A Debt Crisis of its Own Making

A Debt Crisis of its Own Making
A Debt Crisis of its Own Making
from The New York Times


Malcolm Riddell

Founder | CHINADebate

Malcolm Riddell

Founder | CHINADebate

Malcolm Riddell

Founder | CHINADebate

Malcolm Riddell

Founder | CHINADebate

On Sunday, the G7 announced the launch of the:

  • ‘Partnership for Global Infrastructure and Investment’ [PGII]

The PGII aims to be an alternative to China’s ‘Belt & Road Initiative’ [BRI] for developing countries seeking, well, infrastructure and investment.

  • And to push back the geopolitical gains China has garnered from it.

Details about the PGII are sparse.

  • But with BRI facing challenges, its timing couldn't be better.

The BRI hasn’t been in the news a lot in the past couple of years. And for good reasons, three of which are:

  • China’s COVID travel restrictions have made it tough for dealmakers and lenders to go overseas for negotiations – and for Chinese workers and managers to do the projects themselves.
  • The slowing economy leaves less cash to lend abroad.
  • And, amid a wave of criticism at home about poor underwriting and returns and from BRI clients about ‘debt traps,’ Beijing is rethinking the BRI’s aims and methods.

At the same time, demand is down.

  • Poor countries, facing economic crisis, are reluctant to commit big hunks of their GDP to repaying loans to Chinese banks for projects that may never produce the returns or advantages they expected or were promised.

As for the loans already made?

  • ‘Under Xi's rule, China has vigorously promoted itself as an alternative to the West and generously funded risky projects in developing countries,’ writes Minxin Pei, in ‘China can turn debt trap of its own making into historic opportunity.’
  • ‘But now hundreds of billions of dollars worth of loans China has made to poor countries are at risk because the strings attached make them especially vulnerable to economic downturns.’

The result, ‘China itself has fallen into the debt trap it dug for others,’

  • ‘Beijing should brace itself for a debt crisis of its own making.’

And that looming debt crisis has created a dilemma for China - a dilemma the resolution of which will impact the economies of both China and the BRI-recipient nation:

  1. If China demands repayment of BRI loans, poor countries, already facing economic crises, will either default or repay and be in even greater distress. (And China’s reputation as champion of the ‘Global South’ will be tarnished.)
  2. If Chinese state-owned banks write the debts off altogether, their balance sheets will be harmed, leaving Beijing ultimately on the hook for the losses.
  3. But if China restructures the debt - cutting interest rates, temporarily suspending debt servicing, and extending loan maturity – it could stave off the short-term threat of further loan defaults.

As Dr. Pei says, ‘China has few good options to climb out of this hole it has dug for itself.’

  • But executives, investors, and policymakers should be alert to the path China chooses.

Meanwhile the PGII is on the march.

  • And that has its own set of impacts on developing economies - and another initiative to watch.

Part 1 | BRI: ‘…a debt crisis of China’s own making’

1 | Sri Lanka: A cautionary tale

Sri Lanka is a cautionary tale about how accepting BRI projects can go wrong for a country. Dr. Pei says:

  • ‘The recent economic collapse of Sri Lanka is the proverbial canary in the coal mine.’

‘The South Asian country's foreign debt has reached $38.6 billion, about 47% of its GDP.

  • Roughly 10% of this amount is owed to China.’

‘In early 2022, Sri Lanka could not repay the nearly $7 billion debt that came due.’

  • ‘After Beijing failed to offer debt relief, Sri Lanka in April chose to suspend repayment on some of its foreign debt pending a restructure.’
  • ‘Shortly afterward, massive protests toppled Sri Lanka's government.’

2 | But…

Not everyone blames Sri Lanka’s woes on China and BRI debt but instead on longstanding mismanagement of the economy and corruption.

  • And some serious analysts reject the concept of China’s engaging in ‘debt trap diplomacy’ all together.

