OBOR: Economic, Diplomatic and Strategic Dimensions

INTRODUCTION

   OBOR was presented to the world by China in March 2015, as a comprehensive infrastructure & economic development program.[i] Its land component, the new Silk Road, echoes ESCAP's Asian highway, Asian Railway and Asian Economic Corridor Plans from the 1980s and 1990s.[ii] But more importantly it fills in what may be considered missing links, connecting China to the rest of Asia and into Europe.[iii] The naval parts echo what was termed the "String of Pearls" in the Indian Ocean, but extends these Westwards to Europe through the Red Sea and Eastwards to the South China Sea.[iv] Questions and concerns have however been raised about its less defined Strategic aspects, just as they were raised about the "String of Pearls," which was also presented as an economic infrastructure project for development of ports.

ECONOMIC Aspects

     The economic development part is driven and supported by massive overcapacity in China's manufacturing and construction industries and zero or negative returns to domestic investment (on the margin). Thus the opportunity cost of funds is low enough to allow low profit, high economic risk, investment in foreign infrastructure that could support its quest for future raw materials supplies and open its markets to sale of manufactured goods; a modern version of the Prebisch-Singer hypothesis of trade between the colonial "Center" and the colonized  "Periphery".  As current account surpluses are a basic feature of the existing "party capitalism" model of development, a moderate reduction of foreign exchange reserves through capital outflows, still leaves substantial net foreign exchange assets to finance the foreign exchange costs of these investments.  As much of the foreign investment in OBOR will be done by Chinese companies, Chinese labor and Chinese materials, the foreign exchange component is a small fraction of the total cost of these projects. The primary purpose of AIIB is therefore not to supply foreign exchange funds to OBOR projects, but to herald the arrival of China on the global financial stage and to act as the foundation for its global financial diplomacy.

   The land based infrastructure (road, rail, pipelines, digital backbone) aims to connect China to all parts of the Eurasian continent and to the Seas & Oceans surrounding Asia. The countries that such infrastructure passes through (rail, road, pipeline, fiber optic cables) or is located in (port, airport, industrial estate) have to provide the land on which it is built. They may also have to take on debt to pay for part of the real/full cost of this infrastructure. It is uncertain whether the economic benefits they will receive will exceed the costs they incur in terms of land, debts to China etc. I know an economic expert who has been hired by a Central Asian country to evaluate the benefits of a China proposed rail line that will cross its territory, and he was hard put to think of the benefits to this country which may become feasible (e.g. new exports). OBOR countries have to be extremely careful in evaluating the benefits and costs to them of any infrastructure built by China. The cost of permanently transferring land to Chinese Companies and/or taking on debt on behalf of projects, could prove very onerous to host countries in the medium-long term. 

      If the infrastructure is genuinely economic & not strategic, every country in the World should be able to use it once built, as this improves its economic viability, given sunk cost. So third countries, including India, have nothing additional to gain from "joining" the OBOR which will be built by Chinese Construction/ infrastructure companies. All Commercial  companies, including Indian ones, have the option of using the infrastructure (roads, railway, ports, airports, industrial estates) if it reduces costs and improves profitability.

     The AIIB is unlikely to be the primary source of funding for the OBOR, which from available numbers, requires funds of an order way beyond the capacity of the AIIB. As the bulk of financing will be domestic currency financing needed by Chinese construction companies, all that the AIIB can do is to provide the fraction of funds needed in the form of foreign exchange. More importantly, the AIIB is(in my view), needed to provide an international stamp of respectability to OBOR projects. This is suggested among other things, by the timing of the announcement of AIIB so soon after the formation of the New Development Bank (NDB) also referred to as the BRICS bank. The agreement to form the NDB was signed in Brazil in July 2014, after years of discussion.[v] China signed an MOU with 24 countries in October 2014 for the formation of the AIIB, five months after the unveiling of the new silk road and three months after the agreement to form the NDB.[vi]

    A Chinese scholar was recently asked about his estimate of the economic risks and returns to China of OBOR projects. His answer as reported without attribution, was that he didn't expect repayment of 80% of loans to CPEC projects, while repayment on other OBOR project loans would be between 30% and 50%. This implies, (a) That the rate of return on 80% of CPE projects and 60 to 70% is negative. It is not too far-fetched to assume that the rest of the benefits to China would be non-economic, i.e. Diplomatic and Strategic. Even in the projects with a positive rate of return, the economic and social return to the host country, accounting for the contribution of land, oil/mineral resources and natural resources like harbours & dam sites, is likely to be negative. 

