The risks to ’s A Silk Road Economic Belt. Double-Edged Sword

By Friedrich Wu, Vidhya Logendran and Wan Tin Wai

hina means business when it comes to the Silk Road Economic Belt and Maritime Silk Road. That was evident at the Boao Forum in March where President Xi Jinping delivered a keynote address providing the first in-depth explanation of China’s vision for the Belt and Road Initiative. Envisaged as both a network of physical infrastructure such as railways, highways, oil and gas pipelines, and power grids, as well as a facilitator of greater trade and financial integration, China fore- Csees the Belt and Road Initiative feeding the demand for infrastructure investment and fostering greater growth in Asia, Africa, and even Europe. Of course, China would reap benefits from this bold initiative, too. The Chinese implemented a “Going Out” strategy in 1999 to complement their country’s stellar inward foreign direct investment-driven economic growth. In fact, China is expected to be a net exporter of foreign direct in- vestment in 2015, not unexpected for the world’s second-largest economy holding the world’s largest official foreign exchange reserves.Y et China faces some formidable domestic economic challenges, one being the un- even development between its coastal and inner regions, especially the western provinces of Xinjiang and Tibet. Indeed, the Silk Road Economic Belt would provide new impetus for China’s western development strategy The Magazine of international economic policy 220 I Street, N.E., Suite 200 Friedrich Wu is adjunct associate professor at the S. Rajaratnam Washington, D.C. 20002 School of International Studies at Nanyang Technological University Phone: 202-861-0791 Fax: 202-861-0790 in Singapore. He was a former director of economics at Singapore’s www.international-economy.com Ministry of Trade & Industry. Vidhya Logendran and Wan Tin Wai are [email protected] recent MSc. graduates from the same school and university.

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and create new opportunities for accelerating the eco- nomic transformation of the country. China has already been building trade and invest- It was China’s thirst for energy that first ment linkages with the Central Asian republics since their independence in 1990. Yet doubts persist as to whether China would succeed with the overland vision drove it to the Central Asian republics. of the Silk Road Economic Belt, particularly when faced with headwinds of extremism in a region characterized by latent ethnic conflict, porous borders, and shaky re- gimes. Bilahari Kausikan, Singapore’s -at- advancing its economic influence. State-owned enter- large, claimed recently that the Chinese initiative might prises have been able to parlay this influence into busi- fail in Central Asia because “it is building on the very ness wins. For example, in 2013, the Kazakh government treacherous sands of intrinsically unstable regimes.” used its preemptive rights to buy an 8.33 percent stake What lessons can China learn from its experience in in the Kashagan oil project, which it then sold to China Central Asia thus far as it embarks on its ambitious Silk National Petroleum Corporation, thereby blocking a pro- Road Economic Belt? posed sale to ’s Oil and Natural Gas Corp. Another factor facilitating China’s success in Kazakhstan is the How Chinese bucks get acceptance of the Kazakh government’s stipulation that the biggest bang in Central Asia all Chinese investments must involve the Kazakh national It was China’s thirst for energy that first drove it to the oil company, KazMunaiGaz. China often sweetens deals Central Asian republics both through investment and also by offering loans and to the Kazakh government so trade, where China quickly became the largest trading part- that it may purchase stakes in these Chinese investments, ner for all the Central Asian republics except Uzbekistan. like in the case of the 2009 purchase of MangistauMunai China imported oil and gas from the natural resource- Gas where China National Petroleum Corporation pro- rich countries such as Kazakhstan and Turkmenistan. vided KazMunaiGaz a loan of U.S. $5 billion to secure 51 Turkmenistan is China’s largest foreign source of natural percent of the company while China National Petroleum gas, accounting for over 52 percent of Chinese imports in Corporation itself retained 49 percent. China is a major 2013, and in turn, China has replaced as the big- source of money and a benefactor, but has refrained from gest market for Turkmeni gas. Kazakhstan is the region’s interfering in these countries’ internal politics, a practice largest oil supplier to China, accounting for 4 percent of it is likely to continue with the Belt and Road Initiative. It China’s total crude petroleum imports in 2013. differs markedly from Russia, which often seeks political By investing in oilfields and pipeline infrastruc- concessions in return for financial support, or the West, ture such as the China-Central Asia pipeline, China has particularly the and the European Union, helped reduce the reliance of Central Asian republics on which often place conditions on funding. the legacy of Soviet-era pipelines and diversified their energy . China National Petroleum Corporation Potential Speedbumps along the Silk Road is the majority owner of two of Kazakhstan’s major oil But Chinese investment in Central Asia has been a double- companies (it owns 85.42 percent of AktobeMunaiGas edged sword. Chinese transactions are often shrouded in and 67 percent of PetroKazakhstan) and is involved in secrecy, executed through forging links with the political several oil exploration and production projects through- elite, thus stirring up the suspicions of both lower-level out the country, accounting for about 25 percent of bureaucrats and concerned citizens in the host countries. Kazakhstan’s oil production. Chinese enterprises are also often criticized for their Moreover, trade with the Central Asian republics is poor labor conditions, unfair pay, abuse of local work- closely tied to the Xinjiang region, where China seeks ers, and unsustainable environmental practices, leading to counter increasing unrest with accelerated investment to protests and even violence against them. In October and generous economic subsidies. Two-thirds of the 2012, the head of the Chinese Chamber of Commerce trade between China and Kazakhstan, for example, con- in Kyrgyzstan, Li Deming, wrote in a state-run Chinese sists of trade with Xinjiang, while 49 percent of invest- media outlet that doing business in Kyrgyzstan was “not ments from China were by Xinjiang-based companies. easy.” This was after 250 Chinese workers from China’s How has China been able to gain traction in Central Superb Pacific Limited were forced to flee operations at Asia? China has used government-to-government mech- the Taldy-Bulak Levoberezhnyi gold field after a protest anisms and the Shanghai Cooperation Organisation for Continued on page 91

