Bumpy Roads of China Ahead: Domestic Agenda and Financial Realities

Introduction

China today is the second largest global economy, the largest exporter and has the largest exchange reserves in the world.

Chinese reforms for its economy began with Deng Xiaoping’s opening agriculture, defense, industry, science, and technology for development with state-led macoeconomic policies. The economic reforms under Deng’s era increased its role of capitalism and the market with less government control over the economy. This opened up China to overseas investment and introduced market incentives to foster entrepreneurship and state-owned companies and allowed China to become the world’s second largest economy with manufacturing and construction might.

When President Xi Jinping and Premier Li Keqiang stepped in on 2012, the administration unveiled new economic measures some bold and some aimed at promoting a more balanced domestic economic model. It can be divided into three issues: Comprehensively Deepening Reform, which gives a decisive role to the market economy; Promotion of New Type of Urbanization, which aims to give an urban family registry to farmers for families who have moved from rural to the urban, and Macro-Control, which aims to specify a reasonable range for economic management through fiscal measures.

China has been encouraging domestic and foreign investments to support its economic recovery with a fiscal monetary policy for a more market-driven economy to strengthen the resilience of global trade and investment flows. It also sought to reduce reliance on American industrial imports, such as semiconductors, and advance its own competitive advantages in technologies like artificial intelligence.

President Xi’s new vision of development also sought to build partnerships with countries of geopolitical implications for China to jointly develop third-country markets and locate more investable opportunities. This ambitious outward foreign direct investment strategy has been called the Belt and Road Initiative.

Concerns remain about Chinese domestic political stability with regard to its suppression of minorities in furthering the domestic agenda and its potential spillover in countries of investment and trade relations. China’s relatively slow economic growth in the recent years, existing financial risk with increasing debt, and a trade war with the United States question whether it can maintain competitiveness in an economy dependent on high capital spending and the expansion of credit.

There are diverging and opposing arguments about Chinese financial outlook as well as its political ambitions. Experts attempt at dissecting China’s growing power and influence, as they are reshaping the Asian security landscape, global economy, and the dynamism of global governance.

This report is an attempt to examine the risks and opportunities for China in context of its domestic social challenges, strategic technology development trends, and investment opportunities in the increasingly multipolar international systems.

Disclaimer: This report is intended solely for internal purposes and is not to be distributed publicly under any circumstance. Any views expressed or implied contained within the report are those of the writer’s. A deeper subject-level understanding and examination of the topic is needed for a full analysis of the subject concerned.

1.    Slowdown of Economic Performance

The 2018 for China was a slow year comparative to the past twenty years. Its economic growth came at 6.6 percent in 2018, the slowest since 1990, and slower than the 9.5 percent average of the past 40 years.

Its rate of economic growth has raised questions on the role of its excessive debt in the country, the impact of its trade war with the U.S. and the general trajectory of regime given its overseas ambitions over the state control of the economy. The cited reasons for its slow growth is multifold – one including that the growing export-led economy has now reached its point of diminishing returns. Some point at Chinese fueling of the economy in the latest financial crisis and the underlying currents in the Chinese economy as the main reasons.

When the financial crisis had hit in 2007, China released an ambitious CNY 4.0 trillion (USD 585 billion) stimulus package. It was launched with massive investment to fuel economic growth, causing concerns that it could be building up asset bubbles, overinvestment, and overly capacitate the account surplus.

Xi’s policies are fiscal than monetary in nature. China is looking to put a floor on growth than on the credit-fueled economy to balance its bottom-line economic growth of at least 6 percent for the next foreseeable years, for the income levels to rise, and to meet the target of creating 11 million jobs a year. Xi also aims to curb excesses in dividends in productivity growth that has risen about 2.4 percent from the annual 1.9 percent. It forecasts debt will be flat at the ratio of 276 percent of the GDP and to rise about three percentage points in 2019 than the average annual 15-point increase for the past eight years.

