The writer is a senior fellow at Harvard Kennedy School
Announcing a proposed lending facility to rival China’s Belt and Road Initiative, G7 leaders meeting in Cornwall last weekend sent a clear message: they are worried about China’s growing geoeconomic influence as the world’s largest official creditor. There are reasons for concern.
The world of sovereign debt lending is the Wild West. There is little enforceability of sovereign debt contracts (it isn’t easy to seize a country’s assets), the terms of contracts vary widely between creditors and there is no bankruptcy procedure for countries. The worry about China as a lender is not that it is breaking international standards, because there aren’t many of those. The concern is that Chinese loans will leave borrowers worse off — and subject to political pressure by China.
A study by World Bank chief economist Carmen Reinhart and others found that as of 2019, the 50 countries most indebted to China owed Beijing close to 40 per cent of their total reported external debt. China would argue that it is filling a gap in the market, taking on risky lending so poorer countries can finance their development, as it did. It would also highlight that it voluntarily signed up to the G20 Debt Service Suspension Initiative (DSSI) and Common Framework for debt in 2020.
The DSSI allows the world’s 73 poorest countries to suspend debt repayments until the end of this year. The Common Framework applies to the same countries and allows a debtor to request a debt restructuring if it is in an IMF lending programme and extracts the same terms of restructuring from all creditors. This is designed to avoid a collective action problem, whereby some creditors hold out because they’re concerned the debtor will use savings on their loans to repay other creditors.
Critics argue China’s participation is realpolitik. When China was a nascent lender in the 2000s, it could free ride in a debt restructuring and hope to avoid taking a big writedown itself. Now that it is the largest official lender, China wants comparability of treatment so it can share losses as much as possible.
Characteristics of China’s bilateral loans also suggest it isn’t changing by participating in the DSSI and common framework. Two state-owned development banks oversee most BRI lending. They’re public entities, operating more like multilateral organisations, that ultimately answer to the State Council in Beijing and cannot accept losses over a period of time. Based on a study of 100 bilateral loans from Chinese entities, all contracts since 2015 have included a confidentiality clause that makes it impossible for other creditors, investors, banks or taxpayers to determine the financial position of the country.
Nearly one-third of the bilateral Chinese state-owned lender contracts also require the debtor to maintain an escrow account to be used as security for debt repayment. The accounts are funded by government revenues or by money generated by the project financed by the loan. This means a significant revenue stream could be controlled by a foreign lender.
Over 90 per cent of the bilateral Chinese contracts include clauses that allow the state-owned entity to terminate the contract and demand repayment if the debtor country implements a significant legal or policy change. All contracts with Chinese policy banks include cross-default clauses, allowing the creditor to demand immediate repayment if the borrower defaults on other lenders. These clauses allow the creditor to influence the borrower’s foreign or domestic policy, tying its hands in the event of debt distress.
So far, we have little data to guide us on how to think about China as a creditor when a borrower goes into distress. Only Chad’s creditor committee has had a number of meetings under the Common Framework to gain assurances from official creditors that they will restructure the debt. Because Chinese policy banks answer to the State Council, they are extra careful to cross all their t’s and dot their i’s before giving such assurances. There may be no nefarious intentions in the slow pace of the negotiations, but the longer a debtor waits for help, the more help it will need.
Overall, there has not been more debt distress over the past 20 years, as China’s lending grew. But this also coincided with a period of extremely easy monetary policy and ample liquidity. Nor is there much evidence China has exerted political pressure in connection with loans. But in a new world where China is seen as a strategic competitor, and as long as its lending practices are opaque and borrowers can be subject to Beijing’s political influence, the G7 leaders have reason to worry.