Spring 2015 The International Economy 69 Berry

begin raising rates as soon as possible, noted recently that Stone & McCarthy Research Associates, a financial “readings on some indicators have been unexpectedly markets research firm, surveys its clients shortly before weak in recent weeks, some of which may be attributable each FOMC meeting about their expectations for policy to unseasonably adverse weather. It’s too soon say how decisions. Currently the key question was when lift off much, however, and the more prudent approach is to look would occur. The committee earlier said it would not hap- through very short-term fluctuations and assess emerging pen at the late April meeting. A few of the SMRA clients trends based on a longer run of data.” For one thing, the thought the action might come at the mid-June or late healthy gain in payrolls since the middle of last year will July meeting, but a solid majority said mid-September is help consumer spending to continue to rise, with overall the most likely time. GDP growth of more than 2 percent this year. Former Fed Vice Chairman Donald L. Kohn, who Lacker’s counterpart at the New York Fed, William is now at the Brookings Institution, said that Yellen ap- C. Dudley, is more cautious than Lacker about raising pears to be trying to downplay the timing of the lift off. rates. “The unemployment rate is still too high and the Correctly so, in his view, because when rates are first in- inflation rate too low,” he said late last month. “Because creased they “will still be extraordinarily low, and what the economic outlook is uncertain, I can’t tell you when determines financial conditions is not today’s federal normalization will occur. The timing is data dependent.” funds rate but the expected trajectory out into the future.” Then he used a phrase that caught the attention of many The focus on the trajectory also makes it clear that analysts: “When, hopefully, the data support a decision under the leadership of Yellen, Fischer, and Dudley, the to lift off later this year…”. Fed will be moving cautiously because of all the uncer- “Hopefully” means that Dudley, who is also vice tainty about the economy and the state of financial mar- chairman of the FOMC and is the only one among the kets. And at this point, they all believe that if a mistake dozen bank presidents who has a vote at every meet- is made, the consequences of waiting too long for lift off ing, like Yellen isn’t going to rush to raise rates based on or moving too slowly thereafter can more easily be cor- some outdated rule of thumb. rected than moving too soon or too aggressively. u

