China’s “One Belt, One Road” to Where?

During visits to Central and Southeast Asia in 2013, Chinese President Xi Jinping unveiled Beijing’s aspiration to create what it called the Silk Road Economic Belt and the 21st-Century Maritime Silk Road.  Both would entail the construction of new infrastructure to better connect the present-day countries along what was once the ancient Silk Road between China and Europe.  The former would do so over land with roads, railways, and airports; the latter across the ocean with seaports.  China’s two-part aspiration is now commonly referred to as its “One Belt, One Road” initiative.

China One Belt, One Road Initiative

At the time of Xi’s unveiling, China was near the zenith of its economic power.  Not even the 2008 global financial crisis seemed able to derail China’s economic ascent.  Some saw the “One Belt, One Road” initiative as a way for China to extend not only its economic, but also its political reach across Eurasia.  India had begun to worry about what it considered to be China’s “string of pearls,” a series of Chinese-built seaports across the Indian Ocean.  Others viewed the initiative even more broadly as an ambitious effort to reorient global commerce towards China.

But since then the air of invincibility surrounding China’s economy has dissipated.  China’s engines of growth—export manufacturing and infrastructure construction—have sputtered, as the debt that fueled them and the overcapacity that they created have ballooned.  Over the last year and half, Chinese leaders have been forced to repeatedly “fine tune” their economy to keep it growing.  They boosted China’s government spending, devalued its currency, cut its interest rates six times, lowered its bank reserve ratio seven times, and even directly intervened in its stock market.  Still, China’s economy continues to slow.

That slowdown has spurred Chinese leaders to seriously begin to shift their export and infrastructure-led economy to one that is driven by consumers.  How successful that transition will be is uncertain.  But one thing is clear, the “social stability” so prized by the Chinese Communist Party has begun to fray.  Popular unrest is on the rise.  The number of labor protests in China has soared from about 100 in 2010 to almost 2,500 in 2015.[1]

Thus, Beijing has every incentive to keep its giant manufacturing and infrastructure-construction state-owned enterprises (SOE) humming, as its economy makes the transition.  Seen in that light, China’s “One Belt, One Road” initiative looks less like a well-planned strategy and more like a scramble to keep the order books of its SOEs full.  New infrastructure contracts abroad would help do that; and once built that new infrastructure might help Chinese manufacturers export at a lower cost.

One can see China’s push to build more infrastructure projects from Indonesia to Pakistan.  In September, a Chinese-led consortium won approval from Indonesia to build a $5.5-billion high-speed railway in Jakarta.  But the consortium won only after it agreed that the Indonesian government would not have to guarantee the Chinese loans needed to finance the railway’s construction.  While that concession may have secured the approval, it also increased the potential financial losses that the consortium would have to bear if anything goes wrong.  With such large and complex construction projects, it is hard to ensure that will not happen.

Surely, China expected a different outcome after its construction companies built a port at Gwadar for Pakistan in 2007.  Despite a total investment of over $1 billion, the port has remained virtually idle.  Now China is doubling down on the Gwadar project.  It has promised $45.7 billion in fresh financing to build the China-Pakistan Economic Corridor, a series of energy, road, railway, and pipeline projects that will more closely tie Gwadar to China.

Of course, China can still benefit from such infrastructure projects even if they turn out to be unprofitable.  The new road, rail, and pipeline routes through Pakistan will enable China to import strategic resources, like oil, natural gas, and minerals, from the Middle East without being reliant on sea routes through the Indian Ocean.  The projects could also deepen China’s “all-weather” friendship with Pakistan by creating new constituencies within Pakistan that benefit from the economic activity that the trade routes to China could foster.

Other land-based links to China could do the same. The Kunming-to-Bangkok railway is another example.  The portion of it in China is already finished; the portion in Laos broke ground in December; and the final portion in Thailand is slated to begin construction in May 2016.  Given the massive scale of Chinese trade, even if a small portion of it is redirected over the railway, it could reshape the economic interests of a small country like Laos.  Indeed, China may hope to use the railway to pry Laos away from its traditional ally, Vietnam, and gain another friend in ASEAN.  On the other hand, China would not benefit to the same degree from Chinese-built seaports and airports that are not directly connected to it.  While they may boost trade in the host country, the course of that trade could be redirected elsewhere, if trade with China does not evolve as expected.

