become a megacity with a population of 12.53 million, and one of the most economically important cities in China. The city grew not only because of the influx of foreign direct investment, but also because of the growth of supporting industries. Many people who invested in the city early on have enjoyed significant profits as the city grew.
Prudent analysis would require that investors financing micro projects surrounding an OBOR project should perform the due diligence that China's policy banks might have failed to undertake. This may require more resources to carry out than individual investors have, but is feasible for large institutional investors or lenders like Citi.
In sum, investors need to proceed prudently with regard to OBOR projects and recognize that many of the projects have been insufficiently vetted. Plans surrounding visibly successful OBOR projects may bear fruit as long as investors focus on assessing and hedging against risks. After this work is done, one can be cautiously optimistic about such plans.