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Chinese Infrastructure Investments in Serbia: Between Politics and Profit

0 Comments 🕔14.Dec 2015

This article is part of our feature Re-imagining the Silk Road.

Thermal power plant in Kostolac, Serbia. Photocredit: stefanogiantin.

 

by Dragan Pavlićević

China’s relationship with Serbia has been rapidly developing since the two countries established a strategic partnership in 2009. The most attention by far has been drawn to burgeoning cooperation regarding the development of Serbia’s infrastructure. Indeed, in terms of infrastructure development within the Balkans and the CEE region,[1] China has arguably advanced the farthest in cooperation with Serbia. However, other countries—including Montenegro, Bosnia and Herzegovina, Macedonia, and Romania, among others—have also struck deals with China on joint energy and transportation infrastructure projects. Therefore, better understanding the Sino-Serbian experience is valuable in estimating the trajectory of forthcoming Chinese involvement in infrastructure development in the wider region.

This short article aims to describe and recapitulate developments within this Sino-Serbian relationship, including a brief analysis of the key factors shaping China’s interest and involvement in these projects. The article concludes that existing analyses have so far greatly underestimated the importance of a crucial aspect of these projects—their financial feasibility and profitability—to the detriment of a more comprehensive understanding of China’s involvement in infrastructure development in Serbia and a more accurate assessment of its prospects in the region.

 

An Overview of Chinese Infrastructure Investment in Serbia

As of 2015, the number of completed, ongoing and proposed joint infrastructure projects between China and Serbia is nearing double digits. The breakthrough project, a Sino-Serbian Friendship Bridge later renamed for the Serbian scientist Mihajlo Pupin, was agreed upon in 2010. Worth $260 million, the bridge was built by China’s state-owned enterprise, China Road and Bridge Corporation, on the back of a soft loan from the Export-Import Bank of China. This project was soon followed by the first phase of the revitalization of the thermal power plant Kostolac, which included the renovation of an existing power station, construction of desulphurization systems, and an upgrade of accompanying transport infrastructure. This first joint infrastructure project in the energy sector was facilitated with a $293 million state-to-state loan on preferential terms.

Both projects were accomplished in time for the Chinese Premier Li’s visit to Serbia in December 2014, setting a positive tone for the announcement of a new round of joint infrastructure projects. Among the over one dozen agreements signed at the time, construction of the Belgrade-Budapest High-Speed Railway (HSR) has attracted the most attention, both domestically and internationally. The project is conceived as the first section of a future high-speed rail connection stretching from the Greek port of Piraeus, an entry point to Europe for a large number of made-in-China products, to Central Europe, traversing Macedonia, Serbia and Hungary. This expansive route reflects the ever-widening geographical reach of China’s interests and policies. Also considering the advanced technology involved, it has been perceived in the region and beyond as a symbol of China’s status as a true global power in making.

The other notable agreement signed in 2014 concerns a Chinese loan of $608 million for the second phase of Kostolac power plant upgrade. This phase entails the construction of a new, 350 megawatt coal-fired unit, the first new power station in Serbia in approximately three decades, and includes the expansion of a coal mine feeding the power plant.

Serbia and China also agreed that Chinese contractors would engage in the construction and maintenance of several sections of Serbia’s highway network. A memorandum regarding construction of an industrial zone for Chinese enterprises was also signed during Premier Li’s visit. Notably, the list does not end there, as several other projects are reportedly under discussion and new ones regularly emerge. Most recently, China is discussing a plan to finance and build another bridge in the proximity of Serbian capital Belgrade, estimated at €470 million.[2]

Looking South down the Sava River in Belgrade. Photo credit: Jeff Attaway.

 

So far, the operational model for these projects has been broadly identical: enabled by ‘soft’ loans from one of China’s policy banks, the projects are delivered by a Chinese state-owned enterprise as a principal contractor, with up to half of a project’s value possibly subcontracted to domestic enterprises. For example, the arrangement for the second phase of Kostolac’s upgrade includes a loan from the Chinese Export-Import Bank covering the financing of 85% of the value of the project, with a grace period of seven years, a repayment deadline of twenty years, and an annual interest rate of 2.5%. The Chinese state-owned giant China Machinery Engineering Corporation is the main contractor, with expected participation of domestic enterprises of up to 50%.