That is now a real possibility.  If the Chinese economy continues to soften, it means that China will need to import fewer raw materials and export fewer finished goods.  In the second half of 2015 China’s monthly imports fell 10 to 20 percent from a year earlier; and its exports slipped too.  Unless global demand revives or Chinese consumers pick up the slack, Beijing might well expect its “One Belt, One Road” initiative to yield more long-lasting political than economic benefits.

[1] “Number of strikes and worker protests in China hits record high in November,” China Labour Bulletin, Dec. 3, 2015.

Tags: , , , , , , , , , , , , ,

The Almost-Normal Country: Japan and the Use of Force

The enactment of Japan’s new national security bills was a long time in the making.  The bills, already passed by the lower house of the Japanese Diet in July, were approved by its upper house last week.  But ever since Shinzō Abe became Japan’s prime minister in 2012, he had sought legislation that would enable Japan to engage in “collective self-defense,” the ability to aid friendly countries under attack.  While that may seem routine in most countries, it has been anything but in Japan.  Many were unhappy with the legislation’s passage.  Those who opposed it feared that it would lead the country into war; and even some of those who supported it grumbled that it did not go far enough to make Japan a truly “normal” country, one where the use of force is considered as a legitimate tool of international politics.

Japan Collective Self-Defense

Unsurprisingly, China was quick to condemn the legislation’s passage.  China’s Ministry of National Defense declared that Japan’s new security laws ran “counter to the trend of the times that upholds peace, development and cooperation.”  The ministry chastised “Japan’s war mentality, its reinforcement of military alliances and attempts to send more troops abroad.”  Chinese media was less charitable.  Xinhua carried the headlines: “China Voice: Is Japan bound up to battle chariot?” and “News Analysis: Japan’s pacifist ideals stripped as Abe steps closer to resurrecting old war machine.”  One commentator at The People’s Daily blamed the “unyielding spirit of militarism” of Japanese leaders who were “breaking [Japan’s] pacifist promise and getting ready to send its troops to battles again.”[1]

Of course, China rarely passes up an opportunity to remind Japan of its imperial aggression.  Thirty-six years of Japanese economic aid to China—now nearly $1.2 billion per year—has yet to restrain its reflex.  In part, that is because the Chinese Communist Party (CCP) has often used anti-Japanese sentiment to buttress its own political legitimacy.  (Only recently did the CCP even credit its longtime Chinese rival, the Kuomintang on Taiwan, for its contribution—arguably larger than the CCP’s—to resisting Japan in World War II.)

That it took so long for Japan to pass this sort of legislation is a testament to the strength of Japan’s postwar pacifist sentiment.  While militarist elements may still lurk in Japan, most Japanese are decidedly uncomfortable with the use of force in international politics.  That was clear during Japan’s negotiations with Russia over the Northern Territories (or southern Kuril Islands in Russia) in the 1990s.  Though Japan had already begun its long economic stagnation, its military and political might was still near its peak.  In contrast, Russia, following the fall of the Soviet Union, was at its nadir.  Things were so bad in the Russian Far East that it was questionable whether Moscow could provide enough food or heat for its population on Sakhalin Island, let alone defend it.

Yet, Japan did not try to use its military or political capital to pressure Russia into a settlement.  Rather, Japan solely relied on the persuasive power of its economic assistance.  That tactic ultimately came to nothing.  After Russia’s economy recovered, Japan’s window of opportunity to settle the dispute on favorable terms closed.  Today, Russian leaders act without concern over Japanese reaction.  They cavalierly flout Japanese interests.  This year, a series of senior Russian officials visited the four disputed islands, despite repeated protests from Tokyo.  Russian Prime Minister Dmitry even toured one of them in August.  While there, he underlined that the Kuril Islands “are part of Russia… That is how it is and how it will be.”[2]

Japan’s self-imposed limitation on its use of force has also impacted its ability to secure its place in a changing East Asian geopolitical environment.  China’s economic rise has drawn other Asian countries closer to its orbit, while its seemingly relentless military rise has upset the regional balance of power.  Without the ability to form true security partnerships, Japan has risked becoming isolated.  Hence, Abe has eagerly cultivated new political and economic ties across the Asia-Pacific, from Australia and India to the countries of Southeast Asia.  Japan has certainly become more sensitive to changes in Asia’s geopolitical balance.  Last year, after Thailand’s relations with the United States soured, offering China an opening, Tokyo leapt into the breach with pledges of economic engagement with Bangkok.

