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China and South-Eastern Europe: Infrastructure, Trade and Investment Links1

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China and South-Eastern Europe: Infrastructure, Trade and Investment Links1 China and South-Eastern Europe: Infrastructure, trade and investment links1 July 2016 This note examines China’s growing economic links with south-eastern Europe (SEE). In recent years, China has become a major sponsor of flagship projects in the transport and energy sectors of the region. These projects are complementing efforts of the EU and international financial institutions to upgrade regional connections. Chinese-financed infrastructure investments are also motivated by the desire to enhance trade links with the region and facilitate direct investment by Chinese companies in various manufacturing and services sectors. Introduction China continues to expand its interests in south-eastern Europe (SEE). Several years after the first summit meeting of the Prime Ministers of China and sixteen countries of central and south-eastern Europe (“summit 16+1”),2 China’s economic presence in the region is no longer tentative and is likely to increase further in the coming years. The fifth 16+1 summit, which took place in the Chinese town of Suzhou in November 2015, confirmed that investments of up to US$ 10 billion would be made in the coming years in various projects, some of which are already under way. There is also continuing institutionalisation of the cooperation in the 16+1 format, highlighted by plans for the establishment of a permanent Business Council and the signing of a number of high-profile MoUs between state sector entities and governments on both sides. This increasing role for China in SEE is seen by both sides as mutually beneficial. For China, the attractiveness of the region stems from several considerations. Financing investment in the regional port, railway and highway infrastructure in SEE is part of China’s wider effort to support its global trade. With respect to foreign direct investment, Beijing – rightly – counts on the significant catch-up potential of SEE and the future integration of the entire region, including the Western Balkan countries into the EU.3 In economic terms, EU accession for these countries represents prospects for better access for Chinese companies to the main EU markets, as well as to the markets of the Western Balkans countries, where spending power will likely increase once they are in the EU. In political terms, this is a wise investment into what one day may be one-fifth of the enlarged EU in terms of number of members. Based on these long-term economic and geopolitical objectives, China seeks to present itself in SEE as a politically neutral force and a reliable business partner, which, among other things, addresses some concerns in the region triggered by the recent deterioration in relations between Russia and the West. 1 Paper prepared by Oleg Levitin, Jakov Milatovic and Peter Sanfey, Department of Economics, Policy and Governance, EBRD, with a contribution from Matthew Jordan-Tank, Banking Department, EBRD. 2 The 16 countries are: Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, FYR Macedonia, Hungary, Latvia, Lithuania, Montenegro, Poland, Romania, Serbia, Slovak Republic, and Slovenia. 3 For an analysis of the catch-up potential in the Western Balkans, see: “How the Western Balkans Can Catch Up” by Peter Sanfey, Jakov Milatovic and Ana Kresic, EBRD Working Paper No. 185, available at: http://www.ebrd.com/news/publications/working-papers.html. 1 For the investment-hungry countries of SEE Chinese investments are a welcome complement to EU funds. EU integration is the firm long-term choice of all SEE countries, supported by a wide cross-party consensus. However, when it comes to funding, some of them, particularly those in the Western Balkans, perceive Chinese finance as practically the only available way to overcome the following dilemma: access to large EU structural funds for candidate countries is not possible until they join the EU, but in order to make progress towards accession, countries need to improve infrastructure and transport links both within their borders and with neighbours. Western Balkans countries will continue to seek EU and IFI funding for major, capex-intensive infrastructure projects of European importance, such as the Adriatic Highway connecting Greece, Albania, Montenegro, Bosnia and Herzegovina, Croatia and Slovenia, a gas pipeline along the same route (an extension of the Trans Adriatic Pipeline (TAP) designed to bring Caspian gas through Greece and Albania to Italy), the so- called “Peace Highway” connecting Serbia, Kosovo and Albania, and other major transport and energy corridors accepted by the EC as part of the core European network. Regional leaders seem to have understood the importance of improved coordination and better prioritisation of regional projects. However, given the remaining financing gap, which the resources available through EU and IFIs funding alone currently cannot fill (even with the help of the Western Balkans Investment Framework, today