On the surface China's Belt and Road Initiative looks in rude health. In March, the huge global infrastructure scheme pushed further into Europe, signing a deal with Italy. Then last week Malaysia relaunched a multibillion Chinese-backed railway, previously canceled on cost grounds. When President Xi Jinping welcomes global leaders to his second glitzy BRI Forum in Beijing next week, he would be forgiven for feeling triumphant.
Underneath, however, Xi's signature foreign policy now faces its most significant challenge since it was launched five years ago, and one rooted in fact that China is on the verge of running current account deficits for the first time in decades. For all BRI's eye-catching expansion, China's leaders face increasingly tricky choices about how to deploy money abroad, not least given that BRI itself is far from the best use for that cash.
With projects worth hundreds of billions in 60 or more countries, it is easy to understand why BRI appears to have limitless ambitions and bottomless finances. China's recent memorandum of understanding with Italy seemed a case in point, involving a spate of port deals in cities including Genoa and Trieste and prompting alarm among European Union politicians wary of encroaching Chinese influence.
Malaysia's rail announcement last Friday also gave BRI a boost, restarting a planned high-speed link between the country's east and west coasts. Originally slated at $16 billion, the line was canceled last year amid gripes about excessive expense, echoing wider concerns that BRI projects often tempt developing nations into unsustainable debts. But now the deal is back on, albeit with a reduced budget of $11 billion and few indications as to how roughly $5 billion has been shaved off the project's costs.
All this adds to the view that BRI is set to keep expanding almost indefinitely. But that requires money -- and this is something that for the first time in living memory China may soon find in short supply.
Export-fueled growth has long allowed China to run a surplus on its current account, meaning the balance of trade in goods, services and investments. But Xi's government briefly ran a $23 billion deficit in the third quarter of last year. In 2019 it may even run an annual deficit for the first time since the early 1990s, reflecting China's tilt away from exports and toward consumption, and the rapid rise in Chinese tourists splashing cash abroad.
This change will have far-reaching consequences for the global economy. At a more prosaic level it also means Xi must become choosier about foreign investments. Projects developed under BRI are typically paid for in dollars. If China begins to run regular current account deficits, those dollars can be only be found by attracting foreign capital, something the relatively closed Chinese financial system is not well set up to do.
Signs of China's changing financial circumstances can also be seen in a second important recent change: plunging foreign investment rates.
Headlines generated by BRI make it seem as if Chinese companies are investing evermore heavily abroad. In fact, China's outbound investment figures tanked in each of the last two years. In 2018, for instance, foreign direct investment to both the U.S. and Europe plunged by more than three quarters.
Part of this decline reflects aftershocks from the U.S.-China trade war, which have made Chinese businesses wary of spending abroad and American and European officials cautious about allowing tech sector deals.
But equally important has been a drive by Chinese regulators to clamp down on foreign deals amid worries about capital flight and rising corporate debt.
Beginning in 2015, policymakers ended a helter-skelter period in which Chinese conglomerates were snapping up foreign trophy assets, from hotels to English football clubs. Yet that same clampdown has also curtailed useful investments by private companies, including acquisitions that could help to provide China with foreign technology.
China could of course fund any future current-account deficit by borrowing from abroad. But there are few signs Beijing wants to do this, given it might create financial instability while also placing downward pressure of China's currency. Instead, Beijing's preference is likely to spend less abroad.
China now faces a clear choice. Xi has placed two economic priorities at the heart of his leadership, both requiring substantial foreign investment. BRI is the first, designed to win friends abroad while also developing trade ties for China's struggling western interior provinces. The second aims to build a more technologically sophisticated economy, in part by acquiring foreign know-how to meet the ambitions outlined in the "China 2025" strategy for state-of-the-art manufacturing.
As China learns to work within its new current account constraints there is likely to be a tricky trade-off between these two aims, according to Julian Evans-Pritchard, a China economist at Capital Economics. The risk, for China at least, is that Xi jumps the wrong way, prioritizing showy but financially suspect BRI projects, delivered by unproductive state enterprises, at the expense of more useful deals struck by private companies.
There may be a better path. China has faced heavy criticism over the structure of BRI, whose projects often suffer from murky finances. Many of the national leaders gathering in Beijing this month, including Mahathir Mohamad of Malaysia and Imran Khan of Pakistan, have publicly criticized BRI -- even though none have actually opted out of it.
Given China's changing financial position, it would make sense for Xi to co-fund more BRI projects internationally instead, tapping resources from development organizations like the World Bank, or even private sector partners. Such an approach would have the double benefit of lessening China's need to spend its own scarce dollars, while bringing BRI's governance closer to international norms.
More importantly, China would be wise to question the real value of these foreign infrastructure initiatives. Investments that boost growth-enhancing technologies are a reliable way to develop an advanced economy, as Japan and South Korea have shown. Given a choice between investing in a railway in Malaysia or buying a German robotics company, it is clear which way China should go.
Whichever path China chooses, BRI cannot continue for the next five years as it has for the last five. The era in which China bestrode the world with pockets stuffed full of foreign currency is drawing to a close. And as China's finances change, so the freewheeling, high-spending BRI the world has grown used to will soon be over too.
James Crabtree is an associate professor in practice at the Lee Kuan Yew School of Public Policy at the National University of Singapore. He is author of "The Billionaire Raj."