Surely, the most immediate beneficiary of Japan’s new security laws is the United States.  For the past half century, the United States has borne the entire security burden of the alliance between the two countries—if Japan is attacked, the United States is obligated to defend Japan; but if the United States is attacked, Japan has no such reciprocal obligation.  Even during the Cold War, that uneven arrangement rankled some Americans.  To make it more equitable, Japan accepted the lion’s share of the financial burden to host American forces in Japan.  But with the end of the Cold War and the withdrawal of a substantial portion of American forces from Japan (to Guam and elsewhere), the relationship was about to tilt again.  Thus, it was hardly surprising that Washington welcomed the legislation’s passage.

But beyond the United States, the legislation also enables Japan to more effectively cooperate with other countries on security matters.  If Japan’s relationships with Australia, India, the Philippines, and recently Vietnam mature into security partnerships, those countries can now count on Japan as a full partner.  In fact, in the days before the upper house vote on the national security bills, Abe met with Vietnam’s communist party secretary to discuss stronger security ties, in light of Vietnam’s dispute with China in the South China Sea.  Abe pledged more patrol boats for Vietnam.  Such promises is partly what worries Japanese opponents of the bills.  Getting Japan entangled in the disputes of other countries could pull it into a conflict, perhaps with China.  On the other hand, the possibility of facing a regional network of security partners might restrain China’s aggressiveness.  After all, China’s own economic prosperity (tenuous as it has become this year) requires peace and stability.

Even with the enactment of its new national security bills, Japan seems unlikely to seek the active use of military force far from home.  After all, Japan’s debt-laden government is in no position to rapidly expand its self-defense forces without hurting its still-weak economy.  Moreover, the conditions under which Japan can use force to support American expeditionary efforts abroad are still narrowly circumscribed.  The new legislation may be a step toward a Japan that is more comfortable with the idea of the use of force.  But the road to an actual use of force remains a long one.  Ironically, China may be the one country that could propel Japan faster down that road.

[1] “China Voice: Is Japan bound up to battle chariot?” Xinhua, Sep. 19, 2015; “News Analysis: Japan’s pacifist ideals stripped as Abe steps closer to resurrecting old war machine,” Xinhua, Sep. 19, 2015; “Japan’s new security bills against trend of the times: defense ministry,” Xinhua, Sep. 19, 2015; Wen Zongduo, “Abe’s win is Japan’s loss,” Chinadaily.com, Sep. 19, 2015.

[2] “Moscow officials ‘have always and will continue to’ visit Russian Kuril Islands – PM,” RT.com, Aug. 23, 2015.

Tags: , , , , , , , , , , , , , , ,

Modi Flexes His Muscles: India’s Cross-Border Raid into Myanmar

June 16, 2015

Last Tuesday, India launched a punitive raid into Myanmar.  Seventy commandos from the Indian 21 Para (Special Forces) Battalion crossed India’s eastern border to strike two militant bases.  The commandos quickly overran the bases and killed between 20 and 40 militants.  The raid was prompted by the ambush of an Indian army patrol about 110 km south of Imphal five days earlier.  Eighteen Indian soldiers were killed and another 11 were wounded in what was the deadliest attack on Indian security forces in decades.  According to some Indian officials, Myanmar’s government consented to the raid, though Naypyidaw later claimed that the raid occurred on the Indian side of the border.

India Myanmar Raid

Whatever the case, the raid was remarkable.  It reflected Indian Prime Minister Narendra Modi’s willingness to not only use military force, but also take decisive action.  As soon as the ambush on the Indian army patrol occurred, Modi directed National Security Advisor Ajit Doval to coordinate an Indian response.  Within five days, India successfully planned, resourced, and executed the two cross-border missions.  That required not only military, but also diplomatic coordination, if India really discussed the matter with Myanmar.

