Paper short abstract:

The objective of this paper is to study the monetary mechanisms and the financial risks involved in both the Chinese Development Bank (CDB) and the Panda bond financing of the Belt \& Road Initiative (BRI), especially when real investment project financing is involved.

Paper long abstract:

The objective of this paper is to study the monetary mechanisms and the financial risks involved in both the Chinese Development Bank (CDB) and the Panda bond financing of the Belt \& Road Initiative (BRI), especially when real investment project financing is involved. Further, we analyze the balance of payment consequences for both China and the host country of the execution of the real investment projects, distinguishing between Chinese, foreign non-Chinese, and local suppliers. Finally, we analyze the balance of payment consequences for the host country, and the exchange rate risk and balance of payment crisis risk faced by the Panda bonds, differentiating between the real investment project being export-enhancing or domestic-oriented (not generating foreign currency). The policy conclusions are that the CDB may reduce its financial risks by acting as an underwriter of the Panda bonds, but it may also have to act as a dealer of last resort if there are balance of payment crises, and sharp depreciation of the exchange rates, in the host countries. To reduce both the exchange rate risk and balance of payment risk of the Panda bonds, it is important that the real investment projects are export-enhancing for the host country, and that the execution of the real investment projects uses local suppliers, based in the host country. The internationalization of the Renminbi, and the cooperation with the banking systems of the host countries, is key for reducing foreign exchange reserves outflows.