China’s Strategy in the Caucasus
April 3, 2017
When leaders of Azerbaijan and Georgia took part in a session titled “The Silk Road Effect” at the 2017 World Economic Forum in Davos, they were predictably eager to promote the importance of the China-led Silk Road Economic Belt to the economic and infrastructure projects in the Caucasus. Two projects of critical importance are Georgia’s Anaklia Deep Water Port on the Black Sea and the Baku-Tbilisi-Kars railway. However, despite the session’s agenda and the attendance of the Mongolian president, no Chinese officials were present on the platform, certainly not Xi Jinping, who made his first visit to Davos this year.
China remains ambivalent about the Caucasian stretch of the Silk Road, interested in the strategic relevance of the region, but recognizes that commercial engagement remains tentative. Compared to major Chinese-financed infrastructure and energy works completed in Russia, Kazakhstan, and Uzbekistan in the past two years, state-owned Chinese companies have yet to secure any similar scale projects in the Caucasus region. The construction and management of the Anaklia Deep Water Port was awarded to a Georgian-American company in late 2016, following rounds of unsuccessful negotiations with Chinese partners. On the other hand, Chinese upgrading of key Iranian and Uzbek railway tracks (the electrification of Tehran-Mashhad Line) as well as the expected completion of Baku-Tbilisi-Kars Line in 2017 meant that an alternative route of overland transportation that skirts around Russian territory is becoming ever more likely. At the same time, the drive by the Azerbaijani government to diversify its economy dovetailed with Chinese interest in exporting excess capacity in manufacturing and construction. Another factor for the Caucasian republics in attracting commercial Chinese interest has been their accession into preferential custom zones with both the European Union and Russia, as seen in negotiations between the Georgian government and private Chinese companies over the management of the Poti Free Industrial Zone in January 2017.
Chinese Investments in the Region
As a result, Chinese interests in the Caucasus have been limited to facilitating investment by private Chinese companies and establishing a footing for state-owned infrastructure companies through bidding for small to medium-sized projects. This situation is in contrast to Chinese investment in Russia, Kazakhstan, and Uzbekistan, where large-scale Chinese infrastructure projects were financed through preferential loans by state-owned Chinese banks. Reports on current projects undertaken by Chinese firms in Azerbaijan and Georgia suggest that their considerations in investment remain firmly profit-based, which is understandable due to their ownership structure. However, with the first phase of port facilities in Baku slated for completion later this year, the medium-term goals of establishing a southern, non-Russian route of transportation might result in greater infrastructure investment by the Chinese. This projection is supported by figures from PriceWaterhouseCoopers, which revealed that the average size of investments in Chinese sectors related to “One Belt, One Road” increased by 14% in 2016—a pattern that is also reflected in the sub-sectors of public utilities and transportation.
Recent Chinese ventures in the Caucasus have been focused on Azerbaijan, where depleting reserves and low prices in petroleum have prompted the Ilham Aliyev regime to embark on a variety of measures to diversify the economy. According to the government’s own estimates, approximately 70% of Azerbaijani GDP in 2016 is now produced through non-oil sectors although this figure might include public investment in utilities and infrastructure paid through oil-related earnings. However, this statistic hardly bothered the Chinese government, which dispatched a steady stream of senior and mid-level officials to Azerbaijan throughout 2016. Of particular note was a visit by politburo member Zhang Gaoli in June, followed by joint-ministerial sessions on commercial cooperation in August. Chinese officials and Huawei, a Chinese telecommunications equipment company, also participated in Bakutel 2016, an international exhibition on telecommunications and information attended by Aliyev, who visited the Chinese kiosk. Although ministerial meetings often lack the publicity of senior-level visits, they were useful for major Chinese construction and utilities companies. Through these contacts, China Triumph International Engineering Group (CTIEC Group), a state-owned construction firm, became one of the first Chinese companies to complete major construction projects in Azerbaijan when new production capacity was added to the Qızıldaş cement plant in late 2014. Compared to other Central Asian states, Azerbaijan has also been generous in granting major commercial and policy-oriented Chinese banks extensive interest rate tax breaks; however, these tax breaks in themselves have not been effective in enticing commercial Chinese banks to establish branches in Baku.