Modi is surely a different kind of prime minister than India has had in the past.  He demonstrated that when he visited China in May 2015.  He directly communicated to Chinese Premier Li Keqiang “the need for China to reconsider its approach” on issues that hold back their relationship, particularly the territorial disputes between their two countries.  Modi’s predecessors had consistently shied away from such frank discussion, typically sticking “to uninterrupted pledges of friendship and good relations.”[1] While Modi’s visit to China yielded no breakthroughs on the border issue, it was clear that China should take note.

Modi has also embarked on active diplomacy around the world.  Toning down India’s traditional adherence to non-alignment, he has edged close to Australia, Japan, and the United States.  He is clearly interested in having India play a greater role not only in South Asia, but also beyond it.  His ability to act decisively will make that a more likely prospect.

[1] Benjamin Haas, “India’s Modi tells China to ‘reconsider’ approach,” Agence France-Presse, May 15, 2015.

Tags: , , , , , , ,

Strategic Intentions: China’s Military Strategy White Paper

On Tuesday, China published its latest defense white paper.  Unlike its’ eight predecessors, this document was the first time that China publicly unveiled parts of its military strategy.  Even the paper’s title was changed from China’s National Defense to China’s Military Strategy.  Rather than the opaque and retrospective generalities found in earlier versions, the new white paper offered details about China’s strategic intentions and the future development of its military.

One Chinese military official went so far as to state that the greater transparency of the new white paper was a sign of a more confident China.  That said, many of the revelations contained in the document were hardly novel.  It profiled China’s decades-old “active defense” strategy, which maintains that China would always remain strategically defensive–though perhaps not so at the operational or tactical levels.  It also detailed the Chinese military’s primary aim: to prepare itself to fight “local wars under conditions of informationization”—in other words, regional conflicts in which command, control, communications, intelligence, reconnaissance, and surveillance (C4ISR) would play major roles.  That too was already known.[1]

But other revelations in the white paper were more illuminating.  It showed that China intends to focus its force development in four domains: cyberspace (it will boost its cyber warfare capabilities); outer space (it will take steps to defend its interests there, even though it is opposed to the militarization of that domain); nuclear forces (it will build a reliable second-strike capability); and finally the oceans.

Yueyang - China frigate

That last domain is what currently worries China’s neighbors the most, given Chinese assertiveness in the East and South China Seas. Indeed, the white paper highlighted Beijing’s intentions to further expand the Chinese navy and extend the range of its operations—shifting from “offshore waters defense” to “open ocean protection.”  The white paper argued that China’s growing overseas interests have changed the country’s focus from being a continental land power to a maritime power.  That has led China to prioritize its navy in its military modernization plans.  In what once would have been heresy in the Chinese military, the white paper declared that “the traditional mentality that land outweighs sea must be abandoned.”[2]

That means that in the future China would not only defend its coastline from attack, but also its sea lanes of communications through international shipping routes, including those from the Middle East through which over half of China’s oil flows.  That, in turn, means countries like India will have to get used to seeing more of the Chinese navy in the Indian Ocean.  By the same token, Japan and the United States should expect more Chinese naval and air patrols in the Pacific Ocean and maybe one or two more Chinese aircraft carriers.

The white paper also listed China’s strategic concerns.  Chief among them was America’s “rebalance” toward Asia, under which the United States has increased its military presence and strengthened its alliances in the region.  The white paper also noted Japan’s push to revise its military and security policies, characterizing them as “sparing no effort to dodge the post-war mechanism.”  China’s “offshore neighbors” warranted mention too for their “provocative actions [to] reinforce their military presence on China’s reefs and islands that they have illegally occupied,” no doubt referring to the Philippines and Vietnam in the Spratly Islands.

While the white paper’s greater transparency may be the product of a more confident China, it is still a country that has not escaped the classic security dilemma.  As the white paper itself observes, China’s neighbors are rearming and helping the United States bolster its security alliances.  So, even as China strives to improve its security, it has prompted its neighbors to seek ways to improve their security situations, thereby reducing the effectiveness of its own efforts.  That is something that China’s military strategy probably did not intend.

