Belt and Road: China in CEE – On the right track?
Chinese policymakers and firms are showing an increasing interest in central and eastern Europe – but will Beijing’s ambitious plans for infrastructure development put China on a collision course with the EU?
On January 29, a train arrived in Budapest carrying cargo containers full of cheap Chinese furniture. The containers had left Ningbo port in eastern China 26 days earlier and travelled to Greece by sea, before making their way overland by rail via the former Yugoslav Republic of Macedonia and Serbia to Hungary.
For policymakers in Beijing the journey symbolized the opening of an important new transport link between China and Europe. Dubbed the ‘Land Sea Express Route’, the project was conceived in 2014 as part of president Xi Jinping’s Belt and Road Initiative (BRI).
The following year, work began on a new high-speed rail link between Budapest and Belgrade. Financed with Chinese capital and built by Chinese contractors, the $2.9 billion line was designed to cut journey times between the two capitals from eight hours to three and was due to open in 2018.
When China’s Cosco announced in April last year that the Greek government had approved its bid for a controlling stake in Piraeus Port, the transfer point for Chinese goods arriving by ship to Europe’s rail network, it seemed as though all the pieces of the new route were falling into place.
The first containers had barely been unloaded in Budapest, however, before the project suffered a serious setback. In February, reports emerged that the European Commission was investigating whether, by appointing Chinese contractors to construct the new rail link, Hungary’s government had violated EU laws requiring public tenders for large infrastructure projects.
European officials stressed at the time that the assessment was routine and that no action had been taken against the project pending a dialogue with the Hungarian authorities. Nevertheless, work on the Hungarian section of the line was halted and by late August had yet to resume.
The incident highlighted one of the key challenges implicit in the Belt and Road Initiative. One of its stated aims is to speed up the transport of Chinese goods to European consumers by improving connectivity – yet the majority of those consumers are within the EU, which has very different regulatory requirements and governance standards from those of China.
Beijing’s development ambitions also put it on a potential collision course with bodies such as the EBRD and the European Investment Bank, which have long-standing infrastructure strategies of their own, covering both current and aspiring EU member states.
“We believe that whatever plans are put in place in the context of the Belt and Road Initiative must be compatible with existing plans for connectivity that have been developed together with the European Commission,” says Mattia Romani, the EBRD’s head of economics, policy and governance.
|Mattia Romani, the EBRD’s head of economics, policy and governance
He notes that Chinese authorities and local policymakers are starting to make efforts to coordinate with European bodies on infrastructure development in areas such as the western Balkans.
“Our sense is that they are increasingly aware that investment needs not only to be done with the same objectives as existing connectivity plans, but also that the standards of this investment need to be in line with the approach the EC has taken in those regions,” Romani says.
In this respect, the fate of the Belgrade-Budapest rail link will be an important indicator, say sources.
“Policymakers in Europe will be watching it closely,” says one regional banker. “It will be a key test of how Belt and Road investment will be thought through in the context of existing plans and commitments.”
So far, however, such concerns have not prevented several non-EU Balkan countries from securing financial support from China for infrastructure development.
Serbia has been particularly successful in this respect. Even before the announcement of the Belt and Road Initiative, policymakers in Belgrade proved adept at attracting Chinese cash. Since 2010, Beijing has financed nearly $2 billion of infrastructure projects in Serbia, including a clutch of road upgrades and a new bridge over the Danube.
At the Belt and Road Forum in Beijing in May, Serbian transport minister, Zorana Mihajlovic, signed contracts with China Road and Bridge Corporation (CRBC) for a further $3 billion of highway projects, including a motorway that will link Belgrade to the port of Bar in neighbouring Montenegro.
The authorities in Belgrade have also been adamant that work will go forward on the Serbian section of the high-speed rail link to Hungary despite delays on the EU side.
This well-publicized readiness to cooperate with China has brought other rewards. Last year, Chinese state-owned industrial giant, Hesteel Group, paid €46 million for Serbia’s loss-making Smederovo steel plant. The deal, which saved several thousand Serbian jobs, was seen by many as more politically than commercially driven.
China has also funded motorway projects in FYRoM, Bosnia and Albania. Further east along the Belt and Road route, Chinese state entities were involved in the construction and financing of Turkey’s Ankara-Istanbul high-speed rail line, which opened in 2014. Plans are now being formulated in collaboration with Beijing to extend this to Edirne in north-west Turkey and ultimately through to Bulgaria, as well to link it up with a new rail line running from Baku in Azerbaijan via Tbilisi to Kars in eastern Turkey.
There will also be opportunities for intermodal Belt and Road connectivity in Istanbul, where a Chinese consortium led by Cosco bought a 65% stake in Kumport, Turkey’s third-largest container terminal, in 2015.
We are seeing more Chinese companies showing up in our transactions. Sometimes they are successful, sometimes they fail – but in our view this is only the beginning - Mehmet Sezgin, Unlu & Co
As Chinese policymakers have continually stressed, however, the Belt and Road Initiative is not only about infrastructure. Beijing’s enthusiasm for engagement with central and eastern Europe goes well beyond transport links and indeed predates the inauguration of the New Silk Road project.
In April 2012, seven months before Xi Jinping took over as president, officials in Beijing sponsored the creation of a policy forum for cooperation between China and 16 countries in CEE. Known as the ‘16+1’, the initiative is made up of 11 former communist countries in the EU as well as five Balkan states – Albania, Bosnia, Macedonia, Montenegro and Serbia.
