China’s partnerships could lead the way

China’s distinct form of financing infrastructure could prove to be a driving force in realising the sustainable development agenda

Daniel Poon, Richard Kozul-Wright

Development, Economics and finance | East Asia

9 December 2015

China’s public-public partnerships could offer lessons for sustainable development, write Daniel Poon and Richard Kozul-Wright.

The third UN Conference on Financing for Development is now behind us, and building inclusive low-carbon development paths is the challenge ahead. But with no new funds or funding mechanisms identified during the Addis process, how does the international community intend to pay for the big investment push this challenge implies?

Much of the talk has been about public-private partnerships (PPPs) as the way to mobilise domestic and foreign resources of the requisite scale. But while these may have a future role to play, there is little in their record that suggests they can lead the required big push.

Take the issue of infrastructure – transportation, electricity, water and sanitation, etc. – where the financing gap in developing countries has been conservatively estimated to be between $1-1.5 trillion annually. Yet PPPs are estimated to have contributed just $159bn in 2013, with a heavy bias towards telecoms (and energy) projects, that leaves the bulk of financing for other critical, but less-profitable, infrastructure projects reliant on the public sector.

The only directly related initiative from the Addis gathering was a call to launch a “global infrastructure forum”, to better promote and coordinate PPPs. With no real breakthroughs in other policy areas such as international tax reform or official development assistance (and possibly in climate change negotiations), the needed financing for infrastructure does not appear to be forthcoming.

A more unconventional answer might come from looking at what China has been doing in this area in recent years.

China is already a leader in investing and financing in infrastructure in developing countries. The Infrastructure Consortium for Africa has estimated that China’s financing of African infrastructure reached $13.4bn in 2013, exceeding the level of financing provided by European and North American countries combined, including through all multilateral and regional development banks. Since then, new financing institutions with strong Chinese backing, have appeared on the scene.

Admittedly, $50bn in subscribed capital for both the Asian Infrastructure Investment Bank (AIIB) and the New Development Bank (NDB), respectively, will not provide sufficient lending capacity to make a large dent in the infrastructure gap in developing countries. Even with the $40bn China-owned Silk Road Fund (SRF), specifically created to support infrastructure projects in China’s expansive “One Belt, One Road” Silk Road strategy, a massive gap in future financing remains.

But the AIIB, NDB, and SRF will likely selectively contribute joint funding to “crowd-in”, or mobilise, additional public and private financing partners into specific deals. For starters, other Chinese financial vehicles like the China Investment Corp. (CIC), China Development Bank (CDB) and China Export-Import Bank (EXIM), are all minority shareholders in the SRF and well positioned to support project financing – CDB and China EXIM received capital injections of $48bn and $45bn, respectively, in April this year.

Over the years, CDB and China EXIM have also created various smaller bi- and multilateral funds – such as the $10bn China-ASEAN Investment Cooperation Fund, and the $10bn China-Africa Development Fund, among others – that can further support project financing.

The AIIB will not officially start operations until the end of the year and its first batch of projects will not be launched until the second quarter of 2016. SRF and AIIB investment portfolios will not be identical, but the initial deals made by SRF provide a sense of the joint financing arrangements in which the AIIB could one day participate.

The first deal, in April, was an equity stake in a subsidiary of China Three Gorges Corp. that will build the $1.65bn Karot Hydropower project. Located on the Jhelum River in north-eastern Pakistan, the project is a key piece of an ambitious $46bn bilateral infrastructure initiative to connect Pakistan with northwest China’s Xinjiang Province.

Another, in September, saw SRF acquire a 9.9 per cent stake in Russia’s Yamal Liquefied Natural Gas project, located in an area that accounts for about 80 per cent of the country’s natural gas production. SRF’s stake builds on that of China National Petroleum Corp, which owns 20 per cent of the project.

In October, SRF made a $100m investment in China International Capital Corp’s (CICC) initial public offering (IPO) in Hong Kong. CICC was the first joint-venture investment bank in China, founded in 1995 by Morgan Stanley and China Construction Bank. SRF was one of ten cornerstone investors in the IPO, along with seven other state-owned groups.

With a mixture of public and private sector investors, both Chinese and foreign, these SRF deals could be broadly considered as PPPs. But they have also inevitably involved a significant Chinese state enterprise presence that confers stronger “public-public” features than is common to conventional PPPs.

Given the development challenge at hand, Western economies need to pragmatically contribute to these initiatives by establishing purpose-built development banks and investment funds that can similarly mobilise resources for large infrastructure projects and crowd-in their public and private sectors.

Whereas the international community still seems smitten with the idea of relying on corporate finance to meet development goals, it may be China’s distinct form of public-public finance for infrastructure that proves to be an unexpected driving-force to realise the sustainable development agenda.

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