With China set the inflation rate goal as the upper limit and the growth rate and employment goals as the lower limit; if the economy is within the range, short-term economic stimulus measures will not be taken with economic system reform and economic structural adjustment given priority.

Xi’s approach which gives the role of the market force to allocate its resources, retreats from its role in allocating the resources and limited to basic functions like the macroeconomic management, market regulation, public service delivery, and supervision of society.

2.    Debt of China

Debt exploded in China over the past decade after the stimulus used in the 2008 financial crisis. The rating agency, Standard & Poor’s, reported that China has “huge hidden debt” of between $5.5 trillion and $6 trillion as of 2018.

The debt at the local government level is “not very good debt…. [Historically,] the Chinese government has had to write down debts like this a lot in the past.” China’s local governments have established so-called “local government financing vehicles” that fund projects with debt raised from the China Development Bank against mostly land as collateral. “The question is how deeply involved are the local government financing vehicles in this type of borrowing, and with what risks.”

Country’s economic challenges withstand, as banks are forced by the government to continue to lend to companies struggling with debt. Xi’s focus on the supply-side of the economy has channeled its resources towards state-owned firms, less efficient than private sector economies and its causing the Chinese yuan to weaken with interest rates rising.

China has another plan to pump in spending into the economy, but its payoff may not be very effective. “Banks do not want to lend, so the government is forcing them to lend. The idea is to put money where it is more productive, in the private sector,” said Alicia García-Herrero, the chief Asia-Pacific economist at the French bank Natixis.

Chinese companies own a striking number of international assets, and financial difficulties can create international pressures. Many Chinese companies with western assets have taken out unsustainable debts.

The government policy to growth also seems misguided as its injection of cash into the economy with unmatched productivity growth. The idea is to get banks to force more loans to companies that may default and to flourish the role of the private sector and ultimately to shed debt. The goal for China is to rebalance for sustainable growth away from manufacturing and cheap export-led industry sector and government spending towards a more sustainable growth.

3.    China’s Tech Nationalist Agenda

To counteract the slumping economy and to rein in the escalating debt levels, Chinese policymakers have called for a more “proactive fiscal policy” that include tax cuts and introduced its “Made in China 2025” policy. It is a techno-nationalist agenda calling for Chinese global leadership in various technological sectors by 2025, with value-add from predominantly foreign intellectual property.

The goal for China is to de-risk its supply chain by reducing reliance on US imports in key areas such as semiconductors and have supremacy in tech sectors such as artificial intelligence, 5G telecoms, internet of things, self-driving cars, and battery technologies.

Chinese intend to reduce imports from the U.S. and not components made by US companies in China. The value of products that US companies made and sold in China was about $250 billion last year, almost double the $130 billion in products imported from America.

The area where U.S. and China conflicts the most significantly is in semiconductors. This industry is where American industrial leadership and China clash significantly. China seeks to ramp up availabilities of alternatives to US semiconductors. The semiconductor industry is one of Chinese clear ambitions, as out of $300bn committed to help deliver “Made in China 2025,” some $150bn is earmarked to upgrade China’s capacity in semiconductors.

Computer chips are the foundation of today’s digital economy and national security. China is currently reliant on semiconductor imports, therefore China blends its state and corporate resources in pursuit of its chip ambitions. It has incentive programs to attract engineering talent from elsewhere, notably Taiwan. Firms like Huawei have a proven ability to innovate and is well on its way to develop its domestic supercomputing industry.

Huawei’s new computing chips are aimed at powering artificial-intelligence applications. The line of semiconductors includes a chip that is installed on servers and performs complex AI tasks like programming algorithms, as well as a second chip for more routine functions on smartphones and other devices.