While the forum has not proved noticeably successful so far in its purported aim of encouraging meaningful cooperation across the region, it has provided a useful focus for dialogue between China and CEE countries. Over the last three years, it has also become a handy vehicle for pushing the Belt and Road agenda in the region.
At the most recent annual meeting of the group, held in Riga in November, Latvia became the first of the Baltic states to sign up to the Belt and Road Initiative.
In a statement released after the conference, attendees agreed to: “Acknowledge the importance and comprehensive character of connectivity between Europe and Asia and reaffirm support to the progress made under the EU-China Connectivity Platform”.
The ‘Riga guidelines’ also included an explicit commitment by participants to “make concerted efforts” to develop synergies between the Belt and Road Initiative and relevant EU projects such as the Trans-European Networks.
In return, China held out the promise of a sharp increase in capital flows to CEE. During the Riga forum, premier Li Keqiang announced the creation of a €10 billion regional investment fund. Dubbed the China-CEE Financial Holding Corporation and Fund, the new vehicle has been set up by ICBC and will be headed by the policy bank’s former chairman Jiang Jianqing.
Its mandate, according to ICBC, is: “To support CEE infrastructure and capacity cooperation under the Belt and Road Initiative”. The fund’s managers are hoping to persuade regional governments, Chinese and foreign enterprises, financial institutions and various types of private capital providers to contribute to its coffers and, in due course, help them reach their ultimate target of €50 billion.
ICBC has also indicated that the fund’s remit will cover a wide range of sectors.
“[Managers are] actively tracking a number of investment opportunities with great social impact and high economic returns, involving transport and logistics, clean energy, high-tech manufacturing, medicine and healthcare, and food processing,” bank officials said in December.
To date, no investments appear to have been made. A smaller China-backed fund has, however, been active in the region for several years. Announced at the 16+1 summit in Bucharest in 2013, the China-CEE Investment Cooperation Fund was set up by the Export-Import Bank of China in partnership with various regional institutional investors, including Hungary’s Eximbank.
The fund, which is managed by CEE Equity Partners, started with initial capital of $435 million. Investments so far have included a wind farm in Poland, a solar plant in Czech Republic, an education group in Hungary and a Bulgarian manufacturer of climbing walls.
Most recently, the fund paid €202 million to buy Hungarian telco Invitel from regional private equity firm Mid Europa in March. A second fund-raising round was announced at the Riga summit, with the target this time being set at $1 billion. The first close is expected in the fourth quarter of this year.
Pick-up in pace
These initiatives come in the context of a steady increase in capital flows from China to CEE. According to law firm CMS, annual Chinese investment in the region doubled in volume in 2016 to €4.4 billion.
Bankers across the region are expecting a further pick-up in the pace of Chinese deal-making.
“We are seeing more Chinese companies showing up in our transactions,” says Mehmet Sezgin, head of corporate finance at Turkish investment bank Unlu & Co. “Sometimes they are successful, sometimes they fail – but in our view this is only the beginning.
“As Chinese companies start to become more familiar with the market, we will see more of them investing directly.”
The arrival of two state-owned commercial banks in Turkey is also expected to herald an increase of Chinese flows into the country. In 2014, ICBC became the first Chinese entity to buy a full-service retail and corporate bank in CEE when it purchased a controlling stake in Turkey’s Tekstilbank. Bank of China is also looking to set up shop in the country, having acquired a licence to start a deposit bank in January.
The two banks are also starting to build physical networks in central and southeastern Europe. Bank of China has been present in the region since 2003, when it opened a subsidiary in Hungary, and has been in Poland since 2012. This year, it became the first Chinese bank to set up shop in the Balkans, opening a Serbian operation in January.
ICBC was later to the party in central Europe but also entered Poland in 2012 and in May received a licence to start banking operations in the Czech Republic. It will join Bank of China’s Hungarian arm, which last year opened a branch in Prague.
Both banks are expected to step up lending in the region as the Belt and Road Initiative gains momentum. In January, Bank of China signed a strategic cooperation agreement with Hungary’s government, in which the lender agreed to finance Hungarian projects related to the Belt and Road.
Bank of China also used the occasion to unveil plans to issue CEE’s first yuan debit card in Hungary, in collaboration with card specialist China Unionpay. The announcement represented another step forward in Hungary’s bid to become a hub for offshore renminbi transactions, itself part of a wider effort to position the country as the leading proponent of the Belt and Road Initiative in central Europe.
In 2015, Hungary became the first non-eurozone country in Europe to host a Bank of China renminbi clearing centre, as well as the first CEE state to receive a renminbi qualified foreign institutional investor quota.
Hungary also broke new ground for the region in April 2016, when it sold the first CEE sovereign offshore renminbi dim sum bond. It was pipped at the post by Poland, however, in the race to raise offshore renminbi funding. The Polish sovereign made its panda bond debut last August, while Hungary had to wait until July this year to follow suit.
Debt management officials in Budapest said at the time that the deal would be the first of many. They also indicated that some of the proceeds of the inaugural issue would be used for BRI-related projects.
The fact that only one other sovereign – South Korea – has so far tapped the panda market speaks to the enthusiasm of policymakers in central Europe’s key economies for aligning themselves with Chinese interests and tapping Chinese capital.
Provided they, and their counterparts in neighbouring regions, can find a way to reconcile the EU to this stance, the prospects for Belt and Road in the region look promising.