Wednesday, 14 February 2018

China ventures into Europe

This article was published by The Weekly Standard.

Over the past five years, The State Grid Corporation of China has come close to performing a feat the European Union’s €13tr economy has failed at for two decades: to create an electricity grid stretching across much of Europe, introducing efficiencies and economies of scale national transmission operators are incapable of. A €4.75bn acquisition spree of stakes in the grids of Greece, Italy, Portugal and – shortly – Spain, has now made China’s State Grid, as it is known, Europe’s leading investor in electricity transmission.[1]  (Table 1).

State Grid’s astonishing foray into what were until recently jealously guarded national assets has been a wake-up call to the European Union. For years, it has been trying to decouple electricity transmission from generation as it broke up old state monopolies. When the Eurozone directed its indebted Mediterranean members to raise money by privatising state companies in the wake of the 2008 financial crisis, few imagined that these would be snapped up by a single state-owned company.

Meanwhile, China moved in the opposite direction. State Grid was formed in 2002 as an experiment in state capitalism. The galloping pace of China’s economy over the past two decades helped ensure its growth to the world’s largest utility by revenue (it operates 60 subsidiaries in China alone). Released into the free market world, State Grid has been devastatingly effective. Its ambitions have made it a stakeholder in electricity generation and transmission in Brazil, Australia and the Philippines. Today it has revenues of $315bn and controls assets of almost half a trillion dollars.[2] It is halfway to its goal of buying up to $50bn in assets abroad by 2020.[3]

This clash of economic agendas has also exposed Europe’s private sector to competition from state champions. Last September, the continent’s two largest train manufacturers, France’s Alstom and Germany’s Siemens, announced that they would merge their rail operations[4] in order to fend off competition from another Chinese state giant, the China Railway and Rolling stock Company (CRRC), today the world’s largest manufacturer of rail transit equipment. “A dominant player in Asia has changed global market dynamics,” announced Siemens’ chief executive, Joe Kaeser.

Until the turn of the century, investment between Europe and China was virtually nonexistent. European firms started investing in China in 1992. China entered Europe in earnest with strategic timing - after the 2008 financial crisis drained investment capital from the financial system - and it has moved with speed and purpose. Plotted on a graph, the investment relationship now looks like a pair of crossed swords. Europe’s outbound investment to China peaked at €12bn in 2012, just as China’s took off. Last year, Chinese investments in the EU reached a record €35bn, while EU investments in China fell to €8bn[5]. It is this asymmetrical relationship that is keeping European policymakers up at night, because it is becoming increasingly clear that China has seized a strategic initiative whose economic benefits Europe welcomes, but whose political implications are potentially destructive to Europe’s inchoate political union. 

Two axes of euroscepticism

Almost half of Chinese investment in Europe has taken place along two axes. One runs north from Greece to Poland, through the former Yugoslavia and Warsaw Pact countries. The other runs west from Greece to Portugal – the northern Mediterranean rim targeted by State Grid.

China has included both axes in its Belt and Road Initiative (BRI), a global, trillion-dollar investment programme in port, road and railway infrastructure aiming to lower the cost of Chinese exports to the rest of Asia, Africa and Europe. In 2008, the China Ocean Shipping Company (COSCO) bought a lease to operate most of the container traffic through the port of Piraeus, and has already increased it sixfold. Within the next five years, Piraeus is expected to rival Hamburg and Rotterdam, Europe’s busiest ports, in container throughput. Chinese companies have committed €8.29bn, principally on port infrastructure, roads and railways designed to help ship those containers from Piraues as far north as Budapest – a route called the Balkan Silk Road. (Table 2).

On a purely practical level, China is improving a European infrastructure deficit. Europe needs infrastructure investment of €2.4tr in the medium term, with Eastern Europe requiring €615bn of that – several times the €150bn the EU has spent on infrastructure there.

Beginning in 1994, the EU designed transport corridors criss-crossing the continent, each containing hundreds of projects in road, rail, air, logistics and waterway infrastructure; but it can only afford grants subsidising a fraction of the work. States must supplement these, and banks would in theory finance competitive private bids for the remainder. Since 2008, governments have often chosen to award these projects to Chinese contractors directly, whose state banks or government financed 85 percent of the cost or more.

