China and Japan Compete for Southeast Asia's Railways

10 MINS READMay 4, 2016 | 09:31 GMT
China and Japan Compete for Southeast Asia's Railways
Maintenance workers toil on a railway over the century-old Long Bien bridge in Hanoi, Vietnam. The Asian Development Bank estimates that to sustain its economic growth, Southeast Asia must invest $8 trillion by 2020 in improving its infrastructure.
Forecast Highlights

  • In the coming years, Southeast Asia will build up connectivity through projects that include high-speed rail, as part of its broader integration goals.
  • Lacking the capital to fund these efforts on its own, Southeast Asian nations will play China and Japan off each other to exact better contractual terms.
  • Despite China's growing competitiveness, Japan's rail industry will remain a key player in Southeast Asian projects.

China and Japan's competition for commercial influence in Southeast Asia is heating up, with the next contest taking place on the Malay Peninsula. In the coming months, Singapore and Malaysia are expected to move forward on a joint high-speed rail project that will connect five cities between Singapore and Kuala Lumpur. The 350-kilometer (about 217-mile) line is a key part of the geographically fragmented region's broader integration goals and, like a number of other infrastructure projects in Southeast Asia, a priority for both Tokyo and Beijing.

China is hoping to use its vast capital reserves, high risk tolerance and strategic investments in the region to realize what is just one part of its envisioned 1,700-kilometer, pan-Asian rail network connecting Singapore with Kunming, the capital of China's Yunnan province. Tokyo, meanwhile, is seeking to leverage its superior rail technologies, substantial foreign aid packages and widespread commercial ties to keep itself from being further sidelined in regional rail construction — a sector it once dominated. As demonstrated in recent tussles over rail contracts elsewhere in Southeast Asia, the contest on the Malay Peninsula will be decided on economic, political and diplomatic factors that reflect the broader geopolitical dynamics at play in the region. Ultimately, it will illustrate how regional states will seek to exploit the broader Sino-Japanese rivalry for their own aims.

Southeast Asia's Expensive Ambitions

Infrastructure in Southeast Asia is woefully ill-suited to unlock the region's trade potential. In mainland Indochina, mountainous terrain and a harsh environment, coupled with the economic disarray bred by 20th-century conflicts, have largely precluded the cohesive expansion of rail networks needed to lower trade barriers and realize the common market envisioned by the Association of Southeast Asian Nations (ASEAN) Economic Community. Archipelagic states such as Indonesia and the Philippines face more serious connectivity challenges. Currently, the region uses a mix of rail gauges that limits top speeds and cross-border compatibility. According to the Asian Development Bank, Southeast Asia must spend around $8 trillion on infrastructure by 2020 to sustain its current economic trajectory.

Modern high-capacity rail networks can help overcome some of the region's issues. Such networks, which include medium-speed freight lines and high-speed commuter trains with top speeds exceeding 360 kilometers per hour (about 224 miles per hour), help to eliminate export bottlenecks and spur commercial development along the rail lines. They also encourage labor movement, easing the strain on the Southeast Asia's overly congested cities and helping address the region's destabilizing economic disparities.

The proposed high-speed rail between Malaysia and Singapore is particularly ideal. At about 350 kilometers in length, it would fall within the window in which high-speed rail is considered most competitive against air or road transit (between 200 and 1,000 kilometers). The new line would connect two major commercial centers with deep links in trade and business, making the corridor between them ripe for development and investment. Because Singapore itself is the entry point for much of the investment flowing into Southeast Asia, and home to the world's second-busiest port, better integrating it with its neighbors is central to the region's prospects.  

But few countries in Southeast Asia have the resources or technology to complete this type of project alone. For states with relatively small industrial footprints, like Laos, the costs of such an undertaking would likely far outstrip the benefits. This fact, combined with the political appetite that many Southeast Asian capitals have for high-profile projects, opens the door to partnerships with external powers such as China and Japan.

How Railways Serve Chinese and Japanese Goals

For both Beijing and Tokyo, regional rail projects hold considerable economic promise. Construction deals typically include public-private partnerships of broad consortiums, providing opportunities to an array of companies. They also create opportunities for Chinese or Japanese firms in other sectors. (A common sticking point in negotiations on rail projects is the rights to ancillary development projects.) Since high-speed lines usually operate at a loss and have steep initial construction costs, securing long-term benefits is essential for any potential investor.

In 2014, China's railway equipment exports — including urban subway and light rail equipment as well as heavy freight locomotives and high-speed trains — totaled $4.36 billion, a 22.6 percent increase from the year before. Beijing is in part seeking to improve the reputation of its rail industry and overcome reliability concerns. It is also hoping stimulate foreign markets for its goods, while keeping its construction industries active. By supporting domestic sectors, Beijing is trying to help move the Chinese economy away from its reliance on low-end manufacturing exports. 

For China, the benefits are also strategic. The continuity of China's maritime supply routes is of constant concern to Beijing, since many pass through strategic choke points like the South China Sea. To reduce the vulnerability of its imports, China has begun diversifying its trade routes as part of its Belt and Road initiative. Moreover, China views trade and investment as tools it can use to reinforce its influence abroad — for example, by winning over members of ASEAN.

