BELT AND ROAD
Squeezed between China, Thailand, Vietnam and Cambodia, landlocked Laos attracts over 4 million travellers each year, many working their way along the well-trodden tourist track through southeast Asia.
Backpackers in search of history and adventure can spend days or weeks hiking through the jungles in northern Laos, exploring one of the hundreds of Buddhist temples or swimming in the country’s picture-perfect waterfalls.
On some occasions tourists can find themselves trapped, forced to stay in the country’s small, underdeveloped towns and cities when transport becomes too dangerous to chance. Mud slides, road works and potholes make some of the country’s main roads impassable, especially in rainy season.
But Laos is on the cusp of transformation. In December 2016, construction finally began on a high-speed rail network between Kunming in China’s southern province of Yunnan and Laos’ capital Vientiane. It is estimated that 14 million people will use the route annually – 4 million Lao citizens and 10 million tourists. Tourism is set to boom following the construction of the railway line.
Spanning 1,022 kilometres and due for completion in 2021, it will be Laos’ first big railway. Currently the only railway line in the country is a four-kilometre stretch from Nong Khai in eastern Thailand that crosses the Mekong River along the Thai-Laos Friendship Bridge only to end abruptly, 20 kilometres away from Vientiane.
The project is just one of many in southeast Asia to fall under China’s Belt and Road Initiative, which seeks to develop China’s old silk route via land and sea and connect Chinese exports and services to Asia, Africa, the Middle East and Europe.
China’s selling point is expertise and speed in infrastructure building, and this may be precisely what the region needs- Alexious Lee, CLSA
China’s planned Pan-Asian Railway Network will eventually connect China to Singapore through three main routes: one through Laos, one through Vietnam and one through Thailand, providing China with strategic access to ports in the Malacca Strait. Travel from Kunming to Singapore on the new network is estimated to take just 10 hours. Currently the journey overland from Laos to Singapore can take anything up to three days.
“Suddenly Laos, a relative speck on the map in southeast Asia, will have efficient means to transport goods and people throughout the country and beyond,” says Bharat Padmanabhan, regional head, global banking, Asean and south Asia at Standard Chartered.
“The railway could pull Laos up to the next rung of economic development,” he says.
For the China-Laos stretch of rail, policy bank Export-Import Bank of China supplied around $6 billion in financing for the project. China’s largest commercial infrastructure developer, the China Railway Group (CRG), won the bid for construction. The deal marks the first in Laos for CRG, which like many more Chinese corporates, is developing its footprint along the Belt and Road.
For Laos, there are questions over debt sustainability, given that the project is equivalent to just under half of the country’s GDP for 2016 of $15.9 billion.
“This could end up being much more of a burden than a boon for Laos,” says one analyst based in Singapore. The Chinese media reports, however, that Laos will be able to pay off its bilateral debt to China in an ambitious five years’ time. In any case, the shift from landlocked to land-linked country is too appealing for Laos to wait.
What is the draw for China? Moody’s predicts that CRG’s revenue will grow between 7% and 8% over the next three years – up from 5% in the first half of 2016 – thanks to the company’s expansion abroad. It is as yet unknown how much the railway in Laos will play a part in this.
What is apparent so far, however, is that commercial banks are pretty much absent from the Kunming-Vientiane railway, leaving the work to China’s state-owned banks and large companies. Banks and corporates encouraged by policymakers in Beijing are seemingly happy take on the risk.
“There are two approaches to China’s Belt and Road Initiative in southeast Asia,” says Ben Simpfendorfer, CEO of Silk Road Associates, a strategic advisory company that supports multinationals on commercial strategy development in Asia.
Silk Road Associates
“The first approach is directed at strategic investments. These are the projects that might not make the most money, but are pivotal to China’s overall connectivity in the region. The second – which actually account for the majority of projects – is commercial. One Belt, One Road projects in places such as Vietnam and Malaysia, for example, are exclusively commercial. In Laos, by contrast, there’s just not the same commercial scale. I don’t expect rail projects in Laos, for instance, to return a profit – but that’s not the point here.”
“Would a railway line in Laos be that commercially viable by itself? Maybe not,” says Nam Soon Liew, Asean managing partner, financial services, for EY in Singapore. “But connect small economies like Laos to a much larger network that includes the largest economies in southeast Asia and that’s a completely different story. Suddenly this all becomes a lot more interesting – especially for China.”
As economic growth begins to stutter at home and as China transitions from a manufacturing to a service-driven economy, policymakers are increasingly setting their sights on the country’s closest neighbours in southeast Asia.
China’s large state-owned enterprises are slowly running out of lucrative projects domestically, so the growing consumer markets in countries such as Thailand, Indonesia and the Philippines, combined with cheap labour and the low manufacturing costs of the region’s least developed countries such as Laos, Cambodia and Myanmar, are increasingly attractive.
Asean-China trade is projected to increase from $366.5 billion in 2014 to around $1 trillion by 2020. Chinese companies heading south need reliable infrastructure to succeed in southeast Asia’s disparate markets. At the same time, southeast Asia’s infrastructure deficit is huge: according to McKinsey, southeast Asia needs around $7 trillion for new urban infrastructure and housing projects over the next two decades.
From efficient railway networks to reliable power sources, the region needs it all – China is willing to fill the gap.
Compared with some of the more strategic projects in Asean, commercial infrastructure projects are far from straightforward. Railway projects in Indonesia, port development in Malaysia, power plants in the Philippines alongside bridges, toll roads, solar power and telecommunications networks elsewhere – which provide much better commercial returns – are competed for. The problem here for China is that in the tussle to win over regional support and access to trade, Japan keeps getting in the way.
|Nam Soon Liew, EY|
Japan, like China, has its sights set on being a high-speed rail power in southeast Asia. It has been vying for business in the region by exporting its Shinkansen – or bullet train – technology abroad.