DIPLOMATIC Aspects

  The OBOR is however, much more than a connectivity cum economic  program, it is also a comprehensive diplomatic initiative of a rising China.  It is a an instrument of China's diplomatic objective of ensuring that Asia and the World recognize China as a Great Power.  According to the Virmani(2004) Index of Power Potential (VIPP), China became a "potential great power" about  seven years ago, with its economic power exceeding 25% of that of the USA.^[vii]  Its relative economic power has grown rapidly since then to reach 42% in 2015, as per this index VIPP.  The OROP is viewed by the party leadership as an umbrella program for interaction with every country in Asia and the surrounding Seas.

The diplomatic initiative can be seen at three levels: Intellectual, Political and Financial:

(1) Intellectual: OBOR provides a framework for interaction with Academics, Think Tanks and Media, interested in economic development, infrastructure investment and trade & economic relations. This can facilitate movement in both directions; Chinese financed visits of foreign interlocutors to Chinese institutions and invitations for Chinese academics to these countries.

(2) Political: OBOR provides a framework for interaction with the political establishment, including government ministers, of each country. As in the case with intellectuals and academics, the Chinese can facilitate the visits of foreign politicians to China for the purpose of discussing OBOR. It provides a very useful cover for Chinese experts to explain their national position on every issue, including the South China Sea, Japan and USA.

(3) Financial: Every government minister is looking for funds to relieve budget constraints and finance pet projects. OBOR provides a framework for Chinese officials (Party, Govt) concerned with Chinese economy to interact with their counterparts in potential host countries, on their projects, programs and economic development objectives. At some stage it also involves the highest political authorities such as the Finance Minister and the Prime Minister/President of the country, allowing China's views on any subject of their choosing to be heard respectfully.

    Announcements of large financial projects and Programs attract widespread attention of all segments of society, even without any hard economic & financial analysis to determine viability. The personal contacts built during discussions can also be used to finance individual pro-China leaders, politicians & others, as allegedly happened in some S E Asian countries.

STRATEGIC Aspects

   The general strategic objective of OBOR is to  increase China's influence in the countries covered, to reduce US influence in these countries, and to pre-empt any potential increase in influence of US or its allies (existing or future). More concretely, the goal is to establish a strategic presence in these countries, including through sale of military equipment.  The strategic dimension of OBOR has two clear components. The continental and the maritime:

(1) Continental: This takes the name of the old silk road's disparate tracks across Central Asia, and applies the name to a "Hub and Spoke"  system of highways and railways radiating from China at its Center or Hub.  Given that oil pipelines and fiber optic info-ways did not exist at the time of the silk road, this is obviously a modern and valid add-on to traditional highways.  Given China's dependence on imported energy, the oil and gas pipelines are particularly important for diversifying both sources and supply routes for energy. The immediate strategic objectives are, (a) To  secure Central Asian and other neighboring Islamic States (Pakistan, Afghanistan, Iran)  from becoming a base for Xinjiang Liberation Movements, and (b) A revival of the old "Great Game", to develop land routes from continental Asia (China) to the Indian Ocean (through the Bay of Bengal, Arabian Sea and Gulf of Iran).

