Investing in a modern silk road – China’s One Belt, One Road strategy

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Infrastructure investments typically provide exposure to assets boasting long lifespans, low ongoing operational costs and secure contracts that often include inflation-linked pricing; and investing in infrastructure is very topical – particularly post our Federal Budget. Economic commentators rarely agree, but they do when it comes to the desirability of investment in effective (an important qualification) infrastructure – and of all the infrastructure projects in the public eye, the one with the widest scope and broadest vision is China’s One Belt, One Road (OBOR) strategy. 

China wants to revive ancient land and ocean routes to boost trade and transport logistics

‘One Belt, One Road’ derives from two concepts introduced in 2013 by China’s President Xi Jinping – the overland ‘Silk Road Economic Belt’ and the ‘21st-Century Maritime Silk Road’. These are the two major axes China wants to create an infrastructure building boom across Central Asia to help drive economic links to Europe through the Indian Ocean. It will also propose to connect with Africa and Oceania1 and assert Chinese influence in Pacific nations like East Timor, Fiji and Papua New Guinea. To put it into perspective, economists have said OBOR is more than seven times larger than America's Marshall Plan to rebuild Europe after WWII2 while China estimates it could potentially involve 65 countries and 4.4 billion people – that’s around 70 per cent of the global population3.

Its breadth can be measured by the overwhelming interest of global governments

Government delegates from more than 100 countries including more than 20 heads-of-state attended China’s recent forum on the initiative. Some commentaries are focused on Asian economies historically linked by the original Silk Road, however, ‘OBOR-branded’ projects are being discussed and planned as far away from that spot as Africa and Latin America. A relatively unheralded milestone was the April journey from Yiwu in eastern China to London of a freight train laden with Chinese goods and its return journey boasting British goods including whisky and pharmaceuticals.

There are several purported reasons for China’s near obsession with the project

Firstly, it will provide new markets for China’s overcapacity (although unlikely to be material) and it will also fuel China’s desire to be a more influential world power (although this is arguably a xenophobic western viewpoint). OBOR is also seen as supporting China’s motive to use its foreign currency reserves on investments that will return more than simply sitting in US treasuries (illogical as reserves should be exactly that – reserves, they need to be liquid). These and other reasons have greater or lesser degrees of credibility.

In our view, there are three key points China is focussed on that are important for investors

  1. Demographics – China has an ageing population
    The current median age is 43 and rising. The OBOR initiative makes much of connecting China to the younger populations in countries such as India, Pakistan, South-East Asia, and even Latin America and Mexico. In effect, it is looking to tap into the demographic dividends that growing young workforces bring.
  2. Economics – helping to stabilise regions
    From China’s own difficult western provinces to the turmoil in Afghanistan and Pakistan, investment in sound infrastructure that facilitates trade (such as the Port of Gwadar in Pakistan) has potential to bring growth and opportunity to troubled regions – and where there is opportunity and trade, peace tends to follow. To paraphrase Nobel Laureate Dr Vernon Smith, “If you kill people you cannot trade with them”.
  3. Trade itself – perhaps the most important theme
    President Xi’s remarkable address at January’s World Economic Forum championing openness was in marked contrast to the nascent Trump-driven US repudiation of free trade. Trade between consenting actors is what has driven civilisation to improve its lot over the millennia. China has several economic issues that facilitating trade will help it deal with. Most important is that China is no longer a low-cost producer – its wage bill is growing rapidly, driving some manufacturers to move production outside the country. It needs to move itself up the manufacturing value chain to produce higher value-add goods and services – a move facilitated by trade. Improved access to commodities, goods and services sourced from lower cost producers drives economic advantage.

We believe these three areas reinforce several propositions for investors

The demographic driver reinforces long-term consumer growth themes in Asian and emerging markets; geopolitical stability – without question – leads to increased opportunity; and trade is vital to a nation such as Australia – open, small and economically dependent on free markets.

The OBOR initiative is still in relative infancy. Questions remain as to funding and, as with all infrastructure investments, the projects selected need to be cost effective. However, there are already signs that investors are positioning with the long view in mind and we monitor the strategy with great interest.

This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.
 

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Patrick Broughton

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With 25 years’ global investment banking experience in a broad range of financial markets, including equities, fixed income, hybrids and convertibles and foreign exchange, Patrick Broughton is charged with chairing the Dixon Advisory Investment Committee.

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