In February 2021 (before the above account about Sri Lanka), The Atlantic published ‘The Chinese ‘Debt Trap’ Is a Myth.’

  • Authors Deborah Brautigam of the School of Advanced International Studies at Johns Hopkins University and Meg Rithmire of Harvard Business School wrote:

‘As Michael Ondaatje, one of Sri Lanka’s greatest chroniclers, once said, “In Sri Lanka a well-told lie is worth a thousand facts.” ’

  • ‘And the debt-trap narrative is just that: a lie, and a powerful one.’

(More recently, in April, Dr. Brautigam repeated her arguments in the 28m video interview, ‘China's BRI NOT debt trap.’)

And ‘Debunking the Myth of ‘Debt-trap Diplomacy,’ a 44-page analysis from Chatham House, asserts:

  • ‘China’s fragmented and poorly coordinated international development financing system is not geared towards advancing coherent geopolitical aims.’
  • ‘In addition, recipient countries (such as Sri Lanka and Malaysia) are not hapless victims, but actively shape outcomes within China’s development financing system.’
  • ‘Accordingly, the BRI does not follow a top-down plan, but emerges piecemeal, through diverse bilateral interactions, with outcomes being shaped by interests, agendas and governance problems on both sides.’

But whether by intention or happenstance, the BRI has left China with, as Dr. Pei says, ‘a debt crisis of its own making.’

3 | A rock & a hard place

‘With global economic conditions bound to deteriorate further,’ writes Dr. Pei, ‘many other developing countries are, like Sri Lanka, expected to default on their foreign loans.’

  • ‘Many of these are countries that have received hundreds of billions of dollars of loans from China and will present a nearly impossible challenge to President Xi Jinping.’

‘Following Russia's invasion of Ukraine, high inflation, rising interest rates, and a looming recession in the U.S. and Europe, many poor countries are facing the worst economic crisis since the near-meltdown of the global financial system in 2008.’

  • ‘As they struggle with capital flight, food shortages and plummeting commodity prices, except for oil and gas, governments in low-income countries will find it increasingly difficult to service or repay their Chinese loans.’

‘Pressuring insolvent governments to service loans in the middle of an economic crisis will be futile and counterproductive.’

  • ‘China will not only lose its money but will suffer irreparable reputational damage if it keeps pressing these countries to repay their debts when there are bread riots in the streets.’
  • ‘But, writing the debts off altogether will devastate the balance sheets of China's state-owned banks. Those banks made these loans, and Beijing will end up having to cover their losses.’

The best path, Dr. Pei suggests, is debt restructuring.

  • 'China should cut interest rates, temporarily suspend debt servicing and extend loan maturity in order to stave off the short-term threat of further loan defaults.'
  • So far though China hasn't shown much interest in restructuring - that may change with a worsening of the global economy, but it's far from assured.

Recognizing the mess the BRI has gotten it into, China is rethinking the initiative – and something very different may emerge.

  • Some are suggesting that China could decide to pull back from massive infrastructure investment in developing countries.

If you are an adherent to the 'debt trap' narrative, this benefits those nations.

  • But if you believe that BRI investment spurs growth, this portends slower development.

Part 2 | BRI: Down, but not out.

1| Headwinds

‘Since the COVID-19 pandemic started,’ write Alicia Garcia-Herrero and Eryk Freymann  in ‘A new kind of Belt and Road Initiative after the pandemic,’ the BRI has faced four short-term macroeconomic headwinds in four ways:’

  1. ‘China’s much worsened economic situation.’
  2. ‘Recipient countries’ negative sentiments about China as some projects fail to deliver their expected benefits and debt continues to pile up.’
  3. ‘International pushback, both from recipient countries after having increased their debt to finance unviable projects, and from developed economies, especially the US, the EU, and Japan, who see their global influence curtailed by China’s expansion overseas.’
  4. ‘Domestic pushback, stemming from the rather low return on investment for China as a good part of BRI related projects have failed or been delayed, or have ended up with cost overruns.’

