|18 February, 2020

BRI: GCC paves a smooth road for Chinese firms

Chinese firms should be well-prepared to tackle the challenges and risks associated with big construction and real estate projects in the Gulf region under the Belt and Road Initiative (BRI).

General view of Dubai's cranes at a construction site in Dubai, UAE December 18, 2018. Image used for illustrative purpose.

General view of Dubai's cranes at a construction site in Dubai, UAE December 18, 2018. Image used for illustrative purpose.

REUTERS/Satish Kumar

New investment opportunities are emerging for Chinese firms in the Gulf Cooperation Council (GCC) as member countries explore alternative means to finance construction and real estate (CRE) projects.

"There is a growing market for public-private partnerships (PPP) in the region as the CRE sector looks at alternative ways to finance the completion of these projects," said Gan Mei, Director, and China Desk Lead at PwC Middle East.

Most GCC countries are enacting PPP laws and embarking on initial projects, which could be an attractive opportunity for Chinese State-Owned Entities (SOEs) with access to export credit guarantee schemes and financing, she said.

China's President Xi Jinping proposed a package of $20 billion in loans, and about $106 million in financial aid, to Middle East countries, at the 2018 China-Arab States Cooperation Forum, as Beijing wants to revive the region's economy through various schemes including BRI.

To capitalise on the regional opportunities, Mei said, Chinese companies need to understand local development strategies and government initiatives, such as the Saudi Vision 2030 or the Kuwait National Development Plan 2035 (KNDP).

"They also need to understand more specialised local policies and targets, including smart city strategies and building technology initiatives where China can showcase the innovation from some of their fast-growing cities such as Shenzhen," she said.

China has been making huge capital expenditure over the past several years, with 13.4 percent of its Gross Domestic Product (GDP) in 2015 going towards developing economic and social infrastructure, compared to an average 3.2 percent in other BRICS countries, according to International Monetary Fund (IMF) estimates.

"This has provided key learnings for the Chinese, building a leadership position in innovation and application of emerging technologies within the infrastructure and construction space," said Ravi Suri, KPMG Global Head of Infrastructure Finance and Regional Head of Infrastructure Advisory, MESA.

He cited the example of Chinese companies that are at the forefront in the application of 3D printing, bioplastics, and prefabricated prefinished volumetric construction. Some newer urban developments in China also exhibit high standards of sustainable design and architecture, concepts that resonate regionally and globally.

"These concepts have massive potential in the GCC construction market where an increasing number of construction and real estate development is undertaken at a significant scale with sustainability being a key theme," said Suri.

SPECIALISATION IS THE KEY

Mei agreed that specialisation and sophistication would be a key factor for developers, particularly in markets like Dubai, where the development market is maturing but slowing down with decreasing property prices, the recent halt on Al Maktoum Airport construction and government calls for fewer new developments. These are clear signals that a focus on quality over quantity will increasingly become a competitive advantage for developers.

"Any strategy for the Middle East region must be up to date and agile, customised to selected local markets as there is no cookie-cutter approach for the region. It has to be updated constantly and even with variations from city to city," she said.

Suri suggests major Chinese developers and contractors form a partnership with local firms to create a differentiated value proposition in the market as the GCC has many prominent regional developers and construction companies with international experience.

MITIGATING RISKS

Industry experts acknowledge that there are challenges pertaining to some of the larger CRE projects for the local and Chinese companies involved. However, these depend on the nature of projects and geographies.

"Focusing on local needs and local engagement as well as understanding Chinese policy and interest will help mitigate risks and timely execution of projects," said Suri, adding that financing and compliance standards should also be aligned with international best practices.

He said BRI is an evolving programme and includes a good deal of funding through government-to-government (G2G) debt financing tied to sovereign guarantees, in addition to the participation of the state-owned entities and financial institutions.

"However, we are now seeing an increased propensity of Chinese institutions to partner with multi-lateral, bilateral and commercial financial institutions as well as increasing participation in syndicates," he said.

Another critical challenge for BRI would be the speed at which these initiatives are going to be implemented, said Dana Salbak, Director Research for MENA at JLL.

"BRI is a five to 15-year investment, which means returns will be delayed, and therefore investors need to look long-term and think beyond a short-term cycle," she said.

Due to the nature of the construction industry, which is generally high value and long-term return investments, PwC's Mei points out that working capital and cash flow can be preserved and optimised through the implementation of efficient tax processes which will help debunk the "debt trap" stereotype associated with CRE projects.

MANAGE TAX COMPLIANCE

Mei said the Gulf market remains attractive to Chinese investors due to, amongst other incentives, lower tax rates applicable across the Gulf region and the eligibility to claim the Value Added Tax (VAT) paid on expenses in countries where VAT has been implemented.

With the recent implementation of VAT in the UAE, Saudi Arabia, and Bahrain, Mei said Chinese companies need to efficiently manage their tax affairs and compliance similarly to other international tax jurisdictions.

Suri points out that the GCC's relative financial strength, combined with a focus on balancing risk allocation between stakeholders and optimising financing structures, has the potential to effectively reduce financial risks, which have affected Chinese and some host countries in the past.

He recommends credit and potential risk insurance mitigation tools for BRI projects, including export credit financing, risk cover, the participation of alternative funds including infrastructure and pension funds, and innovative financing tools such as efficacy insurance where new technology risks are involved.

Mei pointed out that Chinese companies can further safeguard themselves by ensuring good governance and tax management to counter any potential adverse impact on operations with a careful selection and appraisal of investments, which are generally accepted mechanisms for businesses to safeguard key interests.

"Considering the opportunity for CRE projects, Chinese companies would benefit from strategic planning together with obtaining specialised tax advice in advance to streamline and optimise operations in the region," she said.

(Reporting by Syed Ameen Kader; Editing by Anoop Menon and Bhaskar Raj)

(anoop.menon@refinitiv.com)

(This article was first published in the 3rd edition of BRI CONNECT: AN INITIATIVE IN NUMBERS by Refinitiv. )

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© ZAWYA 2020

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