The Belt and Road Initiative is an ambitious project, a grand vision for Chinese overseas development to connect Asia with Europe and Africa – a modern-day Silk Road with networks both on sea and land. But like someone whose eyes were bigger than their stomach at a buffet, China has had something of a lending binge that is now being corrected.
The project has entered a period of belt tightening and Chinese lending to the Belt and Road Initiative (BRI) has dramatically fallen. Like the buffet, items have been left on the plate and cast aside; partially built roads lead to nowhere and borrower countries have been lumbered with useless ‘white elephants’ and debts they are struggling to repay.
This picture of the BRI has called into question its sustainability. And the fall in lending has been dramatic: according to figures from Boston University, Chinese overseas lending was US$3.9bn in 2019, a fraction of the US$75bn that was recorded in 2016.
Yunnan Chen, a Senior Research Officer in the Development and Public Finance programme at think tank ODI, explains that data from numerous reputable sources shows that Chinese overseas lending has dropped. “The reasons for the decline are manifold,” she tells Treasury Today Asia. And while there have been debates about debt issues and BRI projects not working out, “The main driver of the decline [in Chinese lending] has been the domestic economy,” she says. Domestically, there has been regulatory pressure on financial institutions to rein in their lending. As a consequence, lending overseas has also dropped, she explains.
When compared to other countries, the scale of China’s international lending programme is massive. Scott Morris, Director of the US Development Policy Initiative, Co-Director of Sustainable Finance, and Senior Fellow at the Center for Global Development, explains that official sources – such as World Bank data – show that China is now by far the biggest lender in the world, government lender in the world, and is bigger than all of the major lenders of the Paris Club (which includes the United States, United Kingdom and Japan) combined. However, “It is pretty clear that official estimates understate the scale of lending,” says Morris.
This points to the issue of ‘hidden’ lending. Dr Bradley Parks, Executive Director at research and innovation lab AidData at the College of William and Mary, explains how there has been a major increase in hidden debt. This is based on the AidData report Banking on the Belt and Road – which looked at 13,427 Chinese development projects worth US$843bn across 165 countries – and highlights how debt levels and implementation problems are affecting the BRI.
Matthew Mingey and Agatha Kratz, Senior Analyst and Associate Director respectively at research firm Rhodium Group, also point out that the overseas lending is much larger than previously thought. For example, the Boston University data doesn’t include lending from commercial banks, which has increased. And it is other entities – not governments – that are increasingly the recipients of the loans, such as state-owned enterprises or investment vehicles.
Parks at AidData describes this as a trend of falling sovereign debt and the rise of hidden debt. He estimates that 70% of China’s overseas lending is not to governments. And because these loans are to other entities, they do not appear on the government’s balance sheet even though there may be an implicit – or even explicit – understanding that the government would have to step in if the project runs into difficulty.
Parks says that 42% of countries have levels of public debt exposure that is more than 10% of their GDP. “These unreported debts are worth approximately US$385bn and the hidden debt problem is getting worse over time,” Parks says. He adds that governments of borrowing countries may not know the value of the debts they may or may not have to service in the future.
Another element of the ‘hidden’ debt problem, explains Morris, is that debtors are supposed to report their obligations, but many are just not good at reporting, or they may prefer to keep their borrowing hidden.
Even with lending that isn’t included in official figures, there has still been a decline, especially during the pandemic. Morris comments this is part of a broader trend of China overlending in the past and now there has been a correction.
Mingey and Kratz at Rhodium Group argue that Chinese creditors have been rethinking their lending after they have run into problems with some of their projects. Borrowers have needed to renegotiate their loans, and according to the Rhodium Group researchers, up to a quarter of lending has run into trouble.
AidData research also highlights problems with the BRI projects and found that 35% had experienced problems with implementation, including corruption scandals, labour violations, environmental hazards and public protests.
Amid this, some projects are falling by the wayside. Brooke Russell, an Associate Director at AidData and co-author of the Banking on Belt and Road report said, “Host country policymakers are mothballing high-profile BRI projects because of corruption and overpricing concerns, as well as major changes in public sentiment that make it difficult to maintain close relations with China. It remains to be seen if ‘buyer’s remorse’ among BRI participant countries will undermine the long-run sustainability of China’s global infrastructure initiative, but clearly Beijing needs to address the concerns of host countries in order to sustain support for the BRI.”
Chen at ODI notes that loan repayment issues have become more prominent in the last five to seven years. This comes in the context of accusations of ‘debt trap diplomacy’ and predatory lending by China, which Chen doesn’t agree with. “I would push back against the ‘predatory’ narrative – that these Chinese banks are working to serve a grand strategic purpose of locking in African countries to become tributary states. I think that is very simplistic and it is not evidence based,” she says. The idea of the ‘debt trap’, she adds, is a “myth that refuses to die”.
With many of the cases, says Chen, the reality is a lot more complex. The port at Hambantota at Sri Lanka is often given as an example of China seizing assets. From the outside, she says, it looks like the government of Sri Lanka was in debt and the Chinese took it over. “This is the example that has been thrown around of ‘this is what happens – China seizes your assets’ – but that is not true,” says Chen.
Academics Deborah Brautigam and Meg Rithmire wrote in The Atlantic that Chinese lending has been portrayed as the Mafia lending to a hapless gambler who is then in danger of losing a limb. They argue that Sri Lanka’s debts were much larger than the Hambantota port deal, and the Chinese finance was not a cause of the country’s financial distress. Also, there was never a default on the port and it was not an asset seizure. They write, “China’s march outward, like its domestic development, is probing and experimental, a learning process marked by frequent adjustment. After the construction of the port in Hambantota, for example, Chinese firms and banks learned that strongmen fall and that they’d better have strategies for dealing with political risk. They’re now developing these strategies, getting better at discerning business opportunities and withdrawing when they know they can’t win. American leaders and thinkers from both sides of the aisle still give speeches about China’s ‘modern-day colonialism’.”
