The next 20 years of China’s engagement with African countries on financing development projects will be starkly different from the past two decades as the Chinese financing model shifts to address new dynamics in the sector.
Last year ushered in the new era of Xiao Er Mei (小而美) which means “small or beautiful”, the new approach in China’s overseas project financing which is a shift from the previous larger and more conspicuous developments. The model favors “small projects” which require below $50 million in funding, or “beautiful” ones that enjoy local communities’ support while also aligning with certain Chinese political objectives.
Xiao Er Mei came about after a proposal at the Third Belt and Road Construction Symposium in 2021 which highlighted that small or beautiful developments directly affect people. While this does not mean that big projects failed, judging the “beauty” aspect implied that beautiful projects should have- among other things- a strong environmental, social, and corporate governance (ESG) and a high community impact in host countries or a project that’s deemed politically important to China.
The essence of “small or beautiful” is having Chinese financiers, including the government, funding a small percentage of individual large-scale projects unlike in the past when several big projects were spread across many countries and regions overseas.
But even as this shift is happening, some stakeholders believe that China is still providing loans for large-scale projects as it used to over a decade ago. This shows that they do not fully understand the Chinese thinking and direction in the new development finance approach.
For a perspective on what to expect in the new era of China’s cautious financing approach, I spoke with Wei Shen, a longtime China-Africa energy scholar and the lead researcher at the International Institute of Green Finance in Beijing.
From his experience, I sought to unpack what these financing dynamics portend for future engagements between Chinese financiers and African countries interested in renewable energy projects.
NJENGA HAKEENAH: In one of the papers you co-authored, you said that the template used to promote conventional energy projects in Africa could be used- with some changes- to scale China’s engagement with African countries to develop renewable projects. Are the Chinese players in the sector open to this? Can this same template be used in financing, especially now in the era of small or beautiful?
WEI SHEN: For some projects, yes. In many of the key countries, for example, their understanding and knowledge of the Ethiopian, Kenyan, Nigerian and South African markets will be useful.
There are at least hundreds of business development people and site managers in large SOEs like Power China, Energy China, and China Three Gorges on the African continent. Their know-how and understanding of the African electricity sector can be used to promote conventional energy projects and renewables alike. And I don’t think that in the long run, China Exim Bank or the China Development Bank will just sit there and watch the new markets slip away. But they need to do something now and their previous practices and knowledge can still be helpful. They cannot just directly copy and paste their previous success obviously, and they need to be more flexible and more innovative to support renewables. My understanding is that you can’t expect the Chinese to invest in Africa just like they invest in the Middle East. We need to find innovative ways to encourage investment in these high-risk countries.
I know everybody is talking about the beautiful IPPs or PPPs and so on. But in the end, it’s how likely it is to develop IPPs successfully if there are not timely reforms of the electricity sectors in many African countries. It takes time. You need reforms both in African countries and in China as well to co-develop a new model upon the historical achievements in developing conventional projects.
NJENGA: What are the hindrances Chinese investors and financiers face at home when seeking opportunities in renewables in various African countries? How can these challenges be addressed?
WEI: While there are some challenges that are not confined to Chinese actors, the common hindrance is the reality that large infrastructure projects led by government-to-government (G2G) agreements appear to be coming to a pause. This is not just in renewables or even energy infrastructure but also in roads, railways, and other infrastructure sectors.
These mega projects are coming to an end because the actual demand is shrinking. Compared to what was needed 20 years or even 10 years ago when everyone just wanted new roads, railways (etc.), things are not the same anymore. I’m not saying that there will be no mega projects, but they will be fewer than it has been in the coming years.
If you look at the specific demands of many African countries, they are now more focused on production-related activities rather than fancy highways that lead to nowhere. As things change, the mentality has changed. Most importantly, many governments cannot afford the G2G model anymore.
NJENGA: What then does decreased demand mean for host countries and the financiers back in China?
WEI: If the situation is changing so dramatically from the demand side, then obviously from the supply side, people see these trends and they become more cautious. And this is not just about energy projects.
