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China's Belt and Road project will ease SOE slowdown, as social welfare boosts incomes

Tour guide rides on camel, walking on the desert at sunset. The Mingsha Shan desert (Mount Mingsha) is a part of the ancient silk road.
Zhang Peng | LightRocket | Getty Images
Tour guide rides on camel, walking on the desert at sunset. The Mingsha Shan desert (Mount Mingsha) is a part of the ancient silk road.

More than 70 countries and international organizations are taking part in China's Belt and Road (B&R) investment projects, formally known as the Silk Road Economic Belt, connecting China with Europe through Central and Western Asia by inland routes, and the 21st-Century Maritime Silk Road from China to Europe via sea routes through Asia and Africa.

These modern replicas of ancient trading trails are linking up more than half of humanity and account for nearly half of the global output of goods and services.

They are also big business for China. Last year, China's direct investments in 49 countries on the B&R corridors rose 18.2 percent to $14.8 billion, and the total value of business contracts amounted to $92.6 billion. All that was overshadowed by more than $1 trillion of China's trade transactions (representing about 25 percent of the country's total foreign trade in 2015) along the revived old silk roads.

Just warming up

But that's only the beginning, according to China's President Xi Jinping. In a speech at the Uzbekistan's Parliament on June 22, 2016, he announced that big B&R projects have been finalized and will be coming on stream in the months and years ahead.

That is how much this trade and investment program has become part of the Chinese economy, by offering outlets for a broad range of China's manufacturing and service industries. Indeed, this program is helping to maintain a high level of growth, while Beijing seeks to raise and modernize China's productive potential, and to build the essential welfare services of what the Chinese now call a "moderately prosperous society."

Think, for example, of the extent to which the income generated from the soaring B&R business can soften the blow of scrapping excess capacities and of rising labor redundancies in steel and construction industries.

Predictably, most of that restructuring and modernization process is affecting large state-owned enterprises (SOEs). Although their role in the economy has been steadily shrinking over the past twenty years, they still account for two-thirds of China's non-financial foreign direct investment (FDI), and for a similar amount of trade transactions generated by such projects.

In addition to their leading role in the B&R business, these SOEs were last year at the forefront of an estimated $23 billion and $15 billion of Chinese FDIs in Europe and in the U.S., respectively.

Their strong market presence owes to their ability to adapt. They have gone from the low value-added producers and explorers of energy and mineral resources to manufacturers of high-speed railways, nuclear power plants and power transmission networks. In the process of moving to new business areas, some of these SOEs have also achieved major breakthroughs in communication and airspace technologies.

Since most of the B&R projects will continue to revolve around transportation and energy businesses, China's SOEs will continue to play a key role in these ventures, and they will be supported by the China-based and -funded financial institutions and newly-created multilateral lending agencies focused on Asian infrastructure.

As an example of that, here are some of the investment projects which got media attention during Mr. Xi's participation at the summit of the Shanghai Cooperation Organization (SCO) held in Tashkent, Uzbekistan on June 23-24, 2016.

Focus on Asia

Some 600 Chinese companies are currently working in Uzbekistan on 70 joint-venture projects in infrastructure and energy, partly financed by China's $6.5 billion of direct investments and bank loans. One of these major projects is a recently completed 19.2 km Qamchiq railway tunnel built by a Chinese company and inaugurated during Mr. Xi's visit. The total value of 31 Sino-Uzbek business contracts currently in the process of implementation is estimated at $15.5 billion. And the two countries' close and growing economic ties have pushed the bilateral trade over the last ten years from $670 million to $3.5 billion in 2015.

China's existing infrastructure and energy deals with other Central Asian countries along the B&R routes - such as Kazakhstan, Turkmenistan and Kyrgyzstan - are estimated at about $45 billion.

It is also expected that a new impetus to the B&R business will come from the coordination of its investment activity with similar projects within the Eurasian Economic Union (EAEU), consisting of Russia, Belarus, Kazakhstan, Armenia and Kyrgyzstan. Pakistan (with its $46 billion worth of Chinese infrastructure worksites), Iran and India are also part of this huge program of China-sponsored energy, roads, railroads and ports building programs.

These are some of the most active parts of China's B&R projects, where its companies will be able to use production capacities idled by the slowing manufacturing output at home. That will soften the blow of the much-needed restructuring and modernization, but it will still leave big technological and labor-market challenges as the economy becomes increasingly exposed to international competition.

Other challenges and opportunities will also come from China's strongly rising household consumption, which contributed 84.7 percent of the GDP growth in the first quarter of this year – a large increase from a 66.4 percent share in the latter part of 2015.

That soaring private consumption demand will have to be met by increasingly sophisticated consumer durable and non-durable goods. At the same time, service sector industries will have to provide a broad range of cultural, leisure and entertainment products to the affluent and middle-class consumers currently estimated at about 40 percent of the total population.

Consumer demand remains strongly underpinned by jobs and income gains. The unemployment rate in urban areas has stabilized at about 4 percent (below the 5 percent target), while urban and rural disposable incomes are growing at rates of 7.5 percent and 9.2 percent, respectively. On top of that, a widening social security net and a reportedly universal medical insurance coverage leave a larger portion of household budgets for discretionary spending.

Investment thoughts

China is opening up to the world with huge B&R investment projects designed to provide stable supplies of energy and raw materials for its economy, to increase trade access to global markets and to facilitate the acquisition of best-practice technologies.

A rapid restructuring and modernization of China's industries is accompanied by big strides in education, scientific research and social welfare.

It is pointless to fret about decimal points in China's growth rates. If you follow that fashion, you will end up like that famous investment guru who was amazed to learn last week that China was "the strongest region" for the Carnival Cruise Line and a "leading growth market" for Nike, with "a 44 percent increase in direct-to-customer sales."

And that gives you a hint: You can play China by buying foreign companies with a strong presence in that market, or, if you are so inclined, by looking at a much broader choice of Chinese investment outlets.

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