China is well-positioned to compete in the consumer economy especially in the field of artificial intelligence. Its tech platforms like Alibaba, Xiaomi, Baidu growth trajectories puts them at growth levels that will eventually surpass Microsoft, Facebook, Google, Apple and even Amazon. This is because China has more consumers than North America with capital, people, and computing power, therefore more data for how AI can scale without interference. The platforms have enormous consumer base, generating more data than any other nation, given its 750+ million daily Internet users. Chinese lack of privacy protection makes it a lot easier to openly collecting data as well.

With the development of domestic semiconductors, China can simultaneously upgrade Chinese industry achieving self-sufficiency and paving the way for artificial intelligence supremacy.

Chinese quest has been undoubtedly coupled with going after US technology and intellectual property. America has legitimate concerns about the national-security implications of being dependent on Chinese chips and vulnerable to Chinese hacking.

4.    U.S.-China Trade Tensions

Thus, China’s response to the trade war is set to be carefully calibrated. Chinese companies are being told by Beijing to cut reliance on US technology and intellectual property in their supply chains, replacing them where possible with alternatives from Europe, Japan, Korea, Taiwan and elsewhere.

The US-China trade started with the US disapproval over China’s technology appropriation policy. US began its levies on tariffs on the promise that Beijing would follow through on protecting IP rights and to buying American products.

The U.S. began three rounds of tariffs on Chinese products, a total of $50 billion worth of goods. The first two rounds put in 25% tariffs on $50 billion worth of imports, and Beijing had retaliated putting $90 billion of tariffs on imports to China. The U.S. met with another set of tariffs on a total of $200 billion at 10% threatening to increase to 25% unless the countries come to a deal. The latest levies would put all of Chinese exports under US duties.

Ultimately, both countries would be hurt from the trade wars in the short-term, but China would be significantly more hurt by the trade war. China is more vulnerable to US control of exports of goods than in the U.S. Tariffs making Chinese exports more expensive and punishes the Chinese economy. China responded with tariffs on American exports on US like soybean.

China is at disadvantage – the total share of trade of Chinese GDP is much higher, and Chinese exporting industry employs a massive number of people. In a slowing down economy, China cannot afford to lose its competitive advantage. Also raising tariffs would mean the global value supply chain would be affected. Other countries would be more reluctant to work with China. Its most vulnerable sectors on consumer goods or finished or intermediate goods would be affected.

China also cannot afford to dump its holding of US debt, which is more than a trillion-dollar worth, the US treasury holding will decrease in value. The US would have to offer higher interest to lure interest to keep covering its federal debt, but there still will be buyers.

For Trump, the U.S.-China trade talks has political repercussions. Trump faces voters next year. Xi’s public persona is affected by the trade war, but it will not face voters. Trump needs a verdict that he is tough on China for the 2020 run.

Trump recently delayed a planned increase of tariffs on Chinese imports to 25 percent, from 10 percent, that was scheduled to take effect March 1st. China has offered to lower tariffs on U.S. farm, chemical, auto and other products and offer to buy natural gas from the U.S. and reduce tariffs on imported vehicles. A decision has yet to be made over lifting of the existing U.S. tariffs. They are scheduled to meet again on March 27th.

5.    Belt and Silk Road Initiative

The effects of trade disputes with the United States has led to Chinese ambition to balance its economic growth and financial risks by revamping its investment opportunities overseas. Chinese manufacturing capacities are now challenged by a lower cost emerging market, like Vietnam, and therefore, China is now pursuing a strategy where it invests in infrastructure to reroute the global trade.

Belt and Silk Road Initiative (BRI) is an ambitious plan modeled after the Ancient Silk Road. It would ultimately be a 21st economic belt connecting China to leverage its routes and take advantage of the global trade in areas like industrial parks, mines, fiber optic cables – making it easy to trade with China.

The domestic consequences of China’s initiative are ramping up. Officially China states its five major goals for the purpose of BRI – policy coordination, facilities connectivity, unimpeded trade, financial integration and people to people bonds.

China wants to sign economic agreements with the Belt and Road countries to access new markets; to promote Chinese investment; to secure its supplies of food, resources and energy; to export Chinese products and services; to enhance the yuan’s role as a global currency; and to increase its soft power.

