Growing Doubts about China’s Capacity to Finance Overseas Projects and their Political Implications

Dr. Amitendu Palit's picture

China’s foreign exchange reserves have been declining in recent months with the surge in capital outflows and the People’s Bank of China (PBOC)’s efforts to protect the Yuan from depreciating. At US $3.2 trillion, China still holds the world’s largest foreign exchange reserves. But if it continues to defend its currency, these reserves will deplete further. Declining reserves have begun creating doubts about China’s ability to honor financial commitments in the Asia-Pacific region (APR) and elsewhere, especially those relating to investment project. Major commitments by China like the $5 billion high-speed rail project in Indonesia, which is expected to start this year, and Beijing’s pledge to buy Malaysian treasury bonds have significant implications for the regional economy. Delays in inflows of Chinese capital in these projects could adversely affect the outlook and prospects for the regional economy. The adverse impacts will further strengthen doubts over China’s ability to finance infrastructure development in the APR, South Asia, and Africa. These doubts have begun affecting investor confidence as is evident from the surge in capital outflows and growing lack of investor attention to long-term investments in China. The political implication of deteriorating confidence in China’s ability to finance development also could be significant. Countries might start to lose interest in China’s grand One-Belt-One-Road (OBOR) scheme as well as the Asian Infrastructure Investment Bank (AIIB) and BRICS Bank. China might lose the geo-strategic gains it anticipates from financing greater public goods (essentially infrastructure) through the OBOR. It also might suffer erosion of credibility as a leader of new financial institutions like the AIIB and BRICS that are poised to challenge the financial clout of the Bretton Woods institutions. China must manage its currency and forex reserves efficiently to retain the outside world’s faith it can honor its commitment to global and regional projects.