In the autumn of 2013, President Xi Jinping put forward the Belt and Road Initiative, for the purpose of seeking common development and win-win cooperation. For over 3 years, the development of the initiative has received support and response from more than 100 countries and international organizations, and a broad consensus of cooperation has been formed. This has provided new opportunities for improving people’s welfare in the countries along the route. The development of the initiative involves policy coordination, facilities connectivity, trade connectivity, financial connectivity, people-to-people bonds, among which financial connectivity is an important pillar. Most countries along the route are mostly developing countries, and there is a huge demand for fund to support economic and social development. It is beyond a single country's capacity. To facilitate investment and financing cooperation of the Belt and Road initiative, it is necessary to build a community of shared interests, fully mobilize the resources of countries along the route, clarity the division of responsibility and strengthen collaboration between the government and the market, and adopt a market-based approach with enterprises as the major participants, to ensure sustainability of investment and financing, thereby achieving shared growth through consultation and collaboration.
The investment and financing of the Belt and Road should be market-oriented and adhere to the principle of sustainability and mutual benefit.
Most countries along the route are developing countries which have strong aspiration for economic and social development. However, due to inadequate capacity and fund shortage in infrastructure construction, they have large financing demand and support from the international community is urgently needed.
The international community has long emphasized concessional financial support in investment and financing cooperation in developing countries, including concessional terms in interest rate, maturity and grace period. Concessional loan is such an example. Inevitably, concessional financial support, whose terms and conditions are better than commercial loans, requires fiscal subsidies and government support. But the financial resources of a single country are limited, and the use of government finance is usually constrained by domestic laws. Therefore, most countries don’t have adequate financial resources to support long-term and large-scale external concessional financial support.
Relying on concessional financing may also trigger risks and problems. First, the moral hazard, which means the recipient countries may lack the motivation to fully explore their own resource endowment and other advantages to develop economy. And there will be competition and comparison among the recipient countries in seeking concessional financing. Second, it may give rise to dependent mentality in some countries and their lack of initiatives to seek balanced outcome of mutual benefit. Moreover, it may distort market and hinder efficient allocation of resources and ultimately the development of developing countries.
In the long run, cooperation in investment and financing does not mean one-way financial support. It needs all involving parties to discuss and work together to build a community featuring concerted efforts, shared risks and benefits. It is also necessary to leverage the market forces to fully mobilize all kinds of resources to ensure sustainability. Based on these considerations, the Belt and Road investment and financing cooperation should follow the principle raised by Premier Li Keqiang, which is enterprises participating as the major players in a market-based operation for mutually beneficial results.
- The development of the Belt and Road involves extensive infrastructure construction and industrial cooperation. The financing demand is huge and it is difficult to raise enough funding from governments alone, therefore it is necessary to leverage the market forces. At the same time, it is not easy for a single country to provide all the fund required, therefore it is necessary to leverage countries along the route. Mobilizing resources from various channels and using global funding efficiently is inherent in the concept of achieving shared growth through discussion and collaboration in the development of the Belt and Road.
- The construction periods of most projects in the Belt and Road are long. If the investment and financing is not sustainable and disruption occurs, it will not only affect the project development and economic returns, but also cause political damage. This requires countries along the route to make concerted efforts, strengthen cooperation, promote the efficient coordination between the government and the market, and provide sustainable long-term funding.
- The development of the Belt and Road is not a solo by any single country. Right from the beginning, the initiative has emphasized achieving shared growth through discussion and collaboration. We can only build a community of shared interests by connecting countries with mutual benefit. On the basis of equality and mutual benefit, countries with financial advantages and countries with projects to offer could discuss plans for cooperation, give full play to their respective strength, and work together for shared growth.
Diversify and use multiple investment and financing methods to provide practical financial support for the Belt and Road initiative.
To facilitate financial connectivity along the Belt and Road, it is necessary to build and improve a market-based and sustainable investment and financing system for mutual benefits. Based on our experiences, such a system should at least include the following components.
The use of development finance
For a long time, developing countries have sought financing through traditional development agencies such as the World Bank. In recent years, China Development Bank and similar development agencies have developed rapidly and become important financing partners of many developing countries. Development finance is neither concessional loan nor commercial finance and represents a unique financial business.
Development finance with Chinese characteristics as represented by China Development Bank have multiple advantages and can play an important role in the Belt and Road financial connectivity. First, it does not rely on government subsidy and operates independently. Moreover, it connects the government and the market and integrates resources. Second, it focuses on the long run and may provide mid-to-long-term credit support to meet particular need. Third, it leads and supports commercial capital through a market-based approach.