(2) Maritime: As "silk" is associated with China and the "Silk road" with connectivity, the Maritime dimension has disingenuously been called "Maritime Silk Road".^[viii] The "maritime silk road", clearly represents an evolution of what many called the "String of Pearls strategy".  All analysts writing on the "String of Pearls" agreed, that what had been done and planned so far was primarily economic.  However, those who were most suspicious about the "String of Pearls" warned that it was not merely possible but likely that these Pearls would be transformed into strategic bases, once the economic part was developed. The "Maritime Silk road" concept and the new security strategy[ix] has brought this potential development right into the present.  The strategic maritime dimension of OBOR is to develop a string of logistics basis in the Indian Ocean region, with likely conversion in future, of a few of them into naval bases. From China's perspective, the most desirable geographical locations for naval bases are those at the intersection of the "Maritime silk road" and the "New silk road" i.e.  those Ports that can be connected by overland route to China.[x]

CONCLUSION

  The post World War II, Marshall Plan was explicitly designed to help the revival of devastated European allies and to complement the makeover of Germany in its own image. This paid good social, economic and diplomatic dividends to the USA. However it was complemented by creation of NATO & other military blocks explicitly designed for Strategic purpose. Eventually each complemented the other, even though they may not initially have been part of an integrated economic, diplomatic and national security strategy.[xi]

   OBOR is presented to the world by China, as an infrastructure & economic development program. It is in reality an umbrella for a comprehensive but evolving, Economic, Diplomatic & Security strategy.[xii] It is part of a "Middle Kingdom Doctrine" (authors characterization) that seeks to make China the Central power in Asia: A (soon to become) Super Power that dominates Asia and its surrounding Seas and Oceans & exercises varying degrees of "suzerainty" over peripheral areas (including less well off parts of East Europe).[xiii] One strategic implication of this doctrine is to reduce and eventually eliminate US strategic power and influence in Asia and the surrounding seas.
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A version of this article appeared in the Salute Magazine, July-August 2016:  http://www.salute.co.in/one-belt-one-road-obor-economic-diplomatic-and-strategic-dimensions/

Footnotes:-

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[i]  http://news.xinhuanet.com/english/china/2015-03/28/c_134105858.htm .  In May 2015, we heard about it personally from Chinese scholars, one of who frankly admitted that even scholars like him were not aware of it a 3-4 months earlier, when they were asked to start work on fleshing out the concept of OBOR. 

[ii]  http://www.unescap.org/our-work/transport/asian-highway, http://www.unescap.org/our-work/transport/trans-asian-railway, https://en.wikipedia.org/wiki/Asian_Highway_Network ,  https://en.wikipedia.org/wiki/Trans-Asian_Railway

[iii] The new silk road was unveiled in May 2014 (not in 2013 as now claimed by some: A tentative mention of an idea by a leader is very different from a reasonably worked out Government initiative). https://www.google.co.in/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0ahUKEwjd37PR3ODMAhVEFZQKHadmDfcQFgghMAE&url=http%3A%2F%2Fthediplomat.com%2F2014%2F11%2Fthe-new-silk-road-chinas-marshall-plan%2F&usg=AFQjCNESJKb91Dup4gkiXit38EjW7eNmEA http://thediplomat.com/2014/05/chinas-new-silk-road-vision-revealed/

[iv]  https://en.wikipedia.org/wiki/String_of_Pearls_%28Indian_Ocean%29 , http://thediplomat.com/2015/12/is-chinas-maritime-silk-road-a-military-strategy/, http://csis.org/files/publication/140624_issuesinsights_vol14no7.pdf

[v] I was personally involved in some of these discussions, as Executive director at the IMF, Washington DC, from November 2009 to October 2012, charged with overseeing financial discussions among the BRICS. During this period there was no hint that an AIIB may be formed at the initiative of China.

[vi] https://www.google.co.in/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2  

[vii] See references at https://sites.google.com/site/drarvindvirmani/india-great-power .

[viii] The inclusion of "road" in the designation of a maritime initiative is puzzling to all but those who think every word that CCP leaders use is a nugget of philosophy.

