China’s Southeast Asia Infrastructure Gambit

The governments and people of Southeast Asia must develop a strong sense of ownership and control over infrastructure projects as China increasingly directs its investments towards the region’s infrastructure.

China has pledged US$40 billion for its “New Silk Road Fund” to strengthen transport networks in and between its neighbors. The Silk Road Economic Belt aims to connect China with Europe via Central Asia by land, while the 21st Century Maritime Silk Road will facilitate the development of seaports and maritime connectivity in Southeast Asia and beyond.

China also wants to make Kunming, the capital of Yunnan province, the gateway to Southeast Asia through a high-speed railway network that will potentially extend through Laos, Cambodia, Myanmar, Vietnam, Thailand, Malaysia and Singapore.

In 2014, China became a net capital exporter for the first time, with outward direct investment (ODI) surpassing inward direct investment. It is also now the world’s sixth largest provider of foreign aid, according to the Japan International Cooperation Agency’s latest estimate. Further cementing its presence in ASEAN, China is the region’s third biggest external investor, after the European Union and Japan.

China’s overseas expansion comes as domestic returns on investment have steadily declined over the last decade, with gross capital formation reaching nearly 50 percent of GDP. Inefficient investments can also be seen in the emergence of housing bubbles across the country. On the other side of the equation is mounting total debt, estimated to be as much as 282 percent of GDP.

Recognizing the severity of these potential problems, the Chinese authorities have begun to undo decades of financial repression by reducing entry barriers and liberalizing interest and exchange rates. The situation in China now resembles the Japanese economy in the late 1980s, when following similar reforms Japan witnessed a sharp drop in asset prices. Japan then struggled with accumulated non-performing loans for a decade, followed by the ongoing battle with persistent deflationary pressures.

Why should this concern Southeast Asia? China’s ODI has been associated with expanding the overseas business of Chinese state-owned enterprises (SOEs) in exchange for providing recipient countries with low interest capital. This “going out” policy of SOEs — fuelled by China’s foreign exchange reserves — has raised skepticism. Peking University Professor Yiping Huang warned in a recent opinion piece that “more than half of its [China’s] deals do not provide financial returns … Many state-owned enterprises did not have to shoulder any responsibilities when they failed in their overseas deals. Their blind spending was risky and had a hard time turning a profit, wasting foreign reserves.”

While China funds infrastructure building in Southeast Asia, a number of recipient governments lack the ability to craft bankable development master plans. Their plans instead tend to be prone to inefficiency and corruption. The Asian Development Bank (ADB) estimates the region’s infrastructure needs to be US$8 trillion in this decade alone, but the ADB and the World Bank have a hard time finding economically viable projects. And the more China’s capital flows into ASEAN, the more ASEAN would suffer if China’s economy slows down dramatically.

The 2014 G20 summit identified infrastructure demand in the developing world as a new source of global growth, but financing infrastructure with foreign capital may be a poisoned chalice. China is eager to lend while local governments are eager to borrow. This situation requires a mechanism that can ensure borrowers do not take excessive risks simply because someone else bears the burden of those risks.

Infrastructure is a public good with a typical life cycle stretching over several decades. Building roads, ports, railways, telecommunications facilities, power stations and water supplies will provide a rapid boost to GDP and is therefore often used to attract short-term political support. But the life cycle profitability of an infrastructure project must be assessed carefully before the contract is signed, taking into account any long-term maintenance and operational costs. Local governments and citizens ultimately own the infrastructure and bear any risks. If they do not have a strong sense of ownership and control, we may see more white elephants in Southeast Asia in the future.

This was written for the East Asia Forum. Tomoo Kikuchi is a Senior Research Fellow and Takehiro Masutomo is a Research Associate at the Centre on Asia and Globalisation, Lee Kuan Yew School of Public Policy, National University of Singapore.