Sri Lanka not an isolated case?
“Payment problems on China’s loans are surprisingly common”
05/07/2022, 2:20 p.m
China seeks close relations with countries in Asia, Africa and South America. Chinese state banks therefore grant loans to developing countries under the radar. In an interview, the Kiel economist Christoph Trebesch explains the catches of such contracts.
Mr. Trebesch, you recently published a study that deals with the question of how China finances developing countries. The result was that many of these countries could already be bankrupt. Recently it hit Sri Lanka, for example. That sounds surprising. Shouldn’t the public have noticed?
In itself yes. Private creditors would make a lot of noise about something like this, and rating agencies would also sound the alarm. You can currently see this in the context of Russian government bonds, which are held by private investors.
But?
China’s state banks are lending under the radar. In the event of payment defaults, the public therefore does not notice much of it. However, payment problems on China’s loans occur surprisingly often, we speak of “hidden national bankruptcies”. In the vast majority of cases, China then silently carries out a debt restructuring…
… means: The terms are simply extended.
Christoph Trebesch has been head of the research department International Financial Markets and Global Governance at the IfW Kiel since 2017. Since 2017 he has been a professor of macroeconomics (W3) at the University of Kiel.
(Photo: imago/photothek)
Yes, and the rating agencies don’t get it either. We show that in the past 20 years there have been almost 100 such cases in which China has undertaken a debt restructuring. For example, loans with a payment term of 2022 are then extended to 2027. You could say that China is now by far the most important player in debt crises in developing countries.
With almost 100 debt restructurings, the risk seems to be quite high. Where does China’s strategic interest lie if it’s not money?
I can only recommend the book “The Long Game” by Rush Doshi to everyone. China is striving for close economic integration with countries in Asia, Africa and South America. The communist party speaks of a “common destiny” with China at the centre. But that’s nothing new. Rising powers have always tried to tie the countries in the periphery to themselves. The Belt and Road Initiative is now China’s Marshall Plan, if you will. One vehicle for this is the financing of infrastructure projects.
Which countries even agree to such a deal and why are they doing it?
Chinese loans often flow to poor countries or to those that are often in financial difficulties anyway. For example Ecuador, Argentina, Mozambique, Zambia or Pakistan. You have to be clear: In many countries there is a lack of basic infrastructure, such as motorways or power stations. And then China offers them exactly that, as a complete package with construction, financing and management of the projects. In contrast to Western loans, governments do not have to meet any governance requirements.
But the catch is in the contracts. Her research showed that.
Yes, we examined about 100 original contracts. This shows many overlaps with Western treaties, but also major differences. Three areas in particular stand out: On the one hand, the contracts are not transparent. Debtors are prohibited from passing on information about the content of the contract. Second, China sees itself at the top of the creditor pyramid. It is usually the case that all parties have to participate in a debt cancellation of the same amount. However, Chinese state banks do not feel bound by this standard. They want to be better off than western creditors. And thirdly, most contracts can be canceled very easily. The Chinese banks can detect a breach of contract at practically any time and then demand the full loan amount back. This of course gives the Chinese side great negotiating power. With these constructs, China wants to increase the probability of repayment. That’s a legitimate goal. But the degree is unusual.
Are there examples where China has already exercised this power?
Yes, for example in Argentina in 2015. During the election campaign, the future President Mauricio Macri spoke out against a Chinese dam project on the Perito Moreno glacier. When he wanted to suspend the project as president, the China Development Bank then threatened to suspend all the bank’s other contracts in the country based on the contract clauses, for example a huge rail construction project. The project was not finished after all. The influence of the threat cannot be proven, but one thing is clear: China takes the contracts very seriously.
So China doesn’t just forgive debtors their debts?
No, we only saw that in four special cases. It’s more of a kind of “evergreening”. Old debts are thus repeatedly rolled over and thus rejuvenated. The conditions do not change, i.e. the interest rate and debt amounts remain the same. The growing payment problems are only being postponed into the future. At the same time, we are observing that China seems to be building an alternative system to the IMF and World Bank. For example, foreign central banks can draw liquidity from the Chinese central bank via opaque swap agreements. We also know this from the US central bank – but transparently and actually only overnight. China grants central bank loans of three or twelve months. These are then already hidden rescue packages, which also serve to continue servicing the loans to China.
And how are Western countries reacting to this?
Up until the 1970s, the West invested heavily in emerging markets. Many of these countries then failed to repay the debt in the 1980s. This experience has made Western countries and investors more cautious. After that, the focus was more on reforms, health and education, but less on large infrastructure projects. China has filled this gap and thus tied many countries to itself. The West has now also recognized this and is now following suit with its own investment programs. In the US, for example, with the “Build Back Better” program and in the EU with the “Global Gateway” program.
And are the programs really better for the countries?
So far, the programs are mainly announcements on paper. However, the interest rates on western government loans are typically lower than those in China and the contract terms are also likely to be more moderate. However, Western financiers often call for reforms or high environmental standards, which is less the case with China. In the end, however, it usually comes down to the simple question: is a country offered any investments at all or not?
How big is the default risk for the global markets? Or to put it another way: do we already have a credit bubble in emerging markets?
Risks in emerging markets have increased significantly over the past five years. Up until now, it has mainly been smaller and poorer countries that have had payment difficulties. The credit volumes there are too small to shake the financial markets. The biggest unknown at the moment is China itself, a recession or financial crisis there would have major consequences for the global economy.
Jannik Tilar spoke to Christoph Trebesch