[1] “China sticks to ‘active defense’ strategy,” interviewee Senior Captain Zhang Junshe, Vice President of the China Naval Research Institute, China 24, CCTV, Beijing, May 26, 2015,  http://english.cntv.cn/2015/05/27/VIDE1432675208303328.shtml; “White Paper highlights ‘active’ defense strategy,” interviewee Senior Colonel Zhou Bo, China Ministry of National Defense, host Han Bin, China 24, CCTV, Beijing, May 26, 2015, http://english.cntv.cn/2015/05/26/VIDE1432614727198411.shtml.

[2] China’s Military Strategy (Beijing: State Council Information Office of the People’s Republic of China, May 2015); “China’s defense white paper,” interviewee Senior Captain Zhang Junshe, Vice President of the China Naval Research Institute, host Wang Yizhi, Dialogue, CCTV, Beijing, May 26, 2015, http://english.cntv.cn/2015/05/27/VIDE1432668717544907.shtml.

Tags: , , , , , , , , , , , , , ,

Decline in Oil Prices, Currency Pairs, and National Power

Last autumn, headlines began to declare national “winners and losers” from the precipitous drop in oil prices over the second half of the year.[1]  They contended that the United States and its friends would benefit from the fall in oil prices; and that its most strident adversaries would not.  While largely true, the headlines did not capture the whole story.

Since international prices for oil are quoted in U.S. dollars, the exchange rate between the U.S. dollar and another country’s currency (a currency pair) also matters when calculating the real impact of a change in oil prices on that country.  Take Russia for example.  Much has been made of the fact that half of Russia’s government budget is based on revenues from oil.  One might suppose, because oil prices have fallen about 50 percent over the last six months, that Russia’s government budget would be pinched by about 25 percent (reflecting the 50 percent fall in oil revenues on half its budget).  Such a contraction would be catastrophic for the Russian government and Russia’s economy, given its high dependence on government spending.  That might lead Western policymakers to believe they can easily wait out Russian President Vladimir Putin’s aggressive designs.

But one must remember that the Russian government does not pay for domestic goods and services in U.S. dollars, but rather in Russian rubles.  Any drop in the value of the Russian ruble against the U.S. dollar allows Russia to reap more rubles for its dollar-based oil revenues.  (Even so, a sudden devaluation in a country’s currency can still wreak havoc on that country’s wider economy, because it fails to let people adjust to the benefits of devaluation, before they feel its negative impacts.)  Given the devaluation in the Russian ruble (which has fallen in tandem with oil prices), the real impact of the fall in oil prices is closer to only 8 percent, rather than 25 percent. While that is still a big challenge for the Russian government’s budget, it is a lower hurdle for Putin to surmount.

Similarly, one might expect that Japan, a key American ally in Asia, to unreservedly benefit from the decline in oil prices.  As a country completely dependent on oil imports, any decline in oil prices should boost its economy.  Given that oil prices have fallen about 50 percent over the last six months and that Japan imported about 1.6 billion barrels of oil in 2014, one may naturally assume that Japan is now saving a vast sum that would act as a fiscal stimulus to its economy, making it a stronger country and one better prepared to cope with a rising China.

That has happened, but not to the degree that the halving of oil prices would suggest.  That is because the value of the Japanese yen against the U.S. dollar has fallen too.  During the second half of 2014, the yen devalued about 15 percent, as a result of the Japanese central bank’s quantitative easing policy.   That shaved one-fifth off the benefit from the decrease in oil prices to 40 percent in yen terms.  Ironically, the lower energy input prices had made it more difficult for the Japanese government to achieve its 2 percent inflation target, which Tokyo believes will help lift the country out of its decades-long deflationary economic stagnation. 

As the cases of Russia and Japan have shown, changes in currency exchange rates can make a real difference on the impact that changes in oil prices have on a national economy, whether they are net oil importers (those shaded in blue in the chart below) or net oil exporters (those shaded in red).