 

Explaining China’s Infrastructural Push in Serbia

How can China’s proactive and generous approach to building transportation and energy infrastructure in Serbia be explained? So far, observers have focused on incentives provided by structural factors and China’s strategic response to both domestic and geopolitical priorities, facilitated by the long-standing “going out” policy that aims to ensure that China’s enterprises have a global presence.[3]

In terms of predominantly domestically-driven incentives, upgrading the transportation network in Europe keeps made-in-China products competitive on the global market despite the stronger Yuan and rising costs of production in China. It also relieves China of some of its industrial overcapacity, which has been particularly pronounced since the beginning of the global financial crisis and the recent restructuring and slowdown of the Chinese economy. It supports the state-owned sector—at least the enterprises involved in the related projects—to open new markets and increase profits, all while raising their game in terms of new technology and standards, acquired as they participate and compete in the world market.

From a geopolitical perspective, building infrastructure globally is understood in the context of China’s so-called ‘One Belt, One Road’ strategy to establish the Silk Road Economic Belt and Maritime Silk Road. This foreign policy platform aims to give China more international influence and develop friendly relations with the countries along these routes through physical infrastructure and economic interdependence facilitated by ever greater flows of reciprocal trade and investment. The second layer of this foreign policy strategy is creating space for China to utilize such economic interdependence for political ends. While fears that China’s ‘offensive’ in Serbia and CEE is part of China’s strategy to “divide and conquer” Europe are unfounded, financing and delivering capital projects in Europe inevitably increases Beijing’s leverage over the host countries.

From a Serbian perspective, the country—cash-strapped, largely deindustrialized and in need of investment in infrastructure—relies on external resources for achieving economic development. The financial crisis further increased the need for alternative external funds to make up for local and EU capital shortages. Cooperation with China is perceived as the ‘real deal’ as it couples financing under favorable conditions with technology and expertise needed for capital projects. Hence, complementarity between Serbia’s needs and Beijing’s developmental agenda creates an opportune environment for China’s involvement in infrastructure development in Serbia.

 

Bringing the Balance Sheet Back In

While these perspectives accurately provide the general context of China’s pursuit of infrastructure projects in Serbia and elsewhere in the CEE region, relying exclusively on them may overemphasize structural and strategic aspects at the expense of a more nuanced understanding of developments ‘on the ground.’ Particularly, neglecting to consider financial aspects of the projects may result in making premature conclusions about the future of China’s investments in the infrastructure of Serbia and the wider CEE region. Yet it is precisely in the feasibility and profitability of the projects that Sino-Serbian cooperation currently faces a bottleneck.[4]

Construction workers on the Pupinov Bridge

Construction workers on the Pupinov Bridge. Photo credit: stefanogiantin.

 

It is often overlooked that Chinese state-owned enterprises (SOE) also do business with an imperative to make a profit. As China’s overseas projects are understood exclusively through the prism of Beijing’s intentions to realize strategic geopolitical and economic interests, this basic economic logic often goes unnoticed in analyses of China’s SOE’s international expansion. On the other hand, it is often implicitly assumed that as long as Beijing is willing to open its coffers and offer favorable loan conditions, any developing country is certain to open the door wide for Chinese enterprises and projects. However, in Serbia’s case, the current government’s commitment to control the external debt and budgetary deficit complicates the prospects of China’s investment in Serbia through a loan-and-build model. Hence, new ways of financing, including Public-Private Partnerships and concessions, are touted by Belgrade as potentially more suitable arrangements for financing capital projects than state-to-state loans. However, this may not resonate well with the profit-seeking, risk-averse preferences of Beijing. Taking these factors into account casts major doubt on prospects of a future deepening of Sino-Serbian cooperation in infrastructure development.