“[Eastern Europe’s] financial needs are much bigger than the EU can offer, in terms of funding through plenty of red tape and all those Brussels procedures which are really off-putting,” says Plamen Tonchev, head of the Asia Unit at the Institute of International Economic Relations in Athens. “The Chinese turn up with their chequebooks and suitcases full of money, very few questions asked, and that’s what matters.”

In former Yugoslav Macedonia, for example, Sinohydro Corp. is building two motorways, which form part of Europe’s Corridor 8 linking the Black Sea to the Adriatic. As in many Chinese overseas projects, the financing is provided by China’s Export-Import Bank (Exim), based in Hong Kong, to the tune of €574mn.

In Serbia, the Chinese government has directly provided €350mn in official lending to construct part of Corridor 11[6], running across the country to the port of Bar in the Adriatic. Neighbouring Montenegro has borrowed €680mn from Exim Bank to finance the China Road and Bridge Corp. (CRBC) to build the 120km section of the same highway on its territory. Controversially, Montenegro sacrificed €50mn in loans from the World Bank in favour of the massive loan from Exim Bank, despite warnings that this would put it in China’s debt.

The European Union is beginning to take notice of the political symbolism of Chinese finance and engineering dexterity on its turf. What were once European Union routes are rebranded as part of the Belt and Road Initiative. What was once a symbol of European connectivity and federalisation is now part of Chinese connectivity and largesse.

China has taken this symbolism a step further. In 2012, it launched a political forum called the 16+1, comprising all 16 countries of Central and Eastern Europe (CEE) and the Balkans, plus Greece as an observer. It created two China-CEE Investment Co-Operation Funds worth €10.5bn, and launched a series of mutual high-level visits with CEE leaders. When China launched its Asia Infrastructure Investment Bank in 2015 to finance BRI projects, 14 EU member states became shareholders despite US exhortations to ignore it.

Independent economist Jens Bastian has discovered that the financial return on these investments has an enormous indirect benefit for China. In What China’s Belt and Road Initiative means for the Western Balkans[7], Bastian details a correlation between the amount of Chinese investment in a country, and that country’s trade deficit with China. During the last five years, eastern Europe’s trade deficit with China rose from €26bn to €44bn.

From the European Union’s point of view, there is a more unsettling correlation. Some of the countries benefiting most from Chinese investment are also among the most Eurosceptic. Poland, Hungary and the Czech Republic are at odds with Brussels over a slew of issues. All three have rejected an EU scheme to resettle incoming refugees from the Middle East and Africa. Poland and Hungary are undermining freedom of speech in the media, and Poland has passed a law allowing the government to dismiss senior judges.

Here, China seems to have exploited the very faultline the George W. Bush administration exploited in 2003, as it searched for European allies in the Second Gulf War. Assured of EU membership since the December 2002 summit, Poland, Hungary and the Czech Republic broke ranks with the EU majority and sided with Bush, in a clear setback to a common EU foreign and defence policy. China quietly took note.

“I think there is a sense, of, ‘we can finally again be part of something bigger, and we know the Europeans won’t give it to us, but we can find it elsewhere, and that will open windows of opportunity,’” says Bastian. “This sense of constantly being lectured by the Europeans and, ‘look how smooth sailing it is to do business with the Chinese,’ and then, getting this impression of,  ‘look, they’re rolling out the red carpet for us, they’re inviting us to the forum in Beijing… they’re setting up a China-CEE cooperation forum – they want us. Do they in Brussels really want us?’”

Both for southern and eastern European countries, the mere suggestion of being in parlance with Beijing appears to bestow a certain mystique, which could potentially translate into political leverage with Brussels and Washington. Governments have competed to win China’s favour.

In March last year, Chinese leader Xi Jinping and Czech President Milos Zeman signed a memorandum for projects worth a fantastical €231bn – almost one and a half times the country’s GDP. Among them is a scheme to insinuate the Czech Republic into the BRI by connecting the Black Sea with the Baltic through the construction of canals linking the Danube, Oder and Elbe rivers. Zeman’s China pivot came with an anti-Western attitude. During an interview with China Central Television, he described Czech policy towards China as no longer being “submissive to pressure from the United States and the European Union.”[8]

No country in eastern Europe, however, seems to have made more headway in winning Chinese favour than Hungary. Prime Minister Victor Orban allowed Hungary to issue a renminbi-denominated government bond in April last year, and in July this year to issue another such bond in China. This made Hungary the first country to have sold renminbi-denominated debt onshore as well as offshore China.