The debate on development finance has undergone different stages. At first, global trend was less favorable to development finance. In the late 1990s, in particular, the failure of Long-Term Credit Bank of Japan aggravated people’s negative views on development finance worldwide for a long time. Against this background, in the aftermath of the Asian financial turmoil, global policy-based and development finance was on a decline. After the 2008 global financial crisis, long-term public finance worldwide lost appeal to investors, especially financing for infrastructure, public facilities and other strategic fields. Due to the credit crunch of commercial financial institutions in the aftermath of global financial crisis, the international community acknowledged the need for development finance, and began to look for better ways of using development finance.
China has explored its own path of development finance. Based on China’s experience, development finance serves national strategy and is based on credit support instead of government subsidy. And it is a market-based financing model with the following characteristics, serving national strategies with credit enhancement, rather than government subsidies, operating independently on market principles, with emphasis on long-term investment and financial sustainability, ensuring principal safety and modest returns rather than pursing commercial profitability. It is in between concessional and commercial funds but tends to be more commercial. More than 20 years ago when development finance was at its early stage, development finance institutions rarely received subsidies or assistance due to very limited fiscal resources. In late 1990s, China Development Bank strongly supported the development of infrastructure, basic industries and pillar industries. Later it also supported enterprise efforts of going global, inclusive finance, student loans and poverty alleviation programs. These above projects are development finance, and have achieved financial sustainability without relying on fiscal subsidy. In recent years, China Development Bank and the Export-Import Bank of China have carried out many cooperative projects along the Belt and Road. Terms of credit are not the same as concessional loans or commercial finance, but the projects have generated modest returns and financial sustainability without government subsidy. Such projects are good examples of development finance.
The development of the Belt and Road have characteristic such as a long pay-back period and huge capital demand. Development finance, with its market-oriented, financial sustainability feature, its focus on long-term investment, can play an important role in the development of the Belt and Road.
Build a network integrating financial institutions and services.
The purpose is to establish an interconnected network to share benefits as well as risks. Main content includes facilitating domestic financial institutions to set up overseas branches and foreign financial institutions to set up local branches; connecting financial services, capital markets and financial infrastructures; communicating and cooperating with foreign regulatory authorities. In the past, countries in Belt and Road area mainly depended on financial resources and services from banks or other financial institutions of developed countries. However, those institutions were less motivated and busy with daily operation after the Great Financial Crisis, they can no longer provide enough capital to projects on the Belt and Road area. Moreover, the operating model, business philosophy and terms of loans of the financial institutions in developed countries cannot adequately meet the needs of the Belt and Road countries. Therefore, we can build a network of financial institutions outlets and services, enhance the cooperation among the Belt and Road countries, appropriately use recourses domestic and abroad, and provide long-term and reliable financial resources to them. Six key areas are listed below:
Facilitating domestic financial institutions to establish overseas branches and foreign financial institutions to open branches in host countries. Financial services are provided by financial institutions. In the context of globalization, establishing financial institutions abroad could help with overseas operation of local firms, introduce new services and products to the host country, better satisfy trade-related financial needs, fill the local service gap, learn from each other and improve financial services together. The establishment of overseas branches is a result of two combined forces, the first is motivation and needs from the financial institutions, the second is government facilitation by reducing access barriers.
Connecting financial services. The development of the Belt and Road not only needs cooperation in financing, but also needs lots of supporting services, including correspondent banking services, syndicated loans, clearing and settlement services, project loans, account management and risk management. In the absence of mutually established branches, business through correspondent banks will play an important role in providing financial services to Belt and Road countries. According to the agreement made by correspondent banks and the client banks, a correspondent bank would provide various kinds of services to adequately meet the clients' needs, including cross boarder money transfer, cash management, cheque clearing, making loans and refinancing, and issue letter of credits. Given the large amount of capital requirement and long investment horizon of Belt and Road projects, syndicated loan can fully exercise its advantages by providing financial resources to large firms or major projects and diversifying risks. It has great potential. Basic financial services such as clearing and settlement, project loans and account management can play a significant role in facilitating trade, investment as well as the firms' operations. The Belt and Road Initiative covers multiple jurisdictions across Asia, Europe and Africa. Undoubtedly, there are differences in many aspects, such as macro policies, economic development, financial system and investment environment. It is thus necessary to manage policy risk, market risk, counterparty risk and exchange rate risk by connecting financial services cross borders.
Connecting capital markets. Capital market is the platform to issue and trade bonds, equities and financial derivatives, in which financial institutions can conduct investment banking business and provide financial services such as merger and acquisition. Capital market integration can attract more international capital, reduce the dependence on traditional bank lending and help countries along the route to establish well-layered, full-service financial markets and expand their financial products. China has been actively working in that direction and has achieved certain progress. In recent years, with the progress of RMB internationalization and the inclusion of RMB to the currency basket of the IMF’s Special Drawing Rights (SDRs), countries along the route such as Poland and Russia have successfully issued yuan-denominated bonds (Panda Bonds) in China’s bond market.