Another case that has received widespread attention is the upgrade and expansion to the Entebbe International Airport in Uganda. This was also widely reported as an asset seizure, but the details are more complex. To address the various rumours and speculation, AidData published the actual loan contract between the government of Uganda and China Eximbank. AidData notes that the collateral is not actually the airport itself – an illiquid asset – but rather cash that is deposited in an escrow account. Also the agreement takes the unusual step, notes Parks, of stipulating that they have all revenues generated by the airport – even though this is a public infrastructure that existed before the existence of this loan from China.
Uganda does have agency in this arrangement, however, and has demonstrated that it is possible to push back against stringent terms, notes Parks. For example, when it renegotiated, the government of Uganda pushed back against China Eximbank’s demand that it has the right to approve spending decisions of the Civil Aviation Authority. When Uganda protested, China Eximbank scaled back its demands and agreed to monitoring the decisions instead.
Parks concludes that the Uganda case is not a debt trap. “Our analysis of the terms and conditions in the contract does not support the allegation that China engages in predatory lending. We instead find that Beijing is a shrewd negotiator who is willing to impose intrusive conditions upon sovereign borrowers to protect its balance sheet.”
Despite the reports, the Chinese Embassy in Uganda denied that it would take over the airport. “Not a single project in Africa has ever been confiscated by China because of failing to pay Chinese loans,” it said in a statement.
All this discussion of ‘predatory’ lending is perhaps unhelpful. Countries on the African continent are often being given too little credit to look out for their own interests, says Morris. Rather than using the term ‘predatory’, he prefers to look at the numbers and the behaviour. “Chinese lending is remarkably risk tolerant,” says Morris and these institutions are lending in situations where the borrower is more vulnerable, and having a harder time servicing the loan, because of the scale of the borrowing from China.
On the question of whether they are victims in this lending, Morris comments that “China is willing to refinance and restructure terms.” This is not necessarily a beneficent repayment plan as it can be structured so the creditor receives more money over time. You can go too far in saying that these refinancings are mutually agreeable and these borrower countries can look after themselves; the Chinese contract terms clearly favour the creditor, he adds.
In debt renegotiations, however, there are issues because of the secretive nature of some of the lending contracts. Parks comments, “by shielding their contractual arrangements from public scrutiny, Chinese state-owned banks have made it difficult for other lenders to know if they are positioning themselves at the front of the repayment line.”
On the question of confidentiality, Chen at ODI says, “Debt transparency is definitely a problem for borrowers from China. A lot of these loans require you to take out an NDA [non-disclosure agreement]. Chinese banks do not behave like the World Bank or multilateral development banks; they behave more like commercial banks,” Chen explains. In commercial lending it is advantageous to both the lender and the borrower for the rates not to be disclosed. This is typically not a problem, says Chen – it’s only when the loan needs to be restructured that it is problematic.
Chen explains that the Covid pandemic caused a widespread shock to many countries and affected their ability to repay. “The problem with debt transparency is a bit of a live wire if you want to renegotiate with other creditors,” says Chen, and no one has an interest in opening up their books.
From a legal perspective, says Chen, these contracts are default and commonplace, “They are not particularly unique or nefarious,” she says. She also notes that if there is a legal requirement in a country that the loan has to be disclosed, this overrides any agreement that might be stated in the contract.
In terms of how the Chinese lenders operate, Chen and Kanyi Lui, an international finance lawyer, wrote a report on China’s lending practices and found that, “Chinese lenders tend to give more weight to perceived long-term creditworthiness and the quality of the relationship with the borrower over technical contractual terms. Contractual terms should be evaluated within this broader relational context.”
Chen says that in previous cases Chinese banks have been willing to defer the payment when borrowers ask to renegotiate, “In that sense Chinese banks are quite flexible,” she says.
On the question of what happens to the debtors if they are unable to meet their obligations? “Chinese lenders are perfectly willing to kick the can down the road,” says Morris. “Lending to support big complex infrastructure projects is not easy – you can’t just flick a switch. It’s not easy to walk away,” says Morris.
This may be affecting more countries than previously thought. A paper by the Kiel Institute for the World Economy by Sebastian Horn, Carmen Reinhart, and Christoph Trebesch in January 2022, argues that defaults and missed payments are not usually disclosed. The research constructed a dataset of debt restructurings and found that problems – or ‘credit events’ – are “surprisingly frequent”. The research notes that China’s lending boom will likely result in a number of defaults or restructurings. The report notes, “If history is any guide, multi-year debt workouts and serial restructurings lie ahead.” Also, a lack of transparency means that it is difficult to assess whether the lending will be sustainable.
There are lots of ways that the Chinese creditors seek to get repaid even if the country is defaulting on their debts, says Morris. “It is hard to pick up the project and carry it back to China,” Morris jokes. “The Chinese are kind of stuck with the debtor” and that is why they have large escrow accounts in place. Those accounts may be held in Beijing with a commitment to revenue flows that may or may not be from the project itself, says Morris.
Chen argues that in reality it can be difficult to claim collateral that has been pledged. “We have not seen an asset seizure. In reality it is very difficult to claim it – even if the collateral is in an escrow account overseas,” she says, adding that if money is drawn on that account, then they wouldn’t get the rest of their money back.
This decline in lending, however, does not mean that China’s ambitions for the Belt and Road have changed. “I do not think that the Belt and Road is over or finished,” says Morris. “I think the sustainability of this overseas lending is very much part and parcel of China’s investment scheme,” he says, adding that is likely the government would step in if necessary to support the initiative.