China calls it a “win-win” strategy. For instance in Pakistan, China offered to build a brand new port a corridor, which would effectively connect an economic belt, an alternative route for oil. This led to a huge boost of domestic construction companies in China, increases manufacturing capacities in lower cost areas, and gradually optimize its geostrategic ambitions based on today’s global order.

China claims its competitive advantage is that it claims a far fewer demands offering billions of dollars to corrupt countries and authoritarian regimes with the promise that eventually these countries will have to pay China back.

6.    Domestic Social Challenges

Countries Beijing is making alliances with sometimes wrought with terrorism and otherwise other authoritarian traits. As a frontier of the hub of the one Belt, Beijing has promised its internal dissenters to bring prosperity and stability to the Xinjiang Uyghur Autonomous Region. In some ways, the GDP growth has been achieved, however the national minorities in the region may not share the sentiment.

The Chinese Communist Party (CCP) declared in 2014 that the government would launch a “counter-terrorism campaign” that focused geographically on China’s western regions. The thesis was to “construct walls built with copper, iron, knits, and by boosting police readiness through mass surveillance and mass management.”

As a result, without any evidence of an organized threat, Xinjiang saw an emergence of authorities stepping up mass surveillance programs and security presence. Xinjiang is a region with 11 million Turkic Muslim Uyghurs, and regional stability and State control in Xinjiang is critically important for the success of Xi’s “Belt Road Initiative,” for which it is the primary land route for trade and investment in Central and South Asia, Europe, and the Middle East.

Recently, the Office of the United Nations High Commissioner for Human Rights (OHCHR) examined a report submitted by human rights organizations, and accused China of holding as many as a million Muslims in concentration camps. According to this report, “…The government has implemented militarized security measures, invasive policing, and community surveillance, including through “big data analytics”; forced hundreds of thousands of people into “re-education” camps; and drastically restricted ethnic language, culture, and religion…”

Millions of ethnic Uyghurs and Kazakhs have been imprisoned just due to their ethnicity, culture, and religion to assimilate them into the Han culture. The security threats used in Tibet are used also in Xinjiang, for instance, the installing of QR codes in the homes of the Uyghur Muslim community to get instant access to the residents of the Muslim community.

Beyond the surveillance technologies, Uyghurs have also experienced forms of torture and are currently facing massive imprisonment in re-education camps.

Xinjiang is situated in the border and are points of stability and security for the Chinese interests. Its threats in the social cohesion and stability can also threaten its national security priorities.

Just due to the ethnic distinction, Uyghur ethnicity have accelerated an assimilation process and to build a security framework to reinforce the process through its surveillance, control, and coercion mechanism. It ultimately breaks its ethnic lineages and its unique practices.

7.    Pulse Check: BRI and Sustainability Question

The Chinese state is willing to easily overlook human rights violations and sacrifice its citizens for the larger goals of the Belt and Road Initiative. Although there are a lot of countries as investment cases to examine, this scope examines Pakistan and Sri Lanka to glean into the sustainability of the initative.

The adoption of the Belt and Road Initiative, which was formed to connect China’s trade routes in Central and Southeast Asia with ports, roads, and other infrastructure lines, has also been criticized for lacking transparency, its questionable adoption methodologies, and its debt burden to the nations. The nations’ environmental and social conditions are not often taken into account in the infrastructure process.

It’s become the thorny patch for the U.S. allies as they voice concern over the BRI adoption mechanisms. The Australian government was one of the fifteen countries to sign a letter expressing concern over the treatment of Muslims and demanding Beijing to respond to its human rights concerns. Australia has also refused to sign up for the BRI despite its geopolitical significance.

The BRI has already made significant strides with countries signing up to the treaties, cooperation, and other funds. However, hard data on the benefit to the domestic economy, increase in the number of jobs, or even foreign exchange reserves is unclear.

