By Eric Vandenbroeck and co-workers
The Toll Of Beijing’s Belt And Road
We covered this
subject in 2018. However, this year now marks
the tenth anniversary of Chinese President Xi Jinping’s Belt and Road
Initiative, the largest and most ambitious infrastructure development project
in human history. Through the scheme, China has lent over $1 trillion to more
than 100 countries, dwarfing Western spending in the developing world and
stoking anxieties about the spread of Beijing’s power and influence. Many
analysts have characterized Chinese lending through the BRI as “debt trap
diplomacy” designed to give China leverage over other countries and even seize
their infrastructure and resources. After Sri Lanka fell behind on payments for
its troubled Hambantota port project in 2017, China obtained a 99-year lease on
the property as part of a deal to renegotiate the debt. The agreement sparked
concerns in Washington and other Western capitals that Beijing aimed to acquire
access to strategic facilities throughout the Indian Ocean, the Persian Gulf,
and the Americas.
But a different
picture of the BRI has emerged over the last few years. Many Chinese-financed
infrastructure projects have failed to earn the returns that analysts expected.
And because the governments that negotiated these projects often agreed to
backstop the loans, they have found themselves burdened with huge debt
overhangs—unable to secure financing for future projects or even to service the
debt they have already accrued. This is true not just of Sri Lanka but also of
Argentina, Kenya, Malaysia, Montenegro, Pakistan, Tanzania, and many others.
The problem for the West was less that China would acquire ports and other
strategic properties in developing countries and more that these countries
would become dangerously indebted—forced to turn to the International Monetary
Fund (IMF) and other Western-backed international financial institutions for
help repaying their Chinese loans.
In many parts of the
developing world, China has come to be seen as a rapacious and unbending
creditor, not so different from the Western multinational corporations and
lenders that sought to collect on bad debts in decades past. Far
from breaking new ground as a predatory lender, China is following a path
well-worn by Western investors. In so doing, however, Beijing risks alienating
the countries it set out to woo with the BRI and squandering its
economic influence in the developing world. It also risks
exacerbating an already painful debt crisis in emerging markets that could lead
to a “lost decade” of the kind many Latin American countries experienced in the
1980s.
To avoid that dire
outcome—and to avoid spending Western taxpayer dollars to service bad Chinese
debts—the United States and other countries should push for broad-based reforms
that would make it more difficult to take advantage of the IMF and other
international financial institutions, imposing tougher criteria on countries
seeking bailouts and demanding more transparency in lending from all their
members, including China.
Hard Bargains, Soft Markets
In the 1970s, Harvard
economist Raymond Vernon observed that Western investors had the upper hand
when negotiating deals in the developing world since they had the capital and
know-how to build factories, roads, oil wells, and power plants that poorer
countries desperately needed. As a result, they were able to strike bargains
that were highly favorable to themselves, transferring much of the risk to
developing countries. However, once the projects had been completed, the
balance of power shifted. The new assets could not be removed, so developing
countries had more leverage to renegotiate debt repayment or ownership terms.
In some cases, contentious negotiations led to nationalizations or sovereign
defaults.
Similar scenarios
have played out in several BRI countries. Major Chinese-funded
projects have generated disappointing returns or failed to stimulate the kind
of broad-based economic growth that policymakers had anticipated. Some projects
have faced opposition from indigenous communities whose lands and livelihoods
have been threatened. Others have damaged the environment or experienced
setbacks because of the poor quality of Chinese construction. These problems
come from long-standing disputes over China’s preference for using its workers
and subcontractors to build infrastructure, edging out local counterparts.
The biggest problem
by far, however, is debt. In Argentina, Ethiopia, Montenegro, Pakistan, Sri
Lanka, Zambia, and elsewhere, costly Chinese projects have pushed
debt-to-GDP ratios to unsustainable levels and produced
balance-of-payments crises. In some cases, governments had agreed to cover any
revenue shortfalls, making sovereign guarantees that obligated taxpayers to
foot the bill for failing projects. These so-called contingent liabilities were
often hidden from citizens and other creditors, obscuring the true levels of
debt for which governments were liable. In Montenegro, Sri Lanka, and Zambia,
China dealt with corrupt or authoritarian-leaning governments that then
bequeathed the debt to less corrupt and more democratic governments, saddling
them with responsibility for getting out of crises.
A Chinese-funded railway near Nairobi, Kenya, May 2023
Contingent
liabilities on debt to state-owned enterprises are not unique to the BRI and
can plague privately financed projects. BRI debt crises differ because these
contingent liabilities are owed to Chinese policy banks rather than private
corporations, and China is conducting its debt renegotiations bilaterally.
