Managing Risk to Build a Better Belt and Road

Risk management is a key part of economic development. China could use some simple principles for managing risk to improve the prospects of its flagship infrastructure initiative.

Expert comment
Published 5 July 2018 Updated 7 December 2018 3 minute READ

Andrew Cainey

Senior Associate Fellow, RUSI

China hosts the Belt and Road Forum in 2017. Photo: Getty Images.

China hosts the Belt and Road Forum in 2017. Photo: Getty Images.

One of the original motivating forces for China’s Belt and Road Initiative is risk management: the aim being to use infrastructure to drive economic development, so improving political stability and creating a favorable impression of China in countries bordering China and beyond.

Yet these investments themselves are inherently risky: large-scale, debt-financed, long-term infrastructure projects in countries that often have weak governance, undefined or poorly-executed rule of law and corruption. China has experience managing infrastructure risks within its borders in its own ways, but it has much less experience overseas.

And, while well-executed investments can enhance stability, the same investments, executed poorly, can create their own backlash in countries that see costs exceed benefits. This increases rather than reduces risks – not just the risks of defaulting on loans, but also the risk of damage to physical assets, loss of life and deteriorating relations with China.

Moreover, China states its desire for greater private sector and non-Chinese involvement in Belt and Road. This will be needed if China is to realize some of its larger ambitions for the initiative. But companies seek attractive returns – adjusted for risk. It is the perceived and actual riskiness of projects that makes commercial involvement a challenge. Focusing on the risk rather than return may be the better place to start to attract partners alongside Chinese institutions.

The risks on the Belt and Road

Overall, these risks fall into four categories.

The first and most critical issues are when projects cannot even get initial funding. Concerns about compliance, corruption and project governance combined with high costs and low revenues mean that the numbers simply do not add up. Working on any of these dimensions to improve them means more projects will get off the ground.

Secondly, there are the familiar risks during construction – budget overruns, unforeseen design issues and work delays, all commonplace in such challenging operating environments. Alongside these are risks to personnel caused by internal tensions and security challenges.

Thirdly, once completed, financial and non-financial risks remain. At its simplest, revenues may fall short and the project debt cannot be repaid. A series of other factors may reduce willingness to pay: difficulties in enforcing penalties against non-repayment; fiscal pressures elsewhere in the budget; popular resistance to sending money to overseas financiers. And the completed projects and individuals operating them often remain at risk to local political tensions and security challenges.

Finally, throughout the whole process, projects risk stirring up resentment and hostility rather building stability through economic growth. Incumbent governments may make project commitments that fit their own interests rather than those of the country – or at least are perceived to do so. Sri Lanka and Malaysia offer current examples. The way in which projects are implemented can compound the problem – for example, if promised job creation among local contractors does not happen or local ethnic rivalries are not taken into account.

Approaches to risk

How then to address these risks? Some simple principles about risk management highlight avenues to explore and institutions to get involved.

First, what can actions be taken to mitigate or reduce the risks and who is best-placed to do this?

Secondly, who is best-placed to bear and accept risks that cannot be reduced at an economical cost? Should the risk be diversified across many different parties so that each bears only a portion of the risk or rather concentrated and held by those who are knowledgeable on the specifics of the risk?

Thirdly, for those who end up bearing the remaining risk, how large is it and what actions are needed now to protect against future loss?

The myriad of risks along the Belt and Road suggests a myriad of risk solutions and participants. Putting that all together is in itself a skill and will not happen of its own accord. It requires active planning and structuring of which partners to involve where in a way that makes sense for all involved. Three areas stand out.

Successful construction is more than an engineering exercise. It requires positive engagement with local communities; credible, active communication of the benefits that the project brings; and protection of the people and equipment involved in the work. Doing this well means understanding the specific situation on the ground in often remote regions and acting accordingly.

Donor agencies, NGOs, other multinationals and provincial and national governments all have experience to bring to the table. Chinese contractors have demonstrated success in rapid, low-cost implementation and are learning about how to work in a wide range of countries. This is, though, an opportunity to draw on the experience of contractors from other countries, local subcontractors and the experience of multilateral organizations.

Financing is at core about the risk/return-based allocation of capital. The raison d’etre of the insurance sector is risk management. Multilateral institutions have a complementary role to play alongside private sector financial institutions. Drawing on this experience can play an important role in making investment projects economically attractive and bankable.

The opportunity to match the investment portfolios of long-term institutional investors with the long-term financing needs of infrastructure has long been a topic of discussion: the Belt and Road provides a new menu of projects. These approaches all thrive on verifiable data, standardization and transparency clarity and standardization.

Not all projects will fit these requirements, but some will. And in all cases, drawing on sector- and country-specific risk management experience from banks and insurers can reduce risks.

Government can be thought of as the ultimate back-stop, a risk manager for its people across the entire risk spectrum. Actions that strengthen the capacity of all governments involved to assess and address risk mean more effective risk management, greater success and the avoidance of ‘debt traps’.

Examples include sharing experience between countries; multilateral or bilateral support with the assessment of financial burden and debt terms; support to strengthen governance and oversight of project implementation; and approaches that ensure the involvement of affected local populations. Making use of dispute resolution procedures that are accepted by the key participants reduces risk all round.

Countries, businesses and individuals grow through the judicious taking of risks. But unnecessary risk-taking is wasted effort. Belt and Road projects will be most effective when those best-placed to tackle risks and opportunities are encouraged to do so.