The sources of funding are the following: The China Development Bank and the Export–Import Bank of China would grant a special loan of $250 billion yuan and reached an additional 830 billion yuan by 2018. The Chinese government itself pledged USD $15.5 for the creation of the state-owned fund devoted to BRI, and the Asian Infrastructure Investment Bank (AIIB) is also expected to provide funds as well with a capital of $100 billion. The Bank of China has also issued four rounds of international bonds for OBOR with a total value of more than USD $10 billion.


In July 2018, a total of 234 out of 1,674 Chinese-invested infrastructure projects in 66 Belt and Road countries since 2013 have encountered enormous difficulties. Scandals related to the projects are multifold – both domestic and abroad presenting clear challenges ahead for Xi’s ambitious global agenda.

The corruption scandals run rampant as the grant is initially given to the Chinese officials. It is rather easier for Chinese officials to obtain a greenlight and a large amount of money, and without a clear anticorruption mechanism, tracking the use of money can be difficult. The Supreme People’s Procuratorate of China’s website states corruption occurs in the processes of decision making, examination and approval, land acquisition, and material procurement of the projects.

“…After terms are reached with a host country, funds are transferred directly into the Beijing-based bank accounts of China’s state-owned enterprises, which build the project often with Chinese materials. This is a model Beijing has employed extensively in Africa. Once Beijing’s political blessing for a project is communicated via funding from its policy banks, China’s national- or provincial-level state-owned enterprises build it, often with little or no political or financial risk assessment or market research.”

The investments also come with a price tag on the domestic economy. Local governments are suffering from lack of funding in areas of education, medical care and social welfare. Students in Leiyang broke out in protest as the lack of resources in public schools led to the government cutting its class sizes and transferring students from public school to a private school with much more expensive fees and problematic dormitories. The provincial city has racked up 2.464 billion yuan of outstanding debt at the end of 2017, or 111% of revenue.

A success case seen with the Chinese overseas investment is Pakistan. For Pakistan, its rural fishing village in Gwadar is now undergoing construction to transform into an urban port city. China signed a plan known as the China-Pakistan Economic Corridor, or CPEC. China has pledged to spend $63 billion toward Pakistani initiative with more than 1,000 people, half of them Chinese, now working to complete a 660-meter container terminal. The strategic advantage is clear for China – it could allow all ships carrying goods from the Persian Gulf to directly move through its port. Pakistani faces both peril and promise, as its ambitious undertaking would mean: “ten years’ tax concessions, 90-year leases for Chinese companies and cheap imports will impact the competitiveness of existing domestic industries.” Pakistan would also have to potentially be laden with a huge debt burden with an already increasing trade deficit with China.

For China, its “primary interest in Pakistan is geopolitical rather than strictly economic, and therefore, for China, repayment of the debt burden will be secondary to maintaining a good political and economic relationship with Pakistan,” said Mushtaq Khan, an economist and former chief economic adviser at the State Bank of Pakistan.

The U.S. Department of State has its suspension of security assistance to Pakistan, but Pakistan has seen a growth despite its rampant terrorism and poor governance infrastructure of 5.4% in 2017, a fastest rate in 10 years. Some concerns over Pakistani port becoming a military base lingers.

Other countries have not been so lucky. Sri Lanka, when China began operating the port of Hambantota, the construction began with an ambitious stride under President Rajapaksa’s looming election. However, now the Mattala Rajapaksa International Airport is cited as “the world’s emptiest international airport” with only four regular flights in use per week. Sri Lanka also had to grant over a 99-year lease of its port to China to cut its overwhelming debt, an external of $48.3 billion. Sri Lanka is a strategic point for the BRI as a main oil shipping route. China could foreseeably takeover the territory as Sri Lanka’s sovereignty has been compromised in the region.

