A New Silk Road

Despite the lack of a free trade agreement, bilateral trade between the GCC and China has increased dramatically in recent years. Published in Bloomberg Businessweek, 16 August 2014

This summer marked the tenth anniversary of the start of free trade negotiations between China and the GCC, a milestone that passed without much notice. Since the trade talks were launched in July 2004 there have been numerous meetings but no breakthrough. According to China’s Ministry of Commerce, the two sides have agreed on the majority of issues related to the trade in goods, but issues relating to the trade in services remain in the balance.

Free trade agreements (FTAs) are notoriously difficult to hammer out and this is far from the first to make slow progress. For evidence of that you only have to look at the GCC’s negotiations with Europe, which began in 1991. A deal with China ought to be a simpler proposition in at least some respects. After all, there are no awkward questions about human rights violations when the GCC and China sit down together, as happens when talking to EU leaders. But while the discussions with China have been moving at a sluggish pace, there are signs that the momentum may now be picking up.

“An FTA has been stated as an important priority by the Chinese government for this year,” says Tim Summers, senior consulting fellow on the Asia Programme at the UK’s Chatham House think tank. “I would expect a push from China in the second half of this year, perhaps including visits to the GCC by some senior Chinese leaders.”

Evidence of that enthusiasm came at a meeting with a GCC delegation in Beijing in January, when President Xi Jinping called for a renewed push for an FTA, saying: "I hope both sides can sign the agreement at an early date.” As a stop-gap measure, the two sides agreed a cooperation plan for the next three years in areas as diverse as politics, trade, energy, environmental protection, culture, education, and health.

Even without an FTA in place, however, the value of trade has increased enormously over the past decade. The initial aim of the FTA talks was to increase the value to more than $100 billion but that goal has already been comfortably exceeded. The total value of bilateral trade between the GCC and China rose from $33.8 billion in 2005 to $165.3 billion in 2013, according to the UN Comtrade database.

The trade is – not surprisingly – dominated by oil. According to the US Energy Information Administration, China accounts for a third of global oil consumption and in the final quarter of last year became the world’s largest net importer of oil. The Middle East is the most important source of those imports, with Saudi Arabia the largest supplier followed by the likes of Oman, Iraq and the UAE. In addition, Qatar supplied 9.2 billion cubic metres of liquefied natural gas to China last year, accounting for 17.7 percent of all Chinese natural gas imports.

In the other direction, the main Chinese exports to the Gulf include clothes, telecoms equipment, furniture and other consumer goods, most of which enter the region via the UAE and Saudi Arabia. But the two elements are not equally balanced and all those oil tankers and LNG carriers making their way from the Gulf to terminals on the south and east China seas mean there is a large trade surplus in favour of the GCC. Last year it was worth almost $46 billion.

When it comes to investment by companies, the roles are reversed. There have been some large investments in China by the likes of Saudi Aramco and Saudi Basic Industries Corporation (Sabic), which are naturally enough focused on their strengths in oil, gas and petrochemicals. Saudi Aramco established a sales and marketing office in Beijing in 1998 and these days is working closely with Sinopec on the Fujian refinery and petrochemicals complex in Quanzhou. Sabic also works with Sinopec, on the Tianjin Petrochemical Company, and last year opened a $100 million technology centre in Shanghai.

Kuwait and Qatar have also been linked with refinery projects in China. Such investments are more the exception than the rule, however, and most of the corporate activity flows in the other direction.

“The investment is pretty much one-sided,” says James Wu, chief representative in China for the Dubai-based bank Emirates NBD. “There are very few GCC entities operating in China but we see a lot of Chinese investment in the GCC and it is getting larger. It was disrupted a bit during the financial crisis but now there are a lot of companies that are very active in the GCC, like China State Construction Engineering, China Railway, PetroChina, SinoChem, and China Harbour Engineering.”

Emirates NBD opened its representative office in Beijing in 2012 and Wu says the core part of its operations is providing a gateway for Chinese investors wanting to target the GCC and the wider MENA region, rather than Gulf companies looking to do business in the People’s Republic.

Other banks from both sides have been trying to tap into the same trend. National Bank of Kuwait was an earlier arrival, opening its representative office in Shanghai in 2005. National Bank of Abu Dhabi followed in 2012 and Qatar National Bank arrived a year after that. In return, financial institutions such as Agricultural Bank of China, China Construction Bank, Industrial & Commercial Bank of China and Bank of China have opened branches in the Gulf.

For most of the Chinese banks and companies it is the UAE, and Dubai in particular, that appears to be the easiest first port of call in the region. From there they can service customers around the Gulf and further afield in the rest of the Middle East and parts of Africa.