Renewables which are now the major activities, are different from conventional projects in that they are now developed in highly sophisticated and capital-intensive way. While this is not in terms of large amounts of investment, it means that they are capital markets’ favorite babies now. Problems emerge when global capitals chase around green projects and things start to follow a very different logic compared to G2G projects, and very sophisticated financial models are now applied that are very different from the G2G model too. Since the capital wants to cash in and cash out very quickly, they use all their leverage and very advanced financial tools in developing all these projects, particularly in the Middle East and in the Central Asian markets, which is different from Southeast Asian and African markets that are still applying rather conventional financial and business model.
NJENGA: What are the unique challenges when it comes to Chinese finances and capital in this new dispensation where competition has gone up a notch?
WEI: China is not leading this new (finance) game at all but follows the new investors and project developers as EPC or technology suppliers, as they did in the G2G era. Only the Chinese policy banks are now lagging behind as they are in a very preliminary stage of understanding this new trend. And if you think about the big policy banks, they’re big and when they’re trying to provide loans, it’s not always cheap. It’s incomparable in terms of the efficiency and in terms of their appetite needed in these markets. But when you talk about flexibility, innovative capacity, and quick decisions, they can’t compete with commercial banks. And even if they want to work with these Western financiers, it is difficult. They’re not on the same page at all and that’s why the Chinese financings are left behind.
The Chinese are very good technological suppliers. If you talk about the quality of panels and the quality of wind turbines, no problem at all. They are very good construction workers. They’re hardworking people. They’re working in almost all conditions. It doesn’t matter how hard the situation is. Even in the middle of the desert, they can build things up. Best builders in the world. But they’re not the best financiers yet.
NJENGA: In consideration of China’s financial muscle, does it mean that they have the money and not the know-how to invest this money?
WEI: There’s a misconception that they are doing something different from the West in the previous decades or that they have different ways of risk evaluation, risk management, or portfolio management. Quite the opposite, they learn the trick from the West in terms of export financing and lending. I think basically they still have the funding but limited know-how on IPP financing.
Back to the fundamentals though, high risk is a high risk, particularly at a turbulent and difficult time with very high interest rates. They have limitations and are understanding these challenges now. I’m not saying that the finances are gone but the funders are more cautious about lending, in addition to their inefficiency and unfamiliarity with IPP financing.
NJENGA: The BRICS event was a huge show. Do you think this will probably bring some impetus to project financing and other related activities on the continent?
WEI: Chinese companies are actively seeking new renewable energy opportunities for sure, but the financiers are a little bit more cautious and less innovative. They know they are left behind and trying to find ways out but this takes time. Chinese companies are still on the ground desperately seeking new opportunities, but the question is where these projects are located, developed by whom, and if they are eventually bankable.
With the Chinese financiers and investors being left behind, Chinese companies are now looking only to a handful of markets or regions at the moment. The Chinese entrepreneurs and investors are not looking at Africa as their priority. They’re focusing on South East Asia and Central Asia, Vietnam, Kazakhstan, Uzbekistan and Saudi Arabia, understandably. How can we change their perceptions to say we still have valuable renewable energy assets (in Africa) and bankable solutions to be captured or to be realized? It’s going to be a hard job.
NJENGA: Now that you’ve mentioned the kind of shift towards where they are focusing, do you think it’s because maybe the return on investment is faster in Vietnam or in other Asian countries, Saudi Arabia, etc, than it is in Africa?
WEI: Well, Vietnam is close. Proximity matters. Also, safety in terms of transportation, better understanding the markets and actors, and more complete value chains, easy access to spare parts, services and better logistics.
We see a lot of potential in African markets, but when talking about achievable or tangible potentials, these are capacities that can be materialized. Such potential is still limited, or it is not convincing enough compared to other markets to the investors I think. In comparison with Vietnam, investors believe it’s going to happen. When they have a five-year plan, people just believe it’s going to happen. When an African country has a long-term strategy, not many investors truly believe it’s going to happen.
There are big plans, ambitious plans. But it is about implementation, which affects investors’ confidence in the policy targets, confidence in the market potential, I mean achievable market potential.
For the Chinese power generation SOEs, their appetite for equity investment is always small. I don’t mean those EPC contractors. For their small appetite, they would prefer to invest in a nearby neighboring country. Understandably, such as in Cambodia or Laos, for example, even though in comparison to countries like Kenya the investment risk is not necessarily low.
Wei Shen is the lead researcher at the International Institute of Green Finance in Beijing.