the most effective tool for pooling these resources), the relatively slow process of project preparation, and other institutional obstacles, China is often able to present an attractive alternative with its offer of streamlined approval processes, state-backed financing, and speedy implementation. The major Chinese venture in the region will be the extension of its Belt and Road Initiative (BRI, also referred to as the ‘New Silk Road’ and ‘One Belt – One Road (OBOR)’) into the Balkans. As sea shipping remains the cheapest route from the Far East to Europe, China plans to establish a rapid transport connection from the Greek port of Piraeus, the first major European container port for ships entering the Mediterranean from the Suez Channel, through the Balkans further to EU markets – the Balkan Silk Road. This will come as the part of the BRI unveiled by China’s President Xi Jinping in 2013. The Balkan Silk Road will be based on the existing railroad corridor X linking Central Europe with the Aegean Sea via Hungary, Serbia, FYR Macedonia and Greece. The first operational move to realize the plan was made when the Chinese shipping giant Cosco Pacific bought into the existing Piraeus port in a 35-year concession, with the aim of turning the port into one of Europe’s top five container ports. Transit time between Shanghai and Piraeus is approximately 22 days, 10 days less in comparison to the transit time between Shanghai and the North European ports of Rotterdam and Hamburg. By shortening the delivery time between China and Europe in a significant way Piraeus could become a major penetration point for Chinese goods in Europe. However, to take full advantage of the port, the Chinese investors understand that investments into the transport links across the Balkans are needed. Railway modernization and better regionalisation of the network across the region, such as major improvements to the railway between Belgrade and Budapest, are part of the plan. Beyond pure investment in physical upgrades to rail network, it will be also critical to harmonise rail track access for regional rail freight operators in order that regional goods movement by train can occur without having to switch carriers as each border. Such actions, though critical and long understood, require political will by governments to mandate changes within their state-owned rail companies to open their networks to international operators. In a region composed of several small countries, this issue carries even greater importance. China’s economic links with SEE come in three broad forms. The highest-profile involvement is through direct lending to governments for infrastructure – roads, railways, 2 ports, power plants, etc. The second way is through trade links: Chinese exports to, and imports from, the SEE region have grown dramatically in the past decade, with the potential for further strong growth in the coming years. Lastly, Chinese companies are showing an increasing interest in direct equity investments in SEE. 1. Lending for transport and energy infrastructure Regional integration through transport projects has become a key priority for SEE countries, while development of energy resources is also crucial for the region’s future. Chinese funding in SEE is highly visible in these two sectors. The upgrade and modernisation of the region’s infrastructure are not only crucial for economic development in the Balkans, but would also considerably shorten existing trade routes between China and Western Europe and therefore reduce the costs of trade between these two major trading blocks. Financing is usually offered on favourable financial terms relative to most alternatives. Typically, funding comes as a loan from the state-owned Exim Bank of China covering about 85 per cent of the needed capital, with the rest financed by the home (i.e., recipient) country. The loans normally have a long maturity (of ca. 20 years) and low interest rates (at ca. 2 per cent). However, while these conditions may seem attractive, the spillovers to the rest of the economy are sometimes limited as Chinese companies often bring their own workers and supplies, and rely only to a limited extent on local resources. A further concern is that loans are usually contracted in US dollars which, given the recent strengthening of the dollar, is an added burden for SEE countries with currencies tied to or closely shadowing the euro. This foreign exchange risk for SEE will grow as the cumulative size of Chinese-supported investments made on dollar terms increases. Major transport projects are already under way. The bridge over the Danube in Belgrade, opened in December 2014 by the Chinese and Serbian PMs, was the first major Chinese- supported infrastructure project completed in the region, and was built with significant Chinese labour under the terms of the bilateral agreement. In transport, flagship projects supported by Exim Bank loans include motorways in both Bosnia & Herzegovina and FYR Macedonia. A huge road project has started in Montenegro, linking the country’s port of Bar on the Adriatic Sea to the border with Serbia.
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