China is the largest creditor in the world, funding infrastructure projects in the developing world in exchange for access to raw materials. A new study shows that the risk of a new debt crisis is significant.
The future rail link cuts its way through the jungles of Laos for over 400 kilometers. Soon, trains will be rolling through — over bridges, through tunnels and across dams built just for the line, which runs from the Chinese border in the north to the Laotian capital of Vientiane on the Mekong River.
After five years of construction, the line is set to go into service in 2021. And the Chinese head of one of the sections has no doubt that it will be finished on time. “Our office alone employs 4,000 workers,” he says. There is also no lack of money: The Chinese government in Beijing has earmarked around 6 billion dollars for the project and has recently become both Laos’s largest creditor and most significant provider of development aid.
China, after all, isn’t just directly financing 70 percent of the new train lain, it is also building dams, schools, military hospitals and has even launched a communications satellite into space for the country. In April, Beijing loaned Laos another 40 million dollars for road construction — a credit that was provided through the multilateral Asian Infrastructure Investment Bank based in Beijing, a financial institution that China established as an alternative to Western development banks.
If Hong Kong is included, China isn’t just the largest creditor in Laos, but in the entire world. Beijing’s foreign loans dominate global markets almost to the same degree as its toys, smartphones and electric scooters do. From Kenya to Montenegro, from Ecuador to Djibouti, roads, dams and power plants are being built with billions in loans from Beijing. And all of those countries will have to pay back those loans in the years to come. With interest.
The flood of capital from China helped prevent the global economy from plunging into depression following the bankruptcy of Lehman Brothers and the ensuing financial crisis. But it isn’t without controversy.
For some, the billions of dollars from China are a welcome contribution to helping many underdeveloped regions in Asia and Africa expand infrastructure. For others, the loans from Beijing have forced half the world into economic and political dependency on Beijing. Some have described the situation as “debt bondage,” while a group of U.S. senators wrote a letter to Secretary of State Mike Pompeo last summer warning of China’s “attempt to weaponize capital.”
A Lack of Transparency
Furthermore, little is actually known about the loans. China’s foreign assets are now worth $6 trillion, but outside of the government in Beijing, nobody knows much about where that money has been invested and what conditions and risks are attached. Because China doesn’t completely open its books to international organizations like the World Bank and the International Monetary Fund (IMF), there is a lack of needed transparency, says IMF head Christine Lagarde.
Now, though, with the release of a new study by a German-American team of academics under the leadership of Harvard professor Carmen Reinhart, Largarde will have a clearer picture. For months, the economists dug through both known and unknown source material, compiling the most comprehensive analysis yet of Chinese foreign loans. And the image that has resulted does nothing to assuage concerns about the financial power being exerted by Beijing.
On the contrary: The data shows that many countries in the poorer regions of the world have accepted far more credit from China than previously known. And the loans frequently come with onerous conditions that are strongly oriented toward Beijing’s strategic interests and increase the risk that many countries in the developing world could plunge into financial crisis. “The West still hasn’t understood how profoundly China’s rise has changed the international financial system,” says Christoph Trebesch, a co-author of the study from the Kiel Institute for the World Economy.
Sitting in a library in Hamburg, Trebesch scrolls through hundreds of lines of data on his laptop: loan periods, interest rates, intended purposes and collateral on almost 5,000 Chinese loans and aid payments to 152 countries. The information comes from almost a dozen databases that were compiled with the help of aid organizations, banks and the CIA.
Trebesch describes the process of compiling the information as “a kind of economic archeology.” The process involved him and his colleague Sebastian Horn analyzing the data and then comparing it with official sources to put together a comprehensive picture of China’s foreign assets — the kind of picture that Beijing, no doubt, would prefer to keep under wraps.
Closed Financial Loop
According to the study, China exports more capital to developing and emerging countries than all other industrialized countries put together. Moreover, numerous conditions are attached to the loans that weigh heavily on thier recipients.
Whereas Western governments and multilateral organizations generally attach low interest rates and long repayment periods to their loans, China tends to impose short periods and higher rates. To ensure that the loans are paid back, the contracts guarantee Beijing a number of rights, such as access to foodstuffs, raw materials or the profits of state-owned companies in the recipient countries. Frequently, the Chinese government directs the money straight to Chinese companies that have been contracted to build airports, ports or dams, an approach that creates a closed financial loop without the involvement of a single foreign account.
In addition, more than 75 percent of the direct aid loans provided in recent years have come from two state-run financial institutions: the Export-Import Bank of China and the China Development Bank. That means that the government is constantly informed of every phase of their aid projects and when crisis befalls creditor countries, China is well-positioned to grab its collateral ahead of other creditors. The study notes that China has developed a new form of development aid in which state loans are provided at commercial terms.
That can result in ugly conflicts when projects fail to proceed as planned. In Sri Lanka, for example, China took control of a port after the government ran into difficulties servicing its debt. In Ecuador, Beijing secured 80 percent of the country’s oil revenues to compensate for the costs associated with an enormous dam project. In Zambia, which owes China an estimated $6 billion, regime critics are concerned that Beijing will take over the state energy supplier Zesco.