Beijing is also clearly negotiating hard because BRI countries increasingly opt
for bailouts from the IMF, even though they often come with harsh conditions,
rather than trying to negotiate further relief from Beijing. Among the
countries that the IMF has intervened to support in recent years are Sri Lanka
($1.5 billion in 2016), Argentina ($57 billion in 2018), Ethiopia ($2.9 billion
in 2019), Pakistan ($6 billion in 2019), Ecuador ($6.5 billion in 2020), Kenya
($2.3 billion in 2021), Suriname ($688 million in 2021), Argentina again ($44
billion in 2022), Zambia ($1.3 billion in 2022), Sri Lanka again ($2.9 billion
in 2023), and Bangladesh ($3.3 billion in 2023).
Some of these
countries resumed servicing their BRI debts soon after the
new IMF credit facilities were in place. In early 2021, for instance,
Kenya sought to negotiate a delay in interest payments for a struggling
Chinese-funded railway project linking Nairobi to Kenya’s Indian Ocean port in
Mombasa. However, after the IMF approved a $2.3 billion credit facility that
April, Beijing began withholding payments to contractors on other
Chinese-financed projects in Kenya. As a result, Kenyan subcontractors and
suppliers stopped receiving payments. Later that year, Kenya announced that it would
no longer seek an extension of debt relief from China and made a $761 million
debt service payment for the railway project.
The stakes for Kenya
and the rest of the developing world are enormous. This wave of debt crises
could be far worse than previous ones, inflicting lasting economic damage on
already vulnerable economies and miring their governments in protracted and
costly negotiations. The problem goes beyond the simple fact that every dollar
spent servicing unsustainable BRI debt is a dollar that is
unavailable for economic development, social spending, or combating climate
change. The recalcitrant creditor in today’s emerging market debt crises is not
a hedge fund or other private creditor but rather the world’s largest bilateral
lender and, in many cases, the largest trading partner of the debtor country.
As private creditors become more keenly aware of the risks of lending
to BRI countries, these countries will find themselves caught between
squabbling creditors and unable to access the capital they need to keep their
economies afloat.
Hidden Figures
Beijing had multiple objectives
for the BRI. First and foremost, it sought to help Chinese
companies—primarily state-owned companies but also some private ones—make money
abroad, to keep China’s huge construction sector afloat, and to preserve the
jobs of millions of Chinese workers. Beijing also undoubtedly had foreign
policy and security goals, including gaining political influence and in some
cases, securing access to strategic facilities. The large number of marginal
projects Beijing undertook hints at these motivations: Why else fund projects
in countries with huge political risks, such as the Democratic Republic of the
Congo or Venezuela?
But accusations of
debt trap diplomacy are overblown. Rather than deliberately miring borrowers in
debt to extract geopolitical concessions, Chinese lenders most likely did poor
due diligence. BRI loans are made by Chinese state-owned banks
through Chinese state-owned enterprises to state-owned enterprises in borrowing
countries. The contracts are negotiated directly rather than opened to the
public for bidding, so they lack one of the benefits of private financing and
open procurement: a transparent market mechanism for ensuring that projects are
financially viable.
The results speak for
themselves. In 2009, the government of Montenegro asked for bids on a contract
to build a highway connecting its Adriatic port of Bar with Serbia. Two
private contractors participated in two procurement processes, but neither was
able to raise the necessary financing. As a result, Montenegro turned to the China
Export-Import Bank, which did not share the market’s concerns, and now the
highway is a major cause of Montenegro’s financial distress. According to a
2019 IMF estimate, the country’s debt-to-GDP ratio would have
been just 59 percent had it not pursued the project. Instead, the ratio was
forecast to rise to 89 percent that year.
Not all BRI projects
have underperformed. Greece’s Piraeus port project, which expanded the
country’s largest harbor, has delivered the win-win outcomes Beijing
promised, as have other BRI initiatives. But many have left countries
suffering crushing debt and wary of deeper
engagement with China. Sometimes, the leaders and elites who negotiated the
deals benefited, but the broader populations did not.
In other words, China’s
BRI poses problems for Western countries, but the primary threat is not
strategic. Instead, the BRI creates pressures that can destabilize
developing countries, which creates problems for international institutions
such as the IMF and the European Bank for Reconstruction and
Development, to which those countries turn for assistance. Over the last six
decades, Western creditors have developed institutions such as the Paris Club
to deal with sovereign default issues, ensure cooperation among creditors, and
manage payment crises equitably. But China has not yet agreed to join this
group, and its opaque lending processes make it hard for international
institutions to assess how much trouble a given country is inaccurate.