2 | Slowing down

‘The longer China remains locked within its borders, and the deeper the Chinese economy slides in the second half of 2022, the harder it will be to maintain the same level of ambition.’

  • ‘As long as borders are closed, China’s overseas investment is bound to remain muted, limiting the number of new projects Chinese firms will want to take on.’
  • ‘Cross-border mobility restrictions will also hamper China’s ability to send workers overseas for construction and logistics purposes.’

‘The pandemic’s negative economic effects on many developing countries have also reduced interest in the BRI.’

  • ‘Many prominent BRI partner countries now face debt distress arising from unrelated pressures including a strong dollar, high oil and food prices, and a collapse in the tax base during the pandemic.’

‘This has made Chinese banks and firms relatively less interested in projects in many of these countries.’

  • ‘And this undermines the ability of host countries to contemplate ambitious capital expenditures in the BRI’s traditional sectors, such as transport and logistics.’

‘Chinese development finance (lending rather than equity purchases) into BRI geographies has also plummeted.’

  • ‘This is particularly problematic for countries that are highly dependent on Chinese lending to finance their infrastructure.’
  • ‘Some of these countries have growing current account deficits which they will need to finance.’

‘Many BRI projects underway before the pandemic appear to have been abandoned.’

3 | But not out

‘Notwithstanding these challenges, the Chinese government does not seem ready to abandon the BRI.’

  • ‘The strategy is just too important for the Chinese leadership.’

‘If anything, it is more important than ever as China needs to build alliances in its strategic competition with the US.’

  • ‘And the BRI is linked increasingly to China’s geopolitical objective of proposing an alternative global order to the liberal order led by the United States.’

4 | A new BRI?

‘The BRI is transforming from an infrastructure-led project to a more political one where soft, and even hard, power is central.’

  • ‘In other words, Xi Jinping’s grand vision of the BRI is evolving into a more versatile and hard-edged instrument of statecraft.’

‘China seems to be losing interest in funding infrastructure and would prefer to increase its soft, and possibly even hard, power through other means of influence.’

‘Reflecting some of these concerns, in February 2022 Politburo Standing Committee member and chairman of the Leading Small Group responsible for the Belt and Road, Han Zheng, said:’

  • ‘Chinese banks and companies should focus on projects that “improve people’s sense of gain in participating countries,” and’
  • ‘The leadership should seek “greater alignment” of the BRI and China’s domestic macroeconomic strategies such as dual circulation, while strengthening “risk monitoring and prediction”.’

‘This is much more in line with China’s broader domestic goals, as financial resources are increasingly needed within its own borders.’

  • ‘It is potentially also more effective at furthering China’s interests abroad.’

Part 3 | The Empires Strike Back

1 | PGII

Ever since Xi Jinping announced ‘One Belt, One Road’ in 2013, I watched it expand China’s economic and geopolitical influence and lay the foundation for projecting its military power – and become by many accounts an exploiter of the developing world itself.

  • I’ve also watched in amazement as the U.S., Europe, Japan, and other developed countries sat by pretty much idle and let this happen. (Okay, they have done a lot of projects, but these have been uncoordinated and have certainly not achieved the clout from them that China has from its branded initiative.)

China has been filling the very real need for infrastructure throughout the developing world.

  • A need not fully met by international institutions like the World Bank or IMF and certainly not by the developed countries themselves.

Now almost ten years after the start of the BRI the G7 has responded as a group.

On Sunday, at the G7 meeting, President Biden announced that the Group of Seven has pledged $600 billion in private and public funds over five years to finance needed infrastructure in developing countries, the:

  • ‘Partnership for Global Infrastructure and Investment’ [PGII].

In his announcement, Mr. Biden said:

  • ‘I want to be clear. This isn't aid or charity. It's an investment that will deliver returns for everyone.’
  • He added that it would allow countries to ‘see the concrete benefits of partnering with democracies.’

