Update Country Report Maldives 17 Aug 2020

• The coronavirus (Covid-19) pandemic has illustrated the importance of developed markets in China's trade relations, with merchandise trade flows to countries under the Belt and Road Initiative (BRI) falling noticeably in April-June 2020.
• Much of the slump in economic activity across the second quarter was due to falling global energy prices. However, growing debt risks in BRI countries also threaten to soften related trade and investment activity later in (and beyond) 2020.
• The Economist Intelligence Unit expects the centre of gravity under the BRI to swing increasingly towards South-east Asia, buoyed by the stronger prospects for post-pandemic recovery in that region.

The global recession induced by the coronavirus has hit emerging markets particularly hard. In our previous BRI quarterly we identified the major fiscal and economic risks facing the BRI as a result of the pandemic. With many of these shocks having materialised, how will the initiative develop in 2020-21?

The BRI trade outlook

BRI merchandise trade faltered in April-June as the global economy went into lockdown over the second quarter. Chinese exports to BRI countries fell by 4.5% year on year over that three-month period, worsening from the 4% fall in January-March, while imports from BRI markets dropped by 13.7% over the same period, partly as a result of a slump in oil prices. These disrupted trade dynamics materialised even as China's economy normalised in April-June. They also contrasted with China's headline trade performance more generally, with total goods exports expanding by 0.1% year on year (and imports falling by a shallower 9.7%) over that same period.

Much of this is tied to the specific nature of the health crisis. BRI countries have struggled to maintain normal economic activity amid national lockdowns, while plummeting global energy prices have eroded export receipts. Chinese data suggest, however, that trade flows were more resilient between countries with successful viral containment strategies; exports to Thailand and Vietnam rose by 12.2% and 6.8% respectively, while there were falls in shipments to India (-39.7%), the Philippines (-18.7%) and Indonesia (-11.7%).

Complicating any Chinese pivot from the West

These takeaways suggest larger strategic consequences for China. The April-June trade data confirm the outsized importance of developed markets in China's trade relations, despite long-standing calls for China to use the BRI to cultivate alternative economic partners. This dynamic will deepen rather than recede in 2020-21, as developing nations struggle to sustain economic activity in the aftermath of the crisis.

Diplomatically, these assumptions reinforce our forecast that China will remain committed to its first-phase trade deal with the US, partially in order to slow the deterioration in US-China ties (which will persist through 2020-24). Even if US-China ties continue to fray, the desire to engage with developed markets will preserve the focus on relations with Europe and North-east Asia. There is evidence of appetite for some co-operation: Chinese state media reported that in January-May, 12,520 tonnes of Chinese medical supplies were delivered by rail to Europe to fight the pandemic.

These relations will face numerous challenges, however, including in regards to China's industrial policy, security concerns over Huawei and diplomatic tension tied to China's actions in Hong Kong, Xinjiang, Taiwan and the South China Sea.

Changing investment dynamics

However, the investment outlook is marginally more positive. This is counter-intuitive: the pandemic has flattened capital valuations across a wide range of industries and sparked bankruptcies in developed markets (the source of most foreign direct investment), while also souring the economic and business environment outlook in most developing economies. Nevertheless, data from China's Ministry of Commerce indicate that Chinese overseas direct investment (ODI) flows to BRI countries increased by 19.4% year on year in January-June, even as general non-financial ODI fell by 4.3% over that same period. Member countries of the Association of South-East Asian Nations (ASEAN) benefitted particularly from these trends, with Chinese investment in ASEAN rising by 53.1% year on year in the first half of 2020. Most of these flows were concentrated in Singapore, Indonesia, Laos and Cambodia.

This partly reflects global political dynamics. Growing investment strains between China and the US, the EU and other markets have pushed Chinese investors away from developed markets. In addition, a recent surge in Chinese agricultural and energy investment has also dovetailed with domestic efforts to diversify food and fuel imports, as part of import security plans.

Some investments continued to work under existing agreements. A number of projects under the China-Pakistan Economic Corridor (CPEC) are moving forward, with China signing up to two major hydropower projects in Pakistan-administered Kashmir (a region disputed with India) in May and June. Although these projects were commissioned before the recent downturn in China-India relations, they may now command deeper geopolitical significance: stronger Chinese investment in CPEC may be a way to keep China-Pakistan relations strong, in order to balance growing tension with India.

We expect the risk of future coronavirus outbreaks in 2020-21 to prompt Chinese companies to focus on completing major flagship projects rather than launching new initiatives. Hints of this are evident in data on Chinese overseas construction projects: the value of newly signed and completed projects fell by 5.2% and 7.8% year on year respectively in the first half of 2020, amid delays to business activity and labour flows.

The fragility of the economic and healthcare situation in many BRI markets also suggests that much of the investment momentum in January-June may soften by the second half of 2020. This will be particularly the case as developing economies struggle to deliver any meaningful economic rebound, and as fiscal pressures intensify amid disrupted revenue streams and increased public expenditure. Our own credit rating assessments similarly indicate that the pandemic has deepened the economic risk factors facing emerging economies.

Nevertheless, China's recent investment drive into ASEAN indicates keen acknowledgement of associated debt risks. Much of this stress has materialised in South Asia, Central Asia and across Africa, and although we expect China to retain its investment footprint in those regions, the pandemic has positioned the economies in ASEAN as more attractive by comparison. This may place a floor under growth in Chinese ODI flows to South-east Asia in 2020-21, amid stronger local economic fundamentals and brighter prospects for recovery, even if Chinese investment in other regions (such as Africa) continues to enjoy long-term policy support.