The mega construction and infrastructure projects also require the Chinese state to make considerable efforts to protect its assets and potential external threats. The military-build up is essential to securing Chinese geopolitical interests to balance against the U.S. administration and also for its capitalist development. However, in the current economic situation, further increasing military spending means cuts to education, social welfare or other public spending, which will eventually cause more mass incidents like the one in Leiyang.

Conclusion

The Western globalization model has not lead all countries into prosperity.

The U.S. offers an option in a sea of debt that compromises independence, whereas Beijing’s broader ambition for a global scenario may work. While some countries became the emblem of “Asian Tigers,” China, Central Asia, or North Africa were left behind. There was a governance deficit for many countries that it developed without a proper institutional infrastructure.

If the BRI were to be moderately successful then institutional governance and the way the government is conceived will be profoundly different from the western era of globalization, which had stemmed from the 1980s. Chinese cultural, educational, and political models would stream down without a governance deficit. Countries would model themselves on China, as Japan and Korea have in their stages of development.

China, a country with an exponent experience in development and in export-led manufacturing with a fifth of the world’s population would transform the world economy by shifting the Eurasian landscape. It is an extremely large-scale infrastructure investment that produced the rapid economic growth in its own domestic history.

Chinese model is a successor model of globalization for the developing world, where the growth is a bit faster than of the developed world. The developing world now provides 51-52% of the wealth and it will two-thirds the global GDP.

Chinese communist party state would effectively lattice the continent with fluidity as a dominant and hegemonic superpower with its neocolonial approach of seeking control of ports. It is expected the Eurasian landscape can be developed like China, as China has the experience in economic development, the financial means, and a vision to create a sub global system in its own.

However, the question is really in how these would be financed. Currently in observing the investment trends in the BRI projects at the expense of its domestic economy, it is extremely reminiscent of its own domestic strategy – which is to pump in stimulus without an unmatched sustainable growth in the domestic jobs and at rote suppression of the potential dissenters.

It is skeptical that the Chinese public funding would be ultimately matched with its market principles and its regulatory political character. These countries would develop its trading capacities, upsetting the U.S. uphold in its trade pressures with China.

Observing the trade-conflict and its fiscal outlook and the domestic challenges would be crucial for the emerging economies when they would engage in the large trading opportunity in China. All investment should support the domestic economy and a sustainable, balanced growth grounded in its sociocultural roots.

The ambition in the amount of money is enormous, and there is a real risk in local governments not being able to withstand the Chinese pressure to adopt the Chinese sociopolitical models. For countries like Hong Kong, it is easy to replicate the story with its language and cultural ties. For other countries, its traditional and legal systems may have to be substantially affected.

Countries receiving massive investment to fuel economic growth could also experience similar financial domestic issues, such as asset bubbles, overinvestment, and an account surplus along with its social structures.

The alternative is a comprehensive strategy led by world’s democracies to project values of freedom, democracy, personal autonomy, innovation, and information to counter the Chinese narrative. However, with an unmatched domestic infrastructure and governance systems, it may be difficult to attract the emerging markets excluded in the Western globalization systems.

An ideal trade relation is the one in which it exposes the country to a global competition by reducing barriers to foreign goods. Trump’s America First policy and its pulling out of the multilateral negotiations, such as the Trans Pacific Partnership ultimately has allowed Chinese an increased role in the Asia. It was an ideal platform for China to land on a more ambitious economic trading system where the U.S. is less involved and for an expanded influence for overseas investments.

The financial outlook for China is that the economy may continue to decelerate, as Chinese economy is trying to squeeze debts. Chinese economy is patiently waiting for the stimulus driven recovery to take hold. China needs to be more comfortable with slower growth and also working the economy through the transition from an export – to a consumer led economy. With Chinese motives under increasing scrutiny, China also needs to build upon its public diplomatic instruments that Chinese economic development efforts are less hostile, but a more harmonious attempt for a mutual long-term growth. Only then China can overcome international scrutiny of its political legitimacy balanced with economic stability and achieve its long-term global governance agenda.

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