In an implicit jab at China, the President also said:

  • ‘What we're doing is fundamentally different because it's grounded on our shared values of all those representing the countries and organizations behind me.’
  • ‘It's built using the global best practices: transparency, partnership, protections for labor and the environment.’
  • ‘We're offering better options for countries and for people around the world to invest in critical infrastructure that improves the lives -- their lives, all of our lives -- and delivers real gains for all of our people -- not just the G-7, all of our people.’

2 | Countering China

Despite the White House’s issuing a ‘Memorandum on the Partnership for Global Infrastructure and Investment’ and the ‘FACT SHEET: President Biden and G7 Leaders Formally Launch the Partnership for Global Infrastructure and Investment,’ as well as other G7 nations' explanations, it’s far from clear, to me anyway, how this will work - and how effective it will be.

  • More on this in later issues as the PGII goes forward.

The PGII is intended, as Jake Sullivan, the US national security adviser and an important member of the project has said, to be ‘an alternative to what the Chinese are offering.’

  • But the PGII is also intended to counter the geopolitical influence China has garnered from the BRI.

That said, while the PGII – if it’s implemented as outlined - will no doubt build a lot of infrastructure, it’s tough to see how it will have 'greater than the sum of its parts' impact on geopolitics and security as the BRI has.

  • Unless, that is, China makes the BRI is in retreat.

Part 4 | We are the champions. No, we are the champions

The BRI and PGII are now in competition in the developing world.

  • Each emerged from very different traditions - and it's these that inform the competition and will help determine the outcome.

1 | Out of Africa (and the rest of the developing world)

My focus has always been China.

  • So my understanding of relations between the developed world and the developing world is pretty scant.

My impression, in the broadest terms, is that powerful countries:

  • Colonized weaker countries, and
  • After de-colonization, vacillated between benign neglect and exploitation - and in the middle of these extremes, vacillated between periods of generous and not so generous aid. Same for poor countries that weren’t colonized.

My impression also is that there is a strain of extreme thinking about developing nations reflected in former President Trump’s comment about Haiti, El Salvador, and African nations being ‘shithole countries.’

  • And a counter strain reflected in the laudable missions of international institutions like the World Bank and the IMF, and the aid organizations of many countries.

[I will no doubt get – and welcome – comments challenging my impressions.]

2 | From Bandung to BRI

China's relations with the developing world have taken a very different course.

  • China sees itself, before the founding of the People’s Republic in 1949, as a victim, having both been made a ‘semi-colony’ of and exploited by the western powers and Japan – the ‘Century of Humiliation’ – and identifies with countries with a similar history.
  • Then soon after its inception, the People’s Republic of China, itself then a developing country, made common cause with the so-called ‘Global South’ – and sought to be its leader and champion.
  • And, as part of its credentials, touts that, unlike the west and Japan, it never colonized another country (although some countries may disagree).

As Hong Liu of Nanyang Technological University in Singapore points out in ‘China engages the Global South: From Bandung to the Belt and Road Initiative’:

  • ‘The genesis of China’s systemic engagement with the Global South can be traced back to the Bandung Conference of 1955, which continues to underpin China’s attitude to the developing world.’
  • ‘Underlining this engagement has been China’s belief in the shared experiences and aspirations of developing countries, as well as the enduring value of Bandung and of the Chinese model as a path to economic growth, poverty alleviation, and global governance reforms.’

In our time the most potent expression of China’s efforts is the BRI.

  • [China is following up now with the ‘Global Development Initiative’ and the ‘Global Security Initiative.’ More about these in a later issue as China fleshes them out.]

But those long efforts are in jeopardy - as is China's perceived role as champion of the 'Global South.

  • At the same time the developed countries - alternately exploiter and benefactor of the developing world - is poised to challenge China for its title.

Much of the outcome depends on whether one can remember its roots and the other can avoid the worst of its traditional tendencies.

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