Effect of Exchange Rate Movements on the Decline in Oil Prices in Local Currencies

 

As a region, Asia has benefited from the drop in oil prices.  Almost every country in the region is a net oil importer.  Chief among them is China, whose slightly appreciating yuan against the U.S. dollar, has allowed it to fully benefit from the lower oil prices.  In fact, Beijing has taken advantage of them to less expensively fill its strategic petroleum reserve.[2]  But not far behind have been India and Indonesia.  The currencies of neither country have devalued by more than 6 percent, allowing them to realize almost all of the benefit from the decline in oil prices.  That, in turn, has allowed their central banks to cut their interest rates to spur their economies without having to worry as much about inflation.  Lower oil prices have also enabled Indian Prime Minister Narendra Modi and Indonesian President Joko “Jokowi” Widodo to slash fuel subsidies, which had been draining government coffers in the past, without a public outcry.  That has freed up resources that they can devote to infrastructure and defense, as both national leaders have promised.

However, the fall in oil prices has also pinched some American allies.  One such country is Australia.  Though it is a net importer of oil, Australia has ambitions to become among the world’s leading exporters of liquefied natural gas (LNG).  But LNG prices, which are often linked to those of oil, have followed oil’s prices downward.  That has put into jeopardy Australia’s new round of offshore LNG development.  According to the Australian government, it will likely miss out on about AUS$750 million in petroleum resource rent tax over the next four years—about the cost for one of the new diesel-electric submarines that its navy wants.  The situation would have been even worse had the Australian dollar not devalued by 13 percent against the U.S. dollar.[3]

Finally, some countries, like Venezuela, whose currencies are effectively pegged to the U.S. dollar, have felt the full impact of the decline in oil prices.  Unfortunately for Venezuela, it imports most of its consumer and industrial goods—including food, clothing, machinery, vehicles, etc.—and it holds debts mainly denominated in U.S. dollars.  Thus, any devaluation of the Venezuelan bolívar to temper the impact of lower oil prices would also cause the costs of goods to soar and make its U.S.-dollar debts crushing.  To avoid a financial crisis, Venezuelan President Nicolas Maduro has travelled to China this week.  In the past China has agreed to oil-for-loan agreements, in which China provides immediate financing to Venezuela in exchange for future deliveries of Venezuelan oil.  Already existing deals with China have begun to squeeze out Venezuela’s ability to use its oil to bring Latin American countries into its orbit.  Rather, new deals are more likely to move Venezuela close to China’s orbit.[4]

By the first week of January 2015, the benchmark prices for Brent and West Texas Intermediate crude oil had fallen to $51 and $48 per barrel, respectively.  As long as these conditions persist, oil-exporting countries will suffer and oil-importing ones will benefit.  But to really understand whether these countries are weakening or strengthening to the extent that the decline in oil prices suggest, one would be wise to also consider the trajectories of their national currencies.

[1] “Winners and Losers,” Economist, Oct. 25, 2014.

[2] Abheek Bhattacharya, “China’s Petroleum Reserve Builds Shaky Floor for Oil,” Wall Street Journal, Sep. 3, 2014.

[3] Australia is considering a Japanese submarine design for its next-generation submarine fleet.  The most recently launched Japanese Sōryū-class submarine cost $540 million and AUS$750 million converts to $615 million at today’s exchange rate.  John Hofilena, “Japan launches newest submarine Kokuryu amid party atmosphere,” Japan Daily Press, Nov. 04, 2013, Eric Yep, “Falling Oil Spells Boon for Most of Asia’s Economies,” Wall Street Journal, Jan. 4, 2015; Max Mason, “Oil price plunge sends petrol to four-year lows as Australia feels it at the pumps,” Sydney Morning Herald, Dec. 22, 2014; James Paton, “Plunging Oil Threatens to Spoil Australia’s Next Gas Boon,” Bloomberg News, Nov 27, 2014.

[4] Eyanir Chinea and Brian Ellsworth, “Venezuela’s Maduro to visit China, OPEC nations amid cash crunch,” Reuters, Jan. 5, 2015; Nicole Hong and Kejal Vyas, “Oil Shakes Venezuelan Debt to Its Foundations,” Wall Street Journal, Dec. 22, 2014; “Inside U.S. Oil,” Thomson Reuters, Aug. 22, 2014, pp. 7-8.

Tags: , , , , , , , , , , , , , , , , , , , , ,