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Silk Road Key to China's Next Move

China's recent market meltdown has raised significant questions about the country's transition to a consumer-led economy. As the Chinese economy slows, the question is not if, but how will the Chinese Government react?
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China's recent market meltdown has raised significant questions about the country's transition to a consumer-led economy. As the Chinese economy slows, the question is not if, but how will the Chinese Government react?

So far the focus has been on the Chinese Government's determination to support the Shanghai and Shenzhen Stock Exchanges. While utilising market mechanisms to stabilise its economy, the Chinese Government is not prepared to develop a full market economy, and is still relying on strategic planning and infrastructure investment to drive economic activity.

Receiving relatively little attention has been China's plans to pursue its grand infrastructure vision. In May 2015, China's planning agency, the National Development and Reform Commission, announced 1,043 projects worth 1.97 trillion yuan (USD 318bn). While many of the projects are focused on building infrastructure across China's major exporting provinces, there has been a shift of focus to develop China's inland cities as part of the Government's Silk Road Economic Belt.

Part of China's broader 'go out' strategy, the Silk Road Economic Belt (or One Belt, One Road as it is also called), proposes to create an economic zone that runs through Asia, Europe and Africa, linking China with the Persian Gulf and the Mediterranean Sea through Central Asia and West Asia.

If this were an infrastructure project in Europe or the U.S., it would be caught up in years of planning and debate. But China is already moving forward with the development of its inland regions, which will be the first staging posts. The National Development and Reform Commission's projects include clusters along the middle reaches of the Yangtze River, and the north of the country including provinces such as Hohot bordering Mongolia.

China has also moved rapidly to establish new commercial relationships with Kazakhstan, setting up a future arm wrestle with Russia over influence in Central Asia. In March 2015, China announced that it had reached agreement with the Kazakhstan Government to support 33 infrastructure projects worth US 23.6 billion.

China's One Belt, One Road project has the support of Moody's which in July 2015 stated that the initiative will be 'net positive for the economy.' According to Rahul Ghosh, Moody's Vice President and Senior Research Analyst, "while the government will increase its exposure to unrated or sub-investment-grade emerging markets, this risk appears manageable given China's large external buffers."

The origins of China's Silk Road initiative go back to 2009 when Chinese economist Xu Shanda proposed a Chinese Marshall Plan to create future demand for Chinese exports by providing loans for infrastructure projects that would then be delivered by Chinese construction companies.

The need to create new markets is a recognition by China's communist elite that an economic slowdown that results in rising unemployment is not an option.

China has a long history of rebellions over-throwing dynasties, a point that is not lost on the current Communist Party hierarchy. Social stability is without question the # 1 preoccupation of the Chinese leadership, and extraordinary efforts are constantly being made to preserve it and to snuff out incipient threats to it.

Most recently, President Xi's Operation Fox Hunt has scoured the globe for government officials accused of corruption. This unprecedented campaign has taken down both the high and the low, including former party heavyweights such as ex-security chief Zhou Yongkang and senior generals Guo Boxiong and Xu Caihou, as well as over one hundred thousand lower-level party officials. The reasons for the crackdown on corruption are complex. Some suggest it is about maintaining power through eliminating potential rivals, but the smart money is suggesting something more profound and fundamental: that President Xi is recognising that corruption amongst "princelings" (the sons and daughters of senior Communist Party officials) is undermining society and sowing the seeds for civil disruption. Even with the Government controlling social media networks (or at least attempting to), there is a recognition that it cannot stop the spread of information at a local level.

The question is: what does the recent market turmoil mean for China's infrastructure plans and, in turn, for international investors? Reports in recent weeks have suggested that the slowing economy has led to strikes and industrial unrest. If the economy slows further, then we can expect that the Chinese Government will resort to strategies that have worked in the past. We can expect that infrastructure projects that are already in the wings will be brought forward.

Like China's recent round of industrial development, which involved building cities across its exporting zones, we can expect that China's new direction will involve massive amounts of commodities. With new mining capacity coming on board over the last five years, this won't necessarily result in a spike in prices, but it is likely to support volume demand. Mining companies that are able to generate high volumes at low marginal cost stand to benefit in the medium and long term. More immediately, we at IPCM see a number of attractive buying opportunities generated by the undifferentiated panic from retail and speculative investors.

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