Thailand, Malaysia and Indonesia are specific targets. In Indonesia, after fierce bidding against Japan, China finally secured a deal to build the country’s first high-speed train between Jakarta and Bandung. Unlike Laos, which has a population of just 6.8 million, greater Jakarta alone boasts a population of 10 million – a potential revenue maker for the Chinese banks and companies developing the railway line there.
In Thailand, the development of the Pan-Asian Railway Network has been repeatedly delayed. During negotiations Thailand repeatedly set China and Japan against one another in search of a better deal. Japanese investors were eventually sidelined and China won the mandate for the $5.5 billion railway network after proposed interest charges for the project dropped from between 2.5% and 4% to 2%.
As a sweetener, China also negotiated the right to develop areas along the rail for commercial benefit. Development of the first phase of the railway line, joining the Thai capital Bangkok with Nakon Ratchasima in the northeast, is due to start in October this year.
Locals and analysts alike naturally compare China’s recent deal in Thailand with deals that could have been made with Japan, deals that some say would have been made on better terms – especially in relation to environmental considerations and population relocation. In China, obstacles such as these are quickly solved, partly due to Beijing’s political strength. In Thailand, the ruling military government may be able to exercise the same force, but some argue that if Japan were to take the reins in terms of railway development, environmental and social considerations would be much more central to negotiations.
There are other advantages to the Chinese approach to development.
|Alexious Lee, CLSA|
“I think the draw of China is the fact that they will get the job done much quicker,” says Alexious Lee, head of China industrial research at brokerage and investment firm CLSA. “And, in any case, much of the environmental and relocation issues will need to cleared by local governments in any case, not China.
“China spent the last two decades urbanizing the country,” Lee explains. “If China builds a high-speed railway line, you know it will be completed in around four or five years, whereas the same project may take anything up to 15 years if it’s undertaken by other countries. China’s selling point is expertise and speed in infrastructure building, and this may be precisely what the region needs.”
Robin Xu, China industrials and infrastructure analyst at UBS based in China agrees: “In general, China offers southeast Asia lower costing infrastructure but at higher interest rates compared with Japan. But China wants to accelerate development. If Japan were to get involved, there would be more delays.”
In the race for regional rail supremacy, China appears to be in the lead.
Vying for attention
With infrastructure development well underway, and with Japan sinking into the background, local banks and corporates in southeast Asia are vying for China’s attention. Banks in Singapore are some of the most active, swiftly signing memoranda of understanding (MoUs) with China, looking to open new branches on the Chinese mainland and seeking ways in which they can support Chinese companies doing business in southeast Asia.
In April 2017, OCBC signed an MoU with the Bank of Shanghai; in May DBS signed one with the Agricultural Bank of China at the Belt and Road Forum for International Cooperation held in Beijing; and in June the United Overseas Bank (UOB) signed an MoU with the Chinese Chamber of International Commerce.
DBS is particularly active. Since 2010, a change in direction for the bank saw DBS turn towards Chinese corporates in Asean and, as a result, they have a much better relationship with China than others.
“This has been a deliberate strategy,” says Matthew Phan, Chinese bank analyst at CreditSights.
Part of the reason was the strong dollar and tight onshore liquidity at the time combined with DBS’ excess Singapore dollar liquidity.
“Lending this to Chinese corporates to build out their China corporate franchise made commercial sense,” Phan explains.
“Predominantly [investors are] Chinese-led, but of late, we have been seeing some momentum where non-Chinese investors are considering joint ventures with the Chinese in such projects,” says Lim Wee Seng, head of project finance, DBS Bank. “Talks of collaboration with regional and local sponsors have been gathering pace as the Chinese themselves realize the value of local network and expertise.”
But while there are lots of MoUs being signed, how meaningful are they?
“Better to tentatively agree to plan something with a Chinese bank, than not do anything and risk being excluded from deals in the future,” says Phan.
As Liew points out, currently around 60% of Asean infrastructure projects are financed by the Singaporean banks. “What happens when China comes in, offers concessionary financing alongside technological know-how and a strong push from the Chinese government? The banks in Singapore could lose business, so they need to get involved starting now.”
In the long term, however, the geopolitical risks related to some of China’s Belt and Road projects in southeast Asia may not be worth it for Singaporean – and other – banks and institutions. Indeed, tensions between China and a number of southeast Asian countries continue to simmer under the surface as China seeks economic, strategic and trade dominance in the region beyond the friendly narrative of ‘One Belt, One Road’.
On Singapore’s National Day on August 9, it was reported that China agreed to offer Malaysia advanced rocket launchers and radar systems to be positioned in Johor, which sits just next to Singapore. “If this turns out to be true, I would say this is an act of aggression,” says a Singapore-based analyst.
In the South China Sea, China, Vietnam, the Philippines, Taiwan, Malaysia and Brunei all have competing claims over territory. Control of the South China Sea would offer another trade route for China, could give it leverage over the US (which considers the sea to be in international waters) and could also give it access to oil and natural gas reserves.
“The problem with China’s South China Sea policy is that it is in direct conflict with China’s One Belt, One Road initiative and could encourage countries such as Japan to try its hand at becoming a dominant southeast Asian investor again,” says the analyst.
“At the moment, I’m not sure how China will navigate its way through this Catch-22,” he says.
Whether or not these issues will diminish China’s influence in the region will unfold over time, but for now, southeast Asia will do well to exercise caution – no matter how tempting Chinese investment is.