Caution And Pressure
Some analysts have
argued that the BRI is not a cause of the current debt crisis in
emerging markets. Countries such as Egypt and Ghana, they point
out, owe more to bondholders or multilateral lenders such as
the IMF and World Bank than to China and are still struggling to
manage their debt burdens. But such arguments mischaracterize the problem,
which is not simply bad BRI debt in the aggregate but also
hidden BRI debt. According to a 2021 study in the Journal
of International Economics, approximately half of China’s loans to the
developing world are “hidden,” meaning they are not included in official debt
statistics. Another study published in 2022 by the American Economic
Association found that such debts have resulted in a series of “hidden
defaults.”
The first problem
with hidden debt occurs during the buildup to a crisis when other lenders do
not know that the obligations exist and cannot accurately assess credit risk.
The second problem comes during the crisis when other lenders learn of the
undisclosed debt and lose faith in the restructuring process. It does not take
much hidden bilateral debt to cause a credit crisis, and it takes even less to
shatter trust in efforts to resolve it.
China has taken some
measures to ease the strain of these debts, hidden and otherwise. It has
provided its bailouts to BRI countries, often through currency swaps
and other bridge loans to borrower central banks. These bailouts are
accelerating, with one working paper published in March 2023 by the World Bank
Group estimating that China extended more than $185 billion in such
facilities between 2016 and 2021. But central bank swaps are far less
transparent than traditional sovereign loans, further complicating
restructurings.
China’s preference
for not disclosing lending terms and renegotiating bilaterally may help protect
its economic interests quickly. Still, it can also derail restructuring efforts
by undermining the two foundational elements of any such process: transparency
and comparability of treatment—the idea that all creditors will share the
burden equitably and be treated the same.
The IMF’s policies
for lending into murky distressed debt situations have evolved over decades,
growing more flexible so that the fund can lend into and “referee” debt
restructurings. However, although the IMF was well suited to this role when the
creditors were Paris Club members and even sovereign bond hedge funds, it is
not well positioned to deal with China. Moreover, the mechanisms
the IMF and Western creditors have developed to alleviate
the worsening sovereign debt crisis among BRI countries are insufficient. In
2020, the G-20 established a Common Framework to integrate China and other
bilateral lenders into the Paris Club’s restructuring process with IMF
oversight and support. However, the Common Framework has not worked. Ethiopia,
Ghana, and Zambia have all applied for relief through the mechanism, but
negotiations have been extremely slow, and only Zambia has reached a deal with
creditors. Moreover, the terms of that agreement were underwhelming for Zambia,
Zambia’s non-Chinese official creditors, and, most
importantly, for the prospects of future restructurings.
Under the deal,
reached in June 2023, Zambia’s official creditor debt was revised down from $8
billion to $6.3 billion after a major BRI loan was reclassified as commercial
(even though it was covered by Chinese state-backed export credit insurance).
Furthermore, the agreement may temporarily reduce Zambia’s interest payments on
official debt. If the IMF concludes that Zambia’s economy has improved at the
end of its program in 2026, the country’s interest in official credits will
ratchet back up. That creates a terrible set of incentives for the Zambian
government, whose cost of capital will increase if its creditworthiness
improves and could cause friction between the IMF and China. These results are
not surprising: the Common Framework provides the carrot of IMF support. Still,
it lacks a stick to deal with a recalcitrant creditor, especially with China’s
geopolitical leverage over borrowers.
The IMF's Lending
Into Official Arrears program is another initiative to ease the brewing BRI
debt crisis. In theory, the program should allow the IMF to continue
lending to a distressed borrower even when a bilateral creditor refuses to
provide relief, but it, too, has proven ineffective. In Zambia, China holds
more than half of the official debt, making it extremely risky for
the IMF to extend additional financing. Even in other cases in which
China does not hold a majority of official debt, China has too much economic
leverage over borrowers relative to the IMF, and the fund’s staff and
leadership will always err on the side of caution when attempting to resolve
conflicts between member states.
As long as
the IMF exercises such caution, Beijing will continue to use its
leverage to pressure the fund into supporting borrowers even when it does not
have complete visibility into its indebtedness to China. To prevent future debt
restructurings from becoming as challenging as the ongoing ones in Ethiopia,
Sri Lanka, and Zambia, the IMF will need to undertake substantial
reforms, strengthening its enforcement of transparency requirements for member
states and taking a much more cautious approach to lending into
heavily indebted BRI borrowers. Such a course correction
is unlikely to originate from within the IMF; it must come from the United
States and other important board members.
Slow Learners And Fast Lenders
Some analysts have argued
that China is going through a “learning process” as a debt collector, that
Chinese lending institutions are fragmented, and that building understanding,
trust, and organized responses to sovereign debt crises takes time and
cooperation. The implication is that Western creditors should be flexible while
Beijing grows into its new role—and that the IMF should keep cutting checks.