A similar story lies behind Chinese engagement with Georgia. Since institutional reforms carried out by successive Georgian governments in the mid-2000s, the country has consistently ranked highly in global indicators of business environment; its corruption perceptions and ease of doing business indices were ranked the highest amongst non-Baltic Former Soviet economies in 2016. These institutional advantages are also reflected in the speed of its negotiations with China over free trade in 2016; preliminary talks only began in February, yet by early October, a memorandum of understanding (MOU) was signed by the two countries, with ratification expected in mid-2017. There are indications that the Chinese were comparatively lenient in its opening of market access for Georgian agricultural products, including the burgeoning wine export business (China being the second largest export market for Georgian wine after Russia). Institutional advantages and tax breaks were also dangled in front of private Chinese companies by the Georgians in attracting them to its Free Industrial Zones, where goods manufactured within the country headed for EU markets are waived of all taxes except personal income. By January 2017, Hualing, a private Chinese conglomerate, began managing the Kutaisi Free Trade Industrial Zone in Georgia and acquired significant stakes in the country’s retail banking sector. The Georgian government recently also signed an MOU with another private Chinese group exploring the transferal of Poti Industrial Zone from inactive Emirati management. It is revealing to see that private Chinese companies, as opposed to those with greater governmental support (the Chinese ambassador to Azerbaijan personally opened Huawei’s new staff canteen in Baku in late 2016), are more tempted by the promises of transparency and ease of access. These were also key selling points when Hualing, one of the largest foreign investors in Georgia, pitched its industrial park to Chinese companies and bank branches based in Dubai in June 2016. Given increasingly stringent measures in Chinese foreign exchange control in 2017, private and semi-public Chinese enterprises have become even more reluctant to repatriate their U.S. dollar earnings, preferring to deposit them in overseas branches of Chinese banks. Those stored in Dubai and Istanbul present a particularly viable source of funding for the Caucasian economies.
Challenges to China-Caucasian Trade Relations
However, against the backdrop of institutional improvements, one must point out that there is not much to trade between China and the Caucasian republics, with the odds very much in China’s favor. Even for Azerbaijan, where petroleum and gas related products formed a steady source of export earnings, China enjoyed a surplus of 216 million USD in 2015, with Azerbaijan only exporting 14.66 million USD worth of materials to China in the first half of 2016 (while importing 258 million USD). Figures for Georgia in 2016 were generally similar, with a Chinese surplus of 344 million USD. Sino-Armenian trade figures are even lower with total trade volume for 2015 at 454 million USD and a surplus of 267.21 million USD for China although these numbers placed China as Armenia’s second largest foreign trade partner. Thus, the Caucasian republics must look to improved transportation links and expected transit fees to improve their trade positions with China, barring a significant surge in commodity prices (oil and gas for Azerbaijan, copper for Armenia).
However, expectations of gains from the “One Belt, One Road” project is contingent on the inauguration of the long-delayed Kars-Tbilisi-Baku railway as well as the speed of port facility improvements in both Azerbaijan and Georgia. Although politicians from these countries have pledged cooperation in streamlining customs processes along the route, it is difficult to comment on how it will be carried out on the ground. Furthermore, an increase in trade figures also assumes a degree of political stability in the region, not only concerning Georgia’s fraught relations with Russia, Azerbaijan’s tense relations with Armenia, but also concerning domestic Turkish politics and competing sovereignty claims to the Caspian Sea, a key link in the transportation process. Given these potential gridlocks (and China’s limited sway in this region), it is perhaps just as well that Xi Jinping did not talk up the Silk Road at Davos.