Fears are also growing in South Africa, where President Cyril Ramaphosa is thought to have negotiated loans and subsidies worth 370 billion rand (the equivalent of around 24 billion euros) during a state visit to Beijing last fall. The opposition party Democratic Alliance is concerned that South Africa could become mired in a debt trap and that Beijing may, for example, take control of the struggling state-owned electric utility Eskom. The South African government, Ramaphosa insisted last fall, “is not in the habit of … handing over the assets of our country to any other country or entity.” The reference was clearly to China. To be sure, Western countries are not displeased that China, in many countries of the world, has taken over the role of scapegoat that was long played by the IMF or the United States. But they are nevertheless unsettled by the lengths Beijing goes to in its effort to conceal the true extent of its loans to the developing world.
Danger of Default
The German-American study outlines the scope of that attempt. It argues that many payments from Beijing are masked because they go straight to state-owned companies operating in recipient countries. The balance sheets of those companies, though, are frequently not accounted for in official financial statistics. The result is that a large chunk of Chinese development loans is concealed from Western governments and international organizations. The study found that the amount of foreign debt held by China is around 50 percent higher than is documented by official statistics.
The discrepancy is particularly large in those countries that are already heavily indebted. In Ivory Coast, for example, debt levels are $4 billion higher than previously thought. The difference in Angola is $14 billion and in Venezuela it is $33 billion. Because the Beijing government tends to charge high interest rates, many emerging and developing countries suffer, according to the study, from “growing annual debt service obligations.” That means their interest rate payments continue to rise, which increases the danger that they may ultimately default
Study authors note that the situation is reminiscent of the late 1970s, a time when large banks from the U.S., Europe and Japan provided billions in loans to Latin American and African countries rich in commodities — credits that flew under the radar of international monitoring agencies. When prices for many raw materials crashed, countries like Mexico could no longer service their debts and much of the developing world slid into a debt crisis that set them back for years.
Today, the situation is hardly any different. Once again, many developing countries have accepted huge loans. And once the hidden money flows from China are included, as the study shows, the debt loads being carried by many countries are again as high as they were in the 1980s. The authors write that the situation looks “strikingly similar.”
Already, there are initial indications of an approaching crisis. Pakistan was recently forced to apply for an emergency IMF loan because it was no longer able to service its massive Chinese debt load. In Sierra Leone, the government stopped the construction of an airport that China had intended to finance. Meanwhile, IMF Managing Director Lagarde hardly holds a speech in which she doesn’t mention the dangers facing global financial stability.
What Africa Needs
But there is no end in sight to the flow of Chinese credit. The economic advantages for China are simply too great, as are the political benefits, particularly in Africa.
Whereas the West has largely seen the continent as little more than a source of a steady stream of catastrophes, Beijing has viewed it as a place of untapped future potential. Around 1.5 million Chinese are thought to be living and working in Africa, a group that includes entrepreneurs, IT experts, technicians and merchants.
They have expanded infrastructure in Africa at an impressive pace, building dams, airports, train lines and industrial parks across the continent. In return, China has secured access to natural resources and African markets.
Beijing is delivering precisely what Africa needs, says Rwandan President Paul Kagame. He belongs to a growing number of African strongmen who are seeking to emulate the successful Chinese model of developmental autocracy, often with the support of their citizens. According to a survey conducted by the pollsters at Afrobarometer in 36 African countries, 63 percent view China’s engagement in a positive light.
African rulers prefer cooperation with China in part because it isn’t linked to moral stipulations like those demanded, on paper at least, by Western governments. The Chinese don’t pay much attention to human rights or democratic principles and also tend to ignore environmental concerns and minimum labor standards. And they don’t have too many scruples when it comes to bribing politicians.
Nevertheless, warnings that debt loads have become too high are growing louder in Africa as well. Not just because many projects have proven to be economically unviable, but also because China has been systematically underreporting its influence.
Whereas official Chinese government statistics often only list small loan totals, the real numbers are far higher, as the new study shows. The small country of Djibouti, for example, is carrying a Chinese debt load equivalent to 70 percent of its annual economic output. In Congo, it is 30 percent and in Kenya, 15 percent. It is vastly more than the governments owe to Western countries. Colonialism, made in China.
The situation isn’t likely to change any time soon. “Many of the Chinese projects have been beneficial for the recipient countries,” says Trebesch of the Kiel Institute for the World Economy. After all, many countries in Africa are in dire need of modern infrastructure.
Furthermore, some recent studies from the U.S. have painted a less alarming picture of Chinese development loans. The economist Deborah Bräutigam of Johns Hopkins University in Baltimore found that of 17 African countries stuck in a debt crisis, only three of them received loans from Beijing. The analysts from Rhodium Group, meanwhile, argue that China is not nearly as heavy-handed as many believe. In examining 40 of Beijing’s projects, the institute found that the Chinese government is willing to make concessions on repayment deadlines should it become necessary.
Still, the frequency of such concessions would seem to indicate that the initial conditions imposed by China were far too strict. And the situation is a far cry from conforming to international standards of transparency regarding the size of the loans made by Beijing and the conditions attached.
That, in fact, is the primary improvement that Trabesch would like to see — namely that China finally provide more clarity about its financial activities in the developing world. Firstly, because the economic and political consequences of the loans would become more visible. Secondly, because it could help prevent the outbreak of a new debt crisis in the developing world.
After all, China would be directly exposed were that to happen.