But patience will not
solve the problem because China’s incentives (and those of any other holdout
creditor) are not aligned with those of the IMF or creditors who wish to
negotiate the restructuring of debts expeditiously. The IMF must strictly
enforce requirements that oblige member states to be transparent about their
debt obligations.
Even if the Chinese
lending landscape is fragmented, the IMF and the members of the Paris
Club should treat the Chinese government as capable of organizing its
state-owned entities and providing a state-level response in debt
restructurings. Beijing is capable of doing so in bilateral debt renegotiations.
In 2018, Zambia announced plans to restructure its bilateral debt with China
and delay ongoing BRI projects because of debt concerns. But after
meeting with China’s ambassador to Zambia, then President Edgar Lungu reversed
course and said there would be no disruption of the Chinese-financed projects,
suggesting that Beijing had been able to coordinate with several Chinese
state-owned enterprises and state-owned banks to avert a blowup. If China could
do so bilaterally, it should also be able to do so multilaterally.
One drawback of
adjusting the IMF’s approach to the BRI debt crisis is that it
would slow the fund down, preventing it from responding quickly to new crises.
This is a tradeoff. The IMF cannot act as both an unequivocal lender
of last resort and an enforcer of the norms of transparency and comparability.
It must be able and willing to withhold credit assistance when its requirements
are unmet. The non-Chinese taxpayers who fund
the IMF should not see their money pay for bad Chinese lending
decisions.
One Chinese energy company plans to build hundreds of
solar farms shaped like the bears along Beijing's Belt and Road initiative.
Good For The Imf, Good For
The World
Members of the G-7
and the Paris Club have several options for addressing the BRI debt
crises. First, the United States and other bilateral creditors could
assist BRI borrowers in coordinating with one another. Doing so would
improve transparency, enhance information sharing, and enable borrowers to
negotiate with Chinese creditors instead of bilaterally. China’s approach of
conducting renegotiations secretly and bilaterally
disadvantages BRI borrowers and other creditors, including
the IMF and the World Bank.
Second,
the IMF should establish clear criteria that
distressed BRI borrowers must meet before receiving new credit
facilities from the fund. Several IMF board members should agree on these
criteria to insulate the fund’s staff and leadership from conflict with China,
which is also a critical board member of the IMF. Transparency related to BRI debts
is not the only area that these criteria should address. The IMF should also
set clearer standards regarding which BRI loans will be considered official
credits instead of commercial ones. China has claimed that some
significant BRI loans are commercial rather than official loans
because they are priced at market rates, even though they come from state-owned
lending institutions such as the China Development Bank. The IMF has
considered these classification questions case by case. But this approach is proving
unworkable since it enables scenarios such as the Zambian one in which a
sizable portion of official debt suddenly becomes commercial overnight,
allowing China to seek better terms. The IMF's continued ad hoc
approach will likely lead to similar gamesmanship and conflict in future
restructuring negotiations. The IMF should clarify
which BRI lending institutions will be considered official creditors
in any restructuring process.
Under some
recent IMF programs, borrowers have continued to
service BRI debts through their state-owned enterprises while
receiving sovereign debt relief at the national level. The only way to prevent
this behavior is for the IMF to require borrowers to identify and
commit to including all state-owned enterprise debts with sovereign guarantees
in restructuring processes. Otherwise, BRI lenders will choose which
state-owned enterprise loans they want in restructurings based on whether they
can get a better deal through restructuring or a bilateral renegotiation.
A Chinese construction project east of Cairo, Egypt,
January 2023
Requiring distressed
countries to meet these criteria before they get new credit facilities would
make the IMF less agile and limit its ability to respond quickly to
balance-of-payments crises. But it would give borrowers and the sovereign
finance industry much-needed clarity and certainty on the requirements
for IMF intervention. It would also insulate IMF staff and
leadership from recurring conflicts with China during every debt restructuring.
Some will no doubt
frame such reforms as “anti-China.” In truth, however, they are simply the
steps necessary to protect the principles of transparency and comparability in
sovereign debt restructuring. Western countries must be able to stand up for
key elements of the rules-based international order when they are imperiled
while still cooperating with China, an essential member of that order.
Finally, these
reforms are the only way to protect the IMF from the fallout of
the BRI debt crisis. Conflicts over BRI debt will continue
to impede debt-relief efforts, undermining the economic health of indebted
developing countries and the effectiveness of the IMF. Only a
reformed IMF can reverse the damage—to developing countries and
themselves.
For updates click hompage here