Wu, Logendran, and Wan

Continued from page 69 by Kyrgyz workers against mistreatment and environ- and high-technology sectors. South Korean automobile mental degradation turned violent. In 2013, Kazakhstan companies Ssangyong and Hyundai have built assembly fined China National Petroleum Corporation U.S. $50 plants in Kazakhstan. A Korean-Kazakhstani Technology million for numerous environmental violations. In late Cooperation Center has been established to promote co- 2013, China financed the construction of Kyrgyzstan’s operation among Kazakhstani and South Korean compa- first oil refinery, ending that country’s complete depen- nies and research institutions through joint research and dence on Russian oil. However, by early 2014, work on development, training, and other projects. A recent re- the refinery was suspended by the Kyrgyz prime minister port by the Asia Society states that “Beijing should think after local protestors demanded that the polluting plant about expanding its cultural and philanthropic activi- clean up its act. ties in Central Asia, facilitating educational exchanges, China’s win-win proposition for the Belt and Road and investing in projects outside of the energy sector.” Initiative notwithstanding, it is likely to face similar re- Unsurprisingly, China’s recently concluded deals with sistance across the region. As such, China has to quickly Kazakhstan to the tune of U.S. $23.6 billion involve the learn to deploy together with hard cash to steel, non-ferrous metals, sheet glass, oil refining, hy- smooth its way. South Korea has also built close trade dropower, and automobile industries, showing China’s relations with Central Asia in the last decade in search resolve to broaden engagement with Central Asian of new energy sources, but is viewed as less threatening economies. Beijing also needs to encourage dissemina- by the Central Asian economies because of its strategy of tion of Chinese cultural power by popularizing Chinese a broader-based engagement with the region which has language, arts, and heritage. However, perceived threats resulted in investment in healthcare, retail, automobile, of Sinicization together with China’s preponderant

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economic clout make this an onerous task, especially when cultural influences are disseminated through state channels. In this regard too, South Korea seems to enjoy Islamist influence on Uighurs in the an edge with the putative popularity of K-pop and Korean drama in Central Asia. Xinjiang region is already a problem. Geopolitical Considerations Two main risks stare China in the face as it charges ahead with the Silk Road Economic Belt. Despite outward sta- bility, many Central Asian regimes mask fractious societ- Asian governments such as Kazakhstan to curb support ies, with rising income inequalities, endemic corruption, for Chinese Uighur separatist activities from their local and latent ethnic tensions. Kyrgyzstan is the only Central Uighur communities. The Silk Road Economic Belt, how- Asian republic with a fragile parliamentary , ever, is envisaged as connecting China intricately with while authoritarian presidents rule all the other republics. the through a largely Muslim Central Asian Regime change in all the republics is likely to be fraught conduit, where indigenous Islamist movements such as with political instability, which may threaten Chinese the East Turkestan Liberation Organization and Islamic business interests. In recent years, newly elected govern- Movement of Uzbekistan also fester. Roads, as they say, ments from Sri Lanka to Greece have sought to gain popu- run both ways. China would be forced to deal not only lar legitimacy by often raising the specter of the Chinese with potentially emboldened separatists in Xinjiang but economic bogeyman. also with the security threats that their investments may Some Central Asian republics have also shown a ten- face from terrorist groups. China’s foreign policy ori- dency toward cultivating other powers in or outside the re- entation of non-interference in domestic affairs and the gion as a countervail, despite welcoming Chinese invest- pursuit of a “peaceful periphery” may both be severely challenged, demanding more aggressive diplomatic or military responses which would contravene Beijing’s hith- erto non-interventionist foreign policy orientation. Chinese enterprises are also often The Road Ahead While the path ahead in Central Asia may seem treacher- criticized for their poor labor conditions, ous, it is a known quantity with respect to business risks. As the Belt and Road Initiative starts taking more of a center stage in Chinese international policy formulation, unfair pay, abuse of local workers, and China would need to consider building new paradigms of interaction with its Central Asian neighbors by building a security framework bilaterally or through the Shanghai unsustainable environmental practices. Cooperation Organisation. While addressing the obvious threats to security such as terrorism, China may also need to ponder threats emanating from weak political institu- tions in these countries which are inherently unstable, ment with open arms, as they do not want to “exchange their current authoritarian regimes notwithstanding. China Russian dominance for Chinese dominance,” according to would also need to look to fostering broader ties with the Niklas Swanström, director of the Institute for Security local communities in these countries to counter suspi- and Development Policy in Sweden. Central Asian repub- cion of collusion with the elite and also to better navigate lics also actively engage the European Union bilaterally to change in regimes, if any. This poses unique challenges diversify their trade markets and investment sources. to China, which has scrupulously eschewed any Islamist influence on Uighurs in the Xinjiang region of ideology and its own peculiar institutional framework. is already a problem that China seems to be at a loss to Whether economic influence of the magnitude envisaged deal with effectively. In the past, China had relied on by the Silk Road Economic Belt can be divorced from po- expeditious resolution of border disputes under the ae- litical entanglements in Central Asia will be a formidable gis of the Shanghai Cooperation Organisation and its issue for Chinese policymakers to grapple with in the fore- economic to gain the cooperation of Central seeable future. u

92 The International Economy Spring 2015