ANNOUNCED railway and port projects with Chinese interest could be as large as 32% of Malaysia’s 2017 gross domestic product, spread out over the next 10 to 20 years, but questions remain over commercial viability, funding mechanism and growth spillovers of these projects. Here’s an excerpt of Citi Research’s take on Chinese investment here:
The pivot to Chinese foreign direct investment that started last year continues unabated. Excluding the exceptionally strong 1Q2016 figure of RM11.4 billion, the 1Q2017 jump in Chinese FDI was the strongest Chinese quarterly FDI figure on record, accounting for around 26% of record total quarterly FDI inflows of RM17 billion. At RM4.5 billion in 1Q, 2017 Chinese FDI inflows remain on course to meet or exceed the 2016 figure of RM18.7 billion. Announced port and railway infrastructure projects with significant Chinese interest could total RM300 billion to RM400 billion (24% to 32% of 2016 nominal gross domestic product) 10 to 20-year horizon. While the projects are large relative to the size of Malaysia’s economy, there remain many questions that have significant implications for growth and the ringgit.
First, there are concerns that these projects are motivated more by geopolitical than commercial considerations, especially given concerns of existing overcapacity in Malaysian ports. In particular, Chinese interest in the ports along the west coast of the peninsula stems from China’s desire to secure access to the Strait of Malacca. The East Coast Rail Line (ECRL) and the recently proposed trans-peninsular oil pipeline would serve as the land bridge between these ports facing the South China Sea.
Second, the mode of Chinese involvement is not completely clear. Major government-led projects would be funded primarily by loans from Chinese state-owned banks rather than greenfield FDI, which could lead to a further rise in contingent liabilities for the Malaysian government. Chinese involvement could also come via construction contracts to Chinese state-owned enterprises.
Third, there are questions over the spillover to Malaysia’s GDP, given concerns that the materials, companies and even labour involved in the projects will be Chinese.
Overall, FDI from China may understate the extent of Chinese involvement in the Malaysian economy, but overstate the impact on GDP growth or ringgit demand.
Data from the American Enterprise Institute’s China Global Investment Tracker shows US$14.6 billion worth of investments between 2013 and 2016, but less than half of these — US$6.6 billion — were greenfield investments, with the rest mainly merger and acquisition transactions, which merely represent a transfer of ownership, rather than the addition to GDP growth, but will still be represented as FDI inflows (and support ringgit demand). Even with greenfield FDI, the impact on growth will depend on the extent of leakages due to imports of capital goods and labour.
At US$12.6 billion, construction contracts awarded to Chinese firms during the same period were almost twice as large as greenfield investments, and comparable in size with the total investments in the same period. All else equal, such contracts represent service imports. The gross impact of such contracts is to subtract from headline GDP growth and ringgit demand.
Net impact on ringgit demand would depend on the funding mechanism. If larger government-led infrastructure contracts are funded entirely by loans from Chinese state-owned banks or equity investments from Chinese investors, the net impact on the balance of payments would be neutral (but external debt may rise). There could still be positive impact on ringgit demand, depending on the import content of the project in question.
While not yet included in the AEI data, the RM55 billion ECRL will be designed and built by China Communications Construction Co over seven years, with funding via a loan from China’s Exim Bank (guaranteed by the Malaysian government), to be repaid within 20 years of completion. Forty per cent of the contract will be settled in ringgit, consistent with reports suggesting a similar local content.