Integrating financial infrastructure. Financial infrastructure refers to payment and settlement system, legal system and other financial regulatory policies and institutional arrangements. Integrating financial infrastructure in countries along the Belt and Road can improve financial market efficiency and financial stability. In recent years, China has also made some progress in this respect. For instance, as the bankcard clearing agency in China, China UnionPay has a cross-border network covering 160 countries and regions worldwide, including many countries along the Belt and Road. It not only provides safe, efficient and high-quality payment services to firms and individuals in various countries, but also contributes to the development of local payment systems. Thanks to the development of Fintech, all countries can promote more efficiently the development of inclusive finance based on core business of online/telecom payment and mobile banking. Countries can also strengthen experience exchanges to provide more channels and better coverage of financial services for Belt and Road countries. Financial infrastructure integration will also help to coordinate countries in development philosophy, regulatory standards and governance requirements, achieving integration in rules and regulations.
Let the international financial centers play an important role. It is critical to build a network integrating financial institutions and services. The amount under management of global institutional investors is over $100 trillion, there is a great potential for them to invest in the Belt and Road projects. Regional or international financial centers such as Hong Kong and London host large number of institutional investors and are connected with institutional investors elsewhere. Thus they can serve as important channels for project financing of the Belt and Road area. International financial centers are crowded with major financial institutions and service agencies such as accounting and auditing firms, and can provide professional services such as project financing and risk management for the Belt and Road projects, to efficiently manage financial, legal, environmental and market risks.
Communication and cooperation among financial regulatory authorities is indispensable for a fair, transparent and predictable competition playground. With better information communication and exchanges on local macro-economic condition, financial market development, financial regulatory principles and institutional mechanisms, investment opportunities and risks, as well as local operation and risks of large international banks, financial regulatory authorities can efficiently enhance mutual understanding and trust. Financial regulatory authorities in different countries also need to exchange information on priority issues such as market access, understand and properly handle mutual relations, jointly reduce all kinds of unreasonable access barriers and create an open, fair and orderly regulatory environment. Regulatory authorities should also strengthen cooperation in cross-border resolution and crisis management, anti-money laundering and macro-prudential management to better maintain market confidence and financial stability, as well as prevent and manage risks.
Let the local currency play a key role in the development of the Belt and Road
In the development of the Belt and Road, using local currency for investment and financing have many advantages:
- It helps to mobilize local savings and global capital. The development of the Belt and Road must make adequate use of both local and global resources. Using local currency for external investment and financing will help mobilize local savings, and generate reasonable returns, which, in turn, would serve as a good example to further mobilize local savings and international capital with positive feedback.
- It helps to reduce currency conversion cost. The recipient countries can use the local currency of the funding country to buy products from that country, without the need for currency exchange. As connections between the capital recipients and providers grow stronger, proceeds in local currency will accumulate and can be used for debt service, without foreign exchange costs.
- It helps to maintain financial stability. Increased use of local currency will strengthen confidence in it and improve its appeal. It also helps to develop local currency denominated capital market, expand investment and risk management instruments, and maintain financial stability. In addition, increased acceptance of local currency will help gradually reduce the reliance on major currencies such as the US dollar, and can reduce risks from volatilities of exchange rates.
There are ready and useful experience in the use of local currency in investment and financing in the Belt and Road development. China has already made valuable explorations in this respect. Since 2008, China has signed local currency swap agreements with more than 30 jurisdictions, including 22 countries along the Belt and Road. On the foreign exchange market, the Chinese currency is now directly traded against 23 currencies, including those of 8 countries along the route. Moreover, direct trading between RMB and the currency of 2 countries are available in regional foreign exchange market in China. All these have effectively reduced exchange rate risks and facilitated trade and investment. China has established RMB clearing arrangements in 23 jurisdictions, and designated RMB clearing banks, including in 7 countries along the Belt and Road. China has vigorously developed the Cross-border Interbank Payment System (CIPS), and many of the participants in the system are financial institutions from the Belt and Road countries. Overseas RMB clearing banks and CIPS have provided multiple cross-border clearing choices for overseas market players, improving payment and clearing efficiency, and facilitating investment. China is ready to share experiences with countries along the route, and jointly explore channels of local currency investment and financing to meet market demands and support economic development.
In conclusion, financial connectivity, as an important pillar for the development of the Belt and Road, requires fully mobilizing as many resources as possible, i.e. from the government, market forces, countries along the route, and international investors. By making good use of development finance, promoting the network of service outlets of financial institutions, and encouraging local currency financing, we can ensure sustainability of investment and financing, and truly achieve the objective of shared growths through collaboration and cooperation.
(Published on China Finance, 1 May 2017)
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