Beijing’s global trade scheme faces challenges from capital control, regional competition
Profits remain little changed for companies exposed to China’s ‘Belt and Road Initiative’ in the last three years
Despite the fanfare, companies with exposure to China’s “Belt and Road Initiative” have seen little change in their earnings in the three years since the ambitious global trade strategy was first introduced by President Xi Jinping.
A carefully controlled capital account, the lack of an investment track record, and competition from initiatives in Japan and India are all potential obstacles to successfully monetising the project, analysts say.
Goldman Sachs has picked 230 stocks likely to benefit from Beijing’s trade development scheme, 197 of them mainland-listed, known as A shares, and 33 traded offshore. Of these so-called “B&R beneficiaries”, the A shares have performed better, yielding almost 170 per cent in absolute returns since September 2013. That’s well ahead of the aggregate A-share market growth of just 22 per cent in the same period.
However, valuation expansion has been the primary driver of movement in the stocks’ prices. Profits have barely changed in the past three years, except for companies engaged in materials and utilities, “which are more impacted by domestic policy (supply curtailment) and growth dynamics than the demand from B&R projects”, Goldman Sachs analysts wrote in a note issued on Thursday.
They pointed out that the nexus of yuan weakness, falling foreign exchange reserves, and strict capital controls remains one of the risk factors that could slow the project’s progress and limit its upside in the foreseeable future.
“The internationalisation of yuan and foreign exchange (FX) reserves diversification (and optimisation) are important macro propellants for B&R developments,” the note said.
The Chinese currency has been under pressure against the US dollar, falling 13 per cent since September 2013, while FX reserves have dropped by US$1.0 trillion since their peak in 2014 to around US$3 trillion.
Against that backdrop, “stringent administrative measures are still in place to curb capital outflows. These suggest to us that the funding conditions and policy support for Chinese corporates that look to invest overseas could be less favourable than they were when the yuan was on a steady strengthening path and capital inflows were strong,” the note said.
Besides yuan and the related capital account control, the investment bank’s analysts also include project execution challenges, regional political uncertainties, and economic returns as negative factors.
Analysts with Bank of America Merrill Lynch said the identifiable projects under the belt and road strategy “so far are limited in scale”.
They also highlighted funding constraints as a main factor that hinders fast expansion.
Based on their research, Beijing-led Asian Infrastructure Investment Bank (AIIB) has granted only US$1.7 billion in loans to belt and road projects since January 2016, while the Silk Road Fund has invested only US$4 billion since December 2014. And two-way trade between China and the countries covered by the scheme rose by a negligible 0.6 per cent last year, compared with 25 per cent in 2015.
“We do not expect B&R opportunities to become meaningful over the next few years for China, other than perhaps in very few selected sectors like railway equipment,” the BofA Merrill Lynch analysts wrote in a research note issued on Monday. “We believe that, for investment demand, investors should focus on domestic stimulus policy which is far more influential on sectors including resources, materials, machinery and contractors.”
Another aspect of uncertainty for belt and road companies is the competitive response to China’s policy, particularly from India and Japan, said Mark Tinker, head of AXA IM Framlington Equities Asia.
“India did not attend the [Belt and Road] summit and has long had disagreements with China about its involvement in Pakistan and the ongoing dispute over Kashmir. The Pakistan Economic Corridor is one of the faster moving aspects of the B&R strategy and the Chinese show little sign of slowing down as a result of Indian protests,” he wrote in a note on Tuesday.
“What is interesting therefore are the initiatives from Japan and India to develop similar infrastructure projects elsewhere in the region in order to compete with China. Opening up ports in Sri Lanka or Iran, for example, might be seen as a competitive response from India and Japan, but regardless will help increase trade.”
For equity investment, Goldman Sachs has picked eight buy-rated companies that investors could monetise: Shanghai-listed Baoshan Iron & Steel and Sany Heavy Industrials; and Hong Kong-listed China Railway Signal & Communication Corp, China State Construction International, China Communications Construction, China Merchants Port, COSCO Shipping Ports and Lonking Holdings.
Emerging economies across Asia will need to invest as much as US$26 trillion in building everything from transport networks to clean water systems through to 2030 to maintain growth, eradicate poverty and offset climate change, according to a report by Asia Development Bank in February.