Japan, meanwhile, sees Southeast Asian rail projects as a way to breathe new life into its languishing rail industry. Japan has operated high-speed railways at home for more than 50 years, and it has exported rail technology for over half that time. However, the lack of new opportunities in more-developed neighbors such as Taiwan, along with the closure of several lines at home, has forced Tokyo to look for rail projects further afield. Given Southeast Asia's burgeoning economies, existing ties to Japanese industry, and history of receiving aid from the Japanese government, the region is a natural destination for Japanese investment.

The two countries' contest for Southeast Asia's railways is not always zero-sum, since their differing interests ensure that they do not compete with each other on every project. Nor are China and Japan the only competitors; European and South Korean firms routinely vie for rail-related contracts in the region as well. Nonetheless, the East Asian powers are uniquely positioned to regularly go head-to-head in Southeast Asia, and their recent clashes indicate just how their rivalry might play out.

China Catches up

Japan's Shinkansen rail system is generally considered to be the industry's gold standard, boasting a near-flawless safety record and no passenger fatalities in more than 50 years. However, China is rapidly emerging as a formidable challenger. Over the past two years, Beijing has signed a number of rail deals in Southeast Asia, Europe and Latin America, and in 2014 China pledged $40 billion to its New Silk Road Fund to strengthen its transport networks with its neighbors. The Chinese-backed Asian Infrastructure Investment Bank will open the investment taps further.

The recent deals reflect a number of advantages working in Beijing's favor, particularly its high tolerance for risk and its willingness to use its substantial (if shrinking) capital reserves to shoulder a sizable share of the projects' costs. Several legs of its envisioned Singapore-Kunming network would effectively operate at a loss, though they would serve China's broader strategic goals. (Japanese consortiums, by contrast, have generally walked away from projects deemed economically infeasible.) Beijing also argues that its rail systems are more compatible with the components used in other countries — and that reliance on Japan's purpose-built systems will lead to "technology lock."

These strengths were on full display in China Railway Group's successful 2015 bid to build a 142-kilometer high-speed rail line in Indonesia. The Chinese plan was costlier than Japan's and offered an interest rate of 2 percent, compared to Japan's 0.1 percent. However, Beijing promised $5.27 billion in investment — Tokyo pledged only $4.4 billion — plus a raft of other manufacturing and economic deals. Most important, the Indonesian government was not required to provide any state funding or sovereign guarantee. China also guaranteed that it would meet shorter construction timelines, promising completion by Indonesia's 2019 elections. Moreover, the deal demonstrated greater cohesion between Chinese diplomatic efforts and state-owned rail firms. 

Elsewhere in the region, however, China's railway ambitions have run into obstacles. In 2012, the Philippines canceled a rail contract it had awarded to China in 2004, and Japan is pushing to take over. Meanwhile, permitting issues and private financing concerns have stalled construction on the Indonesia line. Wariness over China's assertive security posture in the region is also undermining Beijing's diplomatic clout in some Southeast Asian capitals, including Hanoi. And though Chinese investments recently helped bail out Malaysia's scandal-plagued 1MDB sovereign wealth fund, its influence with the Malaysian government will likely carry less weight in cross-border ventures like the project with Singapore than it would with Kuala Lumpur alone.

Because Beijing needs certain rail lines far more than its partners do, Chinese companies and lenders have been forced to take on additional costs and risks, often straining negotiations with their associates in the process. Laos, for instance, is ill-suited geographically and economically for its Chinese-backed, $7 billion rail project, which calls for the construction of 76 tunnels and 154 bridges. By virtue of its landlocked geography, Laos has a long-term imperative to eventually see its rail deals through. But the imbalance of interests has allowed the government to repeatedly bring Beijing back to the negotiating table — even since formally breaking ground last year.

Likewise, the Chinese-backed, 845-kilometer line in Thailand is designed primarily with Chinese interests in mind. Its route — bypassing most of the country's major population centers — is clearly optimized to ferry Chinese goods southward. And a number of disputes over the contract's terms compelled Thailand to walk away from most of the deal in March, announcing that it would instead fund a shorter line that stops nearly 400 kilometers shy of the linkup with the Chinese-backed line in Laos. (The revised project will still rely on Chinese engineers and construction firms, partly on the hope that the full line will eventually be built.) 

Japan Sweetens the Pot

Taken together, these setbacks suggest that China's ability to push projects through in the face of financial and political constraints is limited, leaving room for its rivals. Indeed, since its defeat in Indonesia, Japan has secured a major project in India and is nearing approval to break ground on a number of more economically logical lines in Thailand, including a high-speed project.

By all appearances, Japan seems to be adjusting its strategy to remain competitive. It has, for example, discussed softening its demands for sovereign guarantees, and in December 2015 it announced an increase in its development aid budget — the first of its kind since 1999, and much of which is earmarked for infrastructure. The Japan-backed Asian Development Bank is also upping its lending and incentives for private-sector companies involved in Southeast Asian infrastructure. Furthermore, Tokyo's loose monetary policies will likely ensure that Japanese firms have ample capital that they can use to compete with their international peers.

Ultimately, the competition between China and Japan will give Southeast Asian governments an opportunity to build up their infrastructure on terms that would otherwise be unavailable to them. And they will be able to do so without having to sacrifice other strategic interests, including security, to gain the development assistance they need without ceding too much influence to either benefactor.

Lead Analyst: Phillip Orchard

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