“Chinese companies are very active in all the GCC countries, but the UAE has a big concentration of Chinese companies, particularly Dubai,” says Wu. “The infrastructure is very good and also the culture there makes it easier. Chinese companies use Dubai as a gateway to the MENA region. In more traditional countries like Saudi Arabia, there are fewer Chinese companies, as they find it more difficult to manage the cultural differences.”

The trick for governments on both sides is finding a way to expand the current links around oil and gas on the one hand, and construction and consumer goods on the other, into a wider trading relationship. This is certainly something the Chinese authorities appear keen on. Following talks with Saudi Arabia’s Crown Prince Salman Bin Abdulaziz Al Saud in Beijing on 13 March, Xi Jinping was quoted by the official Xinhua news agency as saying: "Both sides should take energy cooperation as a pillar and expand partnership in aerospace and new energy to forge closer ties.”

For the authorities in Beijing, one possible framework for doing this lies in the idea of a new ‘Silk Road’. This is something of a pet project of Xi Jinping and involves an attempt to revive the old trading route between the Middle Kingdom and Europe via Asia. The original route bypassed most of the Middle East but the modern version encompasses both a land route through central Asia and a new maritime Silk Road, which could more easily involve Gulf ports. As yet, it is more of an idea on paper than a reality, but Beijing has brought the idea up in discussions with GCC governments and it may yet have an impact on their trade ties.

“The Silk Road is more than a slogan, though we will have to wait and see exactly how big the impact is,” says Summers. “It reflects several underlying trends. There is the growing importance of China's relations with land neighbours to the west, the fast growth in trade and investment volumes with these countries, the ability of road and rail infrastructure to link these markets in a way they were not linked in the recent past, and some diversification away from traditional developed-market trading partners.

“The main medium-term impact will be on China’s economic ties with central and southeast Asia, though the Chinese idea of the Silk Road certainly extends to the Middle East.”

Despite this vision, there are some doubts about how much deeper the trade relationship can realistically go. For one thing, when Chinese exporters look around the world, the Gulf appears as a fairly small market with limited potential.

“There are natural limits to the trade,” says Ben Simpfendorfer, managing director of the Hong Kong-based Silk Road Associates. “Chinese consumer goods and construction materials have already captured such a large share of the market. Where there will be additional gains will be Chinese manufacturers moving up the value chain, perhaps providing products like oil drilling equipment, or container port crane equipment.

“The areas with real room for improvement are in the protected industries. We’re primarily talking about energy here and both parties are very protective of their energy sectors. This is one of the reasons why there has been a very strong growth in trade between China and the GCC region but investment has lagged.”

From a Chinese perspective, the Gulf does not have much to offer beyond oil and gas resources. In addition, most Gulf companies have historically preferred to look to markets in North America, Europe and Africa when making investments.

“There has been a lot of talk about GCC companies and governments investing in the Far East, in refineries and so on, but physical investments appear to have been quite rare,” says Daniel Kaye, senior macroeconomic editor for the EMEA region at the UK’s Oxford Economics and a former senior economist at National Bank of Kuwait. “To some extent that’s understandable. The GCC has a lot of money that China, with its huge domestic savings, doesn’t really need. Other than capital, the region’s non-oil export capacity is relatively thin.”

In addition, investing in China is not necessarily all that easy. The yuan is not fully convertible, the way politics and business interweaves in China can make life for outside investors difficult – as is also the case in the GCC itself – and of course Gulf countries tend to favour dollar denominated assets given their reliance on oil revenues.

“There is much talk about the need for Gulf governments to diversify their financial reserves, but I think there are limits to how far that diversification will go over the next decade or so,” says Kaye. “The Gulf’s main revenue earner is oil which is priced in dollars so it makes sense to keep a lot of their reserves in dollar denominated assets.”

Even so, while investments may continue to lag behind, the prospects of a rise in the overall value and volume of trade between the partners appears bright, says Garbis Iradien, deputy director of the Washington DC-based Institute of International Finance.

“In 2000, the GCC’s exports to China were 2 percent of total exports. In 2013, it rose to 9 percent of exports. So it’s a fast expansion,” he says. “This trend will continue. It’s all related to the growth of the country and the need for additional energy. The GCC’s imports from China have also been growing fast. They jumped from 6 percent of all GCC imports in 2000 to around 14 percent last year and this will also continue to expand. Chinese products are much cheaper than their European equivalents and Chinese technology is quite advanced.”

As Iradien says, underpinning the expansion of trade is the growth of the Chinese economy. While it may not be racing ahead at the double digit pace of recent years, the IMF says it expects it to grow by a healthy 7.4 percent this year and 7.1 percent next year.

In tandem with the growing trade, the governments of the GCC and China are expected to keep working on trying to finalise an FTA. It is certainly likely to be on the agenda at the next China-GCC Strategic Dialogue, which is scheduled to be held in Doha in 2015. However, the rate at which two-way trade is increasing, some observers may be left wondering whether such a deal is even necessary.