[ix] https://muse.jhu.edu/article/611561/pdf , http://www.chinadaily.com.cn/china/2015-05/26/content_20820628.htm ;

[x] This explains China's keenness to develop ports in Pakistan, Bangladesh and Myanmar. But it also suggests that China may be willing to complement the development of a naval base at Gwadar, Pakistan (CPEC), by participating in development of connectivity to Chabhar port in Iran.

[xi] Chinese Admiral Sun apparently admitted that OBOR has strategic dimension at Singapore Strategic Dialogue 2016: https://twitter.com/d_jaishankar/status/739277268237746177

[xii] Chinese scholars indicated to us (about 20 people), all of them have been instructed to work on OBOR & come up with something (presumably every think tank" in China),

[xiii] According to the VIPP index, China will become a "potential Super Power" at the end of this decade.

Asian Infrastructure Investment Bank (AIIB): Q & A

Q1. Do you think India's decision to put in $ 8 billion -- and become the  second largest shareholder after China -- makes sense?

 A1: As with any company the owned equity capital is not the same as paid up  capital. Thus $8bi is the risk capital committed by India. The amount put  into the account of AIIB will be much less. Being the second largest shareholder gives some influence in determining the nature & amount of loans to infrastructure projects of interest to India, both within India and in other countries which have an overlap of interests with us or similarity of  approach to infrastructure lending.

Q2. From a lay person's point of view -- why doesn't India spend the $ 8  billion on infrastructure projects at home? What would be the added benefit of putting this money in and accessing it through the bank's pool?

 A2: As indicated in A1, the actual money spent by us initially will be a fraction of $8bi committed. The nature of multinational banks is such that actual lending depends on borrowed funds, which are related both to the risk capital committed by all shareholders and the credibility of the institution in Global capital markets. Thus the funds available to the AIIB will be a multiple of the outlays. The loans we get will depend on the proportion of viable projects that are put up to the bank, ie potentially much more loans than the amount we put in equity.

 Q3. China is by far the biggest shareholder, with $ 29.7 billion (out of $ 100 billion capital). According to the voting structure, this will give them a strong say in most decisions (although their influence has been a little diluted in the negotiations process, as voting doesn't just reflect your shareholding but also takes into account your founding member status etc.) Is this unavoidable in a financial institution -- that the majority stakeholder dominates? Will this be a problem for India?

 A3: There is no better way to run a global institution than on basis of voting based on equity shares.  Just as the ADB is a Japanese run bank with US having a significant influence, the AIIB will be a Chinese run Bank. However, given the different relationship between US & Japan, our influence in the AIIB cannot match that of US in ADB. However, India's influence will
 depend on getting support for other share holders in pushing rules and procedures for lending that are seen as objective and rational, and enhance the credibility of AIIB on international debt markets where it will have to raise resources.

 Q4. The bank's officials in Beijing say it aims to position itself differently from the World Bank and ADB by focusing on infrastructure projects -- no poverty reduction/social welfare programs etc. Is this a good idea?

 A4: As the name says clearly this is a bank for infrastructure lending, where there is the greatest gap between needs-demand for loans and supply of loans. These are the sectors that require a lot more capital. This is something we had analysed and focussed, on in proposing the New Development Bank in 2012, when I was at the IMF. The World Bank has been unable to
 fulfill the demand for infrastructure loans as it DC shareholders didnt want to increase the authorized capital. Consequently, it has increasingly focussed on the soft sectors requires less capital investment and tried to substitute "knowledge" for even the lower capital needed.

 Q5. The process of putting out its environmental framework has been criticised -- that this was done in six weeks, that the documents were entirely in English, and that diverse views, ncluding of civil society groups in member countries, were not considered. The bank says the time period and framework meet international standards and follow the standards set by other multilateral banks. There is a fear that since China's shadow on this bank is rather large, it will follow China's (poor) standards when it comes to environment and human rights. Do you think this fear is well-founded?

 A5: China is likely to accept the national environmental standard prevalent in the country in which the project is located, rather than imposing any uniform standards.  To these national standards are below ADB or World Bank standards, the fear is justified.

Written (email) interview to Ananth Krishnan of India Today, Beijing on January 16, 2016.