“You look at the specifics in terms of how it is structured in terms of maturity, interest rate – and you say, ok it’s not exorbitant but it’s not cheap either,” says Bastian. “You could place a US dollar bond or a euro bond… on cheaper conditions than you’ve done it with China. Why are you doing this? Because you obviously want access. You want name recognition. You want also first mover status. And Hungary is at the forefront. Poland is following close behind.”

The size of the bonds – a mere $154mn each - seems to confirm their value as political symbolism. Hungary receives European Union funding of about €3.5bn a year.

The Bank of China last year appeared to reward Orban by choosing Budapest as its regional headquarters. “They are showing financial markets but also they are showing the EU, multilateral organisations like the [European Bank for Reconstruction and Development], the [International Monetary Fund], the [European Investment Bank], ‘we are looking for and are successfully finding alternatives’,” says Bastian.

Europe’s south: The politics of debt

After 2008, the sovereign debt crises of Greece, Spain, Portugal and Ireland demonstrated the raw political power of creditors over debtors, opening a new faultline across Europe. The Eurozone’s wealthier north imposed a recipe of fiscal discipline on all four, which framed the dilution of national sovereignty as a punitive act rather than a cooperative virtue in a political union. The European Court of Auditors is the most recent body to have found serious flaws in the design, management and effectiveness of the adjustment programmes, and those flaws have hurt the authority of Brussels.[9]

Here, as in Eastern Europe, BRI investments have the potential to bring China foreign policy benefits as well as increased trade. Greece most dramatically demonstrates disaffection with the EU core and the shift east. In June 2016, China lost an arbitration brought by the Philippines to the International Court at The Hague over fishing rights in the Spratly Islands - a disputed territory between the two. Greece, which had recently sold the Piraeus Port Authority to COSCO, blocked a common EU statement calling on China to respect the International Law of the Sea[10].

Last summer, Greece blocked a common EU statement calling on China to respect freedom of speech at the UN Human Rights Council in Geneva.[11] It was the first time the EU failed to make its unanimous annual statement. 

Greek Foreign Minister Nikos Kotzias told The Weekly Standard that other EU member states, “accused us of doing this for China because we have economic interests. But we have 0.7 percent of China’s investments in the European Union. Britain has 25 percent. Germany has 20 percent. Why do we have economic interests and not them?... For them it’s business as usual, but if we sell something it affects our political stance. This is hypocrisy and doublespeak, and I have told them so.”

Kotzias went on to state a more startling position: “I respect that the Chinese have a different opinion on human rights. There is a philosophical issue here. Are human rights as the West perceives them generally applicable? Or do some people have a different understanding? One has to respect that. We believe that they are generally applicable. But not everyone believes what we believe.”

Greece has consistently called upon others, especially neighbouring Turkey, to respect international law and human rights. Its modification of both standards within a year is unprecedented.

The EU fights back

Europe’s indignation at Chinese encroachment is neatly summarised by a remark German foreign minister Sigmar Gabriel’s made last September: “If we do not succeed… in developing a single strategy towards China, then China will succeed in dividing Europe,” to told a gathering of French diplomats.[12] He cited disunity on the Hague’s South China Sea ruling as an example.

The EU is beginning to fight back. In his state of the union address last September, Jean-Claude Juncker, president of the EU’s executive, the European Commission, announced that he would look into setting up a common investment screening process. "We are not naïve free traders,” Juncker said. “If a foreign, state-owned, company wants to purchase a European harbour, part of our energy infrastructure or a defence technology firm, this should only happen in transparency, with scrutiny and debate. It is a political responsibility to know what is going on in our own backyard so that we can protect our collective security if needed.”

As if to fire the starting gun on the screening process, The Commission has launched an investigation into a Chinese investment to build a rail link between Belgrade and Budapest, completing the northern end of the Balkan Silk Road. The contract, costing an alleged €2bn, was awarded by direct tender, bypassing the competitive bidding process.  