For example, over the past few months the Serbian government has been actively working on keeping the costs of the Serbian section of Belgrade-Budapest railway down, even below the €400 million mark. This represents a significant reduction from the originally announced project budget of over €850 million. Instead of making a new loan arrangement with China, Serbia is interested in financing the works through its own budgetary means or with the help of a previously agreed-on loan from Russia. While at the moment it is not clear how a smaller budget may impact the project—and whether the downsizing will take place at all—the adjusted budget target signals that the Serbian government has indeed a limited maneuvering space to ensure that this and other capital-intensive infrastructure projects go ahead as desired. If so, that may put other infrastructure projects currently in preparation with China in jeopardy.[5]

In another instance, the progress of previously agreed-on projects to build and maintain several sections of a highway through Serbia has stalled as Chinese companies did not respond to the call to submit project proposals earlier this year. While the Serbian government preferred a concession agreement so as to avoid accumulating further debt, the Chinese regard such an arrangement as financially unfeasible due to the projected low level of traffic, and prefer to finance the project through a state-to-state loan. Furthermore, the Chinese were looking for state guarantees in case of natural disasters, but with the Serbian government so far unwilling to share such financial risk, the future of the projects have been left to hang in the balance.

In conclusion, despite the commitment to cooperation on both sides, China’s involvement in infrastructure development in Serbia may not turn out to be smooth sailing. Complementary developmental priorities, political platforms provided by strong bilateral ties, and readily available Chinese capital and expertise have indeed given a head start to Sino-Serbian cooperation on joint infrastructure development. However, to sustain the positive trend of mutually beneficial cooperation into the future requires that favorable conditions on the macro-level are matched by the financial feasibility of the projects. Having established a solid foundation and built up strong momentum, it is reasonable to expect that both sides will do their best to ensure that cooperation continues into the future. However, whether China and Serbia can identify and then structure projects in a way that would satisfy the financial imperatives of both sides remains to be seen.

If not, the trend of China’s growing involvement in the region through infrastructure projects may be short-lived, as Beijing is likely to face a similar challenge with other regional partners who also work with restrictive, debt-laden budgets. Given a similar pattern of deepening bilateral ties revolving around joint infrastructure projects developing between China and a number of countries in the Balkans and the CEE region, developments in Serbia may yield valuable lessons for policymakers in the region.

 

Dragan Pavlićević earned a PhD from the University of Nottingham’s School of Contemporary Chinese Studies researching China’s domestic politics. Dragan is currently researching China’s multilateral diplomacy and the New Silk Road strategy with focus on Europe. He is a contributing analyst at Wikistrat.

 

This article is part of our feature Re-imagining the Silk Road.


[1] Serbia has been at the forefront of Beijing’s efforts to deepen its relationships with the countries of Central and Eastern Europe (CEE). This foreign policy initiative has been embodied in a new multilateral platform, called “16+1”, and a growing number of accompanying mechanisms meant to advance cooperation between China and 16 CEE countries: Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Macedonia, Montenegro, Latvia, Lithuania, Romania, Poland, Serbia, Slovakia and Slovenia. Serbia’s “vanguard” position was further solidified in 2014 when Belgrade hosted the third China-CEE Summit, and Serbia was repeatedly singled out by members of Chinese officialdom and think tank community as one of China’s key partners in the region.

[2] For further information about China’s infrastructural projects in Serbia and the recent trajectory of Sino-Serbian Relationship, see Dragan Pavlićević, “China’s New Silk Road Takes Shape in Central and Eastern Europe,” China Brief, Vol. 15, Issue 1, (2015): 9-14; Dragan Pavlićević, “China’s Railway Diplomacy in Balkans,” China Brief, Vol. 14, Issue 20, (2014):8-12; Dragan Pavlićević, “Sino-Serian Relationship in a Sino-EU Relationship Context,” Briefing Series No. 68, China Policy Institute, (2011).

[3] For more details about “Going Out” policy and its application to development of Sino-European economic ties, see Shixue Jiang, “Chinese Investment in EU,” Working Paper Series on European Studies, Institute of European Studies, CASS, Vol. 8, No. 1, (2014).

[4] Although other geopolitical or macroeconomic factors should not be discounted in negatively affecting the prospects for a deepening Sino-Serbian relationship, they are not discussed here for reasons of space.

[5] At the time of publication of this article, China and Hungary have already signed the agreement containing the financial details regarding the construction of the Hungarian section of the railway, while the analogue Sino-Serbian agreement is still missing.

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