Belt and Road in Malaysia: Make or Break?

Prime Minister Mahathir Mohamed. Source: Reuters

With the shock election of Mahathir Mohamad in May 2018, Malaysia has put itself at the center of an emerging debate regarding the Belt and Road Initiative (BRI). Across BRI countries, there have been growing concerns in recent months about mounting debt owed to China and uncertainty as to what happens in the eventuality of BRI project failure. Already, Pakistan, Nepal and Myanmar have postponed or cancelled BRI projects in their countries based on such fears. But these were one-off cases; individual projects that were scrapped - but not, as yet, reflective of a wider backlash against big-ticket infrastructure.

This is where Malaysia is different. One of Mahathir’s key manifesto promises was to scale back such big-ticket infrastructure that he viewed as unnecessary, unsustainable and closely related with the corruption scandal that brought down his predecessor Najib Razik. Since coming into power, he has embarked on a quest to deliver those promises. As such, what happens in Malaysia over the coming months will speak volumes for the progress of the BRI more widely. Mahathir has already sought to ‘reset’ Malaysia’s foreign policy through maintaining equidistance from major regional powers[1] and adopting a more pragmatic approach towards Chinese investment in Malaysia.

Malaysia had previously been seen as the golden child of Chinese investment in the ASEAN region. Chinese FDI represented close to 15% of Malaysia’s total FDI inflows in 2016, up from less than 1% in 2008. The acceleration was particularly pronounced in the final two years of Najib’s leadership; with Malaysia becoming the fourth largest recipient of Chinese FDI in 2017, up from 20th place in 2015. Under Najib, Malaysia embraced the BRI and signed up to a number of projects worth an estimated $34 billion.

The flagship and largest of these projects was the East Coast Rail Link (ECRL) worth US$ 13 billion. Work had already commenced on the 700km high speed railway which connected the east and west coasts of Peninsular Malaysia, and an estimated 14% of the total work had already been completed by May 2018. The contractor was the Chinese construction giant China Communications Construction Company (CCCC) and 85% financed through a soft loan from China Export-Import Bank at an interest rate of 3.25%, with a seven-year moratorium on repayments.  

Citing excessive borrowing from abroad, Mahathir’s government last week suspended the construction of the ECRL, along with two pipelines being built by China Petroleum Pipeline Bureau. The total of the projects amounted to around $20 billion. The projects were not scrapped in their entirety, instead Mahathir has stated that he wants to renegotiate the terms of the deals and significantly reduce costs. These negotiations will take center stage when Mahathir visits China later in August, expected to happen at some point between August 13 and 21.

In the interim period, both sides will undoubtedly be working on their negotiation strategies. Yet, what’s at stake here is more than just the construction of a high speed railway. The fate of the ECRL will speak volumes for the progression of the BRI more widely; in Malaysia, ASEAN and beyond. That’s because the ECRL is bigger in size, more ambitious in its vision and already received considerable publicity around the world. The negotiations also come at the time when BRI projects are being scrutinized more heavily.

We boil it down to two potential scenarios:

1)    ECRL goes ahead albeit in reduced form; Chinese side make concessions

 In this scenario, the Chinese side would make concessions to Malaysia. The total cost of the project would come down, and the project would proceed albeit in reduced form. This might involve scrapping the second phase of the project, or looking at alternative and cheaper project specifications. These kind of concessions have been made before on BRI projects; recently in Thailand for a high speed rail project.  

In this scenario, the Chinese would manage to retain their flagship BRI project in Malaysia. They would also improve their reputation as a partner that can show flexibility and accommodate evolving policy environments across different countries. This would help in dispelling a (mis)perception that the Chinese are using the BRI to shoehorn their agenda, projects and companies into BRI countries. It would be a positive move for the progress of the BRI more widely.

At the same time, granting Malaysia the concessions that it desires will also incentivize other BRI countries to take a tougher stance on their own BRI projects with the hope of striking better deals with China and saving themselves millions if not billions of dollars. Chinese financiers, already facing the risk of financially unviable BRI projects that might struggle to yield returns, will face further pressure to bring down project costs and accept even lower returns. For those financiers trying to price according to market costs, further concessions on existing concessional loans may be one step too far.

Whilst each country that receives BRI investments faces its own constraints that in turn determine the specific bargaining chips it holds when negotiating with the Chinese, there’s no doubt that a ‘capitulation’ to the demands of Malaysia would be seen as strengthening the collective bargaining power of BRI countries against China. The Malaysian example would have set a precedent – for China a dangerous precedent - and other countries would be inclined to follow. BRI would proceed into the future, a major roadblock would have been overcome, but the balance of power between lender and recipient would have been skewed.

2)    ECRL gets scrapped.

In this scenario, a deal cannot be reached by both sides and the project is scrapped. The Chinese side would adopt a tough stance on project terms; and demand substantial compensation from the Malaysian side for breach of contract. In response, the Malaysian government, faced with growing anti-China pressure at home, would choose to scrap the ECRL (and pay reduced compensation charges) instead of continuing to proceed with it. This is not beyond the realms of feasibility, indeed in a separate announcement, Mahathir already scrapped the planned Singapore-Kuala Lumpur high speed railway[2].

The PR fall out from this outcome would hurt the BRI significantly. In order to justify to its citizens, the paying of compensation costs, and scrapping of the project when already close to 15% had been completed, the Malaysian government would need to emphasize (and perhaps exaggerate) the concerns associated with the ECRL. The opacity of the deal has already been criticized by Mahathir, and recently the Malaysian administration also raised the expected costs of the project based on the view that CCCC had disregarded costs associated with environmental degradation and land resettlement.

These are all common concerns with BRI projects, but if they were still to be voiced by the Malaysian government even after negotiations with the Chinese, then it would give them new traction across BRI countries. The perception created would be a toxic one for the progress of the BRI; specifically, that the Chinese side is inflexible and unwilling to take onboard the concerns of the countries they are investing in. This will lead to greater scrutiny of Chinese investments and by extension the BRI going forward.

Win-win becomes lose-lose?

It’s clear that neither of these outcomes is particularly desirable for the Chinese. In the first case, BRI countries become more brazen and will feel they have more bargaining power to obtain greater concessions from the Chinese. In the second case, BRI projects will face even greater scrutiny in the future. Such possibilities might well be seen as lose-lose, as opposed to the oft-cited win-win rhetoric synonymous with the BRI.

That all said, for the Chinese, there must be a slight preference towards the first outcome. The damage of losing a signature BRI project in the second case, with potentially harmful wider ramifications, is too great a risk. The best hope is to strike a deal as per the first case, but not ‘capitulating’ to Malaysia’s demands. However, it’s a fine line to tread, the tougher the negotiating stance of the Chinese the more likely both parties are to sleepwalk into the second outcome…We eagerly await Mahathir’s trip to China.

[1] Mahathir’s first two meetings with overseas leaders were with Narendra Modi and Shinzo Abe. This marks a divergence from the Najib government that sought warm ties with China (arguably at the expense of Japan).

[2] The primary contractor for this project had not yet been announced, but it was likely to be led by a Japanese or a Chinese consortium.