At the same time, the Commission is now seriously considering the idea of withholding EU funding from non law-abiding member states – in this case the politically recalcitrant Poland and Hungary, which claim €105bn in the 2014-2020 financial period.[13]

Juncker is also greasing the wheels of integration. The Commission is doubling the size and duration of a European Fund for Strategic Investments (EFSI) Juncker ceated, whose aim is to close the investment gap, to provide at least half a trillion euros in investments by 2020. In October, Juncker targeted the Balkan region, saying the EFSI would back a freight rail link stretching from the Danube to the Black Sea and the Aegean, linking three Greek ports with three Bulgarian ones.[14]

Europe is also hardening its diplomacy towards Beijing. Last year, the EU and US refused to recognise China’s transition to a market economy 15 years after joining the World Trade Organisation. During the first Belt and Road Forum in Beijing this year, Germany, France and the UK – home to half of Chinese investment in Europe - rejected a final summit statement on trade because it did not clearly address the need to uphold environmental and social standards. 

These are not just diplomatic slaps in the face. Last year, the European Commission put in place 21 anti-dumping measures[15] against Chinese steel products. This year, the European Parliament toughened those measures.

EU-China cooperation

Unlike the US, however, the European Union does not feel it can go too far down the road of protectionism. Until the turn of the century, the EU and China were worlds apart. Mutual trade was worth only one percent of the EU’s GDP[16] and mutual investment was virtually nonexistent. Last year trade topped half a trillion euros,[17] making the EU China’s top trading partner, and China the EU’s second largest after the US, while mutual investment was worth €43bn. The EU is so heavily invested in the globalised economy, it is now the leading source and destination for foreign direct investment, topping even the US.[18]

Since Donald Trump’s election, the EU is more openly engaging in positive reinforcement in areas of agreement with Beijing. Preserving the openness of trade and investment through multilateral organisations and treaties, rather than returning to bilateralism, is an area where many Europeans now see greater hope of collaboration with Xi Jinping than with Trump. “The [Chinese] are not interested in becoming the world’s policeman as the US was in the early 1990s. They’re interested in globalisation with Chinese characteristics,” says Tonchev. “The US is on the back foot, that’s clear. The Chinese are stepping into the void, that’s also clear.”

As Trump announced that he would pull the US out of the Paris Climate Accord on June 1, the EU and China issued a joint statement saying that climate change “will become a main pillar” of their relationship.[19]

China shows some signs of easing on protectionism. This year it cut the number of restrictions on foreign investors from 122 to 95 – a number the West still considers unacceptably high. More substantially, in the wake of Donald Trump’s November visit, Beijing announced that it would allow foreign investors to own majority stakes in Chinese financial institutions.[20]

“There’s a growing degree of pragmatism in Europe,” says Tonchev of the EU-China relationship. “It won’t be a walk in the park. There will be disputes. That’s a given. It does not mean we should neglect or downplay important areas of common interest, where we can join hands with the Chinese – Climate change, globalisation – we have to live with that disagreement.” In seeking to teach the Chinese how to invest in Europe and to learn from Chinese strategy, the EU seems to be embracing that complicated relationship. 

Table 1

State Grid acquisitions in Europe

2012 Ren Portugal €1.4bn in investment and credit

2014 CDP Reti €2.1bn

2016 ADMIE €320mn

2016 Eandis $930mn

Total: €4.75bn

Sources: Financial Times, Global Times, Nikkei Asia 

Table 2

Chinese investments in the Balkan Silk Road since 2006

Greece €4.2bn

Former Yugoslav Macedonia €640mn

Serbia €2.7bn

Bosnia-Herzegovina €350mn

Total: €8.29bn 

Source: What China’s Belt and Road Initiative means for the Western Balkans, EBRD Report by Jens Bastian

[1] In December of last year, State Grid bought a 24 percent stake in Greece’s power transmission system, along with an option to buy 51 percent. This followed its acquisition of 25 percent of Portugal’s power grid and gas network, REN Portugal, in 2012, a 35 percent stake in Italy’s power grid and gas distributor, CDP Reti, in 2014, and a 14 percent stake in Belgium’s power grid[1] last year. It is also in talks to acquire the northern Spanish grid from Germany’s E.ON.

[5] MERICS report: Record Flows and Growing Imbalances

[7] What China’s Belt and Road Initiative means for the Western Balkans

[8] Europe and China’s New Silk Roads, ETNC, December 2016, Page. 16

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