Will US interest rate rise trigger funding problems for China’s ‘One Belt, One Road’ plan?

China’s ambitious “One Belt, One Road” initiative could face funding problems as a highly likely rate rise from the US Federal Reserve would increase funding costs and China has imposed strict controls on capital outflow lately, an economist said on Friday.

Speaking at South China Morning Post’s China Conference on Friday morning, Alicia García Herrero, chief economist for Asia Pacific from French bank Natixis, said in a panel discussion that it was not sustainable for China to drain its forex reserves to fund large overseas infrastructure projects on the belt and road initiative, which left room for Hong Kong to be a alternate source of offshore funding in US dollars.

“Constraints in US dollar financing are very strong in China now. I think China will look for alliances for the belt and road,” Herrero said. “Hong Kong is well positioned because this is a financial centre where you get about a trillion US dollars out every year, which is not minor. If you can redirect a bit of that into the belt and road, that is already big enough.”

Since 2014, when the Chinese yuan started depreciating, China has lost more than US$800 billion in its foreign reserves, some of which was used to stabilise the yuan’s exchange rate as it aims at becoming a global reserve currency. This year, the yuan has faced strong depreciation pressure as the US economy rebounds and a rate rise at the end of this year seems almost certain. Strong depreciation expectation on the yuan has provoked capital outflow, leading Beijing to tighten outbound direct investment and the amount of yuan that Chinese companies can remit overseas.

“That makes it [the funding difficulty] even more so. If China Development Bank raises its funding in Hong Kong, and lends it directly to Russia, that’s not an outflow for China,” Herrero said.