| By Dr. Jens Bastian

China’s “Belt and Road Initiative” (BRI), first unveiled by President Xi Jinping in 2013, is a long-term political economy strategy that represents a fundamental shift in how Beijing deals with countries, regions, and continents on a global scale. The geo-economic and geo-political implications of this initiative were reiterated in forceful rhetoric and backed up by ample funding resources at the recently-concluded 19th National Congress of the Communist Party of China.

The “Balkan Silk Road” refers to the transport route and logistics corridor China began to build in the region even before the official launch of the BRI four years ago under its previous title “One Belt and One Road Initiative” (OBOR). The “gate towards Europe,” as Chinese Prime Minister Li Keqiang termed Greece during a visit in 2014, initiates the Southeast European corridor of the newly emerging Balkan Silk Road.

China is a newcomer to Southeast Europe, a region that includes the Western Balkans, Greece, Turkey, Cyprus, Bulgaria, and Romania. It was not until 2009 that China started to establish a footprint in the region. Its outreach has grown through trade expansion, equity investments in port infrastructure, steel mills, lending for highway construction, thermal power plants, and bridge building. The overall funding levels now exceed $10 billion USD.

The evolving Sino-Southeast Europe relationship is a work in progress. Beijing’s engagement includes multiple players with different and occasionally conflicting agendas. China’s expanding activities in Greece, Serbia, Macedonia, Albania, Montenegro, Bosnia and Herzegovina, and Hungary pose a mixture of opportunities and challenges. The question thus arises, what risks do Chinese infrastructure investments pose for these economies? More specifically, what warning signs should we look for, and how might those risks be minimized?

The magnitude of the Balkan Silk Road project poses numerous policy challenges for countries engaging in or seeking to benefit from its implementation. On a macro level, many of the Chinese-led infrastructure projects can improve economic productivity in the medium-term by reducing transport costs within and across countries in the region.

But, the degree to which these new transport links are financially viable in the medium- to long-term remains an open question. Commercial ports and energy pipelines appear easier to monetize in Southeast Europe than thermal power plants, road infrastructure projects, or bridge building. Many of these projects are designed to transport and distribute Chinese goods to different locations in Southeast Europe. But, the emerging supply chains will hardly be cost-effective if they are based on one-way traffic, as illustrated by rising trade imbalances between China and countries in the region.

A grand design such as the BRI requires laying the foundations for a Sino-centric financial architecture. To that end, China is establishing a network of financial institutions that mirror its global development agenda, including the creation of the New Development Bank (NDB) as well as the Asian Infrastructure Investment Bank (AIIB). So far, 18 EU member states have joined the AIIB.

The presence of China’s financial institutions in Southeast Europe is progressing, albeit at a slower pace. The prevailing modus operandi is debt financing of infrastructure projects through banks operating from China or Hong Kong. Loans in excess of $6 billion have been committed or included in Memorandum of Understanding by China to countries in Southeast Europe. Equity investment, albeit with lower volumes (roughly $2 billion), is gaining ground, notably in Greece and Serbia. Most importantly, concessional loans from Chinese banks enable countries in the region to diversify their funding capacity beyond Europe. This is all the more significant for countries in Southeast Europe that continue to have limited access to international capital markets.

A financial sector footprint is gradually being established. In Serbia, the Bank of China opened a new branch in Belgrade in January 2017. Financial connectivity is also being facilitated by the creation of two China-Central and Eastern Europe Investment Cooperation Funds, first in 2012 and most recently in 2016. The second of these funding channels has an initial investment capital of $11 billion, with a leverage ratio of one to five, seeking to raise €50 billion in project finance. Such volumes of financial firepower being made available by a single Asian country for Central and Eastern Europe is unprecedented in the 27 years since the Berlin Wall fell in 1989.

In Hungary, China went a step further, promoting renminbi internationalization for the first time in Central and Eastern Europe. In September 2013, the People’s Bank of China signed a 10 billion Yuan currency swap with the Finance Ministry in Budapest (approximately $1.45 billion). In 2016 Hungary became the first Eastern European country to issue a yuan-denominated sovereign bond, raising 1 billion yuan ($154 million). Most recently, in July 2017, Hungary was the first country from the region to sell debt in China with the issuance of a three-year Renminbi bond.

Hungary’s objective is to cement the country’s position as a connector for Chinese investors in Central and Eastern Europe. The regional headquarters of the Bank of China is located in Budapest. Chinese investments in Hungary have exceeded $4 billion since 2009, while Hungary is the largest Central European exporter to China.

To date, Chinese activities in the region are characterized by a sense of optimism and opportunity. Large infrastructure projects such as the Friendship Bridge spanning the Danube in Belgrade, building the East-West Highway Corridor through Macedonia or the Stanari thermal power plant modernization in Republika Srpska are being completed on time, giving rise to new ventures and initiatives. Building a critical mass of success stories linked to Chinese projects is an essential element of the Belt and Road Initiative.

But what if a project fails or debtors fall behind on their repayment obligations? It is not only engineers and architects drawing attention to the technical feasibility of various high-profile infrastructure projects in the region. Multilateral lenders such as the World Bank and the International Monetary Fund (IMF) are raising red flags that concessional lending by Chinese banks risks creating new levels of dependency for countries in Southeast Europe.

The IMF criticized the authorities in Montenegro in 2015 for signing an €800 million deal to build a highway linking the Port of Bar with Serbia for which China’s Export-Import Bank is providing 85 percent of the credit line. The European Commission expressed concern that the agreement threatens the fiscal stability of Montenegro. The World Bank withdrew a $50 million loan for budget support in 2014 because the multi-year highway project would put too much strain on the fiscal space of the Adriatic country.

Delayed construction of the high-speed railway line between Budapest and Belgrade is not only a reflection of financing challenges and major engineering obstacles. The European Commission opened a preliminary investigation in July 2017 into the transparency of the Hungarian government's procurement practices vis-à-vis Chinese companies for the €2.4 billion project. The Commission expressed reservations that the financing and construction arrangements for the landmark project were agreed to with Chinese bidders without the application of European Union procurement procedures by the Hungarian authorities.

In conclusion, China’s Balkan Silk Road is taking shape. Trade by destination and origin will continue to shift towards China among countries in Southeast Europe. As this shift gains momentum, current trade imbalances with China will continue to grow for countries in the region. Meanwhile, countries in Southeast Europe will further diversify their sources of access to capital through extended Chinese lending and increasing equity investments.

The groundwork for this expansion, i.e. port, rail, and road infrastructure is being established. Access to cheap Chinese consumer goods, from clothing to mopeds and mobile phones, will continue to grow in the region. China and the countries in Southeast Europe are creating a track record of cooperation, learning to work with each other. While China is a newcomer to the region, it will remain firmly in play in the coming years. Its role as a lender, investor, and commercial partner will continue to grow in the region as the footprint of China’s Belt and Road Initiative continues to take shape in Southeast Europe.

Dr. Jens Bastian is an independent economic consultant based in Athens, Greece specializing on investment in Southeast Europe.

This article is part of our Big Questions Series.