Belt and Road: The Debt Threat

Euromoney, April 2018

Countries are queueing to accept Chinese lending for Belt and Road infrastructure projects. But could that borrowing come back to bite them – and China?

On April 12, IMF managing director Christine Lagarde ruffled feathers in Beijing by warning China not to laden Belt and Road recipient countries with unsustainable debt loads.

She was in Beijing to speak at a conference and, nominally, to announce the opening of the China-IMF Capacity Development Center, which aims to support the Belt and Road Initiative (BRI) by training Chinese development officials to work overseas.

But it was her warning on infrastructure spending – that “ventures can also lead to a problematic increase in debt, potentially limiting other spending as debt service rises, and creating balance of payments challenges” – that made the headlines.

The Center for Global Development has looked in detail at the debt burden issue, and Nomura included some of its findings in a new 90-page report released on April 17.

According to this analysis, eight countries are at risk of debt distress as a consequence of Belt and Road-related lending: Djibouti, Kyrgyzstan, Laos, the Maldives, Mongolia, Montenegro, Pakistan and Tajikistan.

So, for example, Djibouti’s public external debt has risen from 50% to 85% of GDP in two years, much of it owed to China Eximbank, while the $6 billion Laos-China Railway project is equivalent to nearly 40% of Lao GDP on its own. The IMF has voiced concerns about Laos’s ability to service that debt.

The CGD and Nomura say that 80% of the increase in Tajikistan’s external debt from 2007 to 2016 is owed to China – a figure that will likely increase with BRI – while loans from China Eximbank to Kyrgyzstan are, at $1.5 billion, equivalent to 40% of the country’s entire external debt.

Pakistan is the biggest name on the list: according to CGD, BRI has brought $62 billion of additional debt to the country, and 80% of it is financed by China.

Terms of debt

Clearly, the terms of this debt are important. And this varies more than you might think.

Many Pakistan projects have been funded with interest-free loans because it is very much in China’s interests to have Pakistan politically onside with it, for reasons varying from commerce to security.

Djibouti, however, which is the terminus of the Addis Ababa-Djibouti railway often seen as a milestone in Chinese infrastructure development in Africa, is believed to have been funded on broadly commercial terms.

“For countries with a high debt burden as a starting point, large front-loaded borrowing at commercial rates of interest, for projects that are unlikely to deliver a high return immediately, can result in a debt trap,” says Nomura.

And once a country gets into that trap, another question heaves into view: China’s attitude to that country getting out of it again. Would China forgive unsustainable debt? Or restructure it?

Nomura notes that over the years, China has provided debt relief to 28 of the world’s 31 heavily indebted poor countries, with several getting full debt forgiveness, among them Afghanistan, Guinea and Burundi.

But – and one suspects this will be the more relevant example with Belt and Road – sometimes China uses other methods. Tajikistan swapped debt for territory in 2011. Sri Lanka, unable to repay its own debt to China, gave the country a 99-year lease over the Hambantota Port instead.

We are just at the start of the BRI. Nomura expects total investment of at least $1.5 trillion over 10 years, of which $300 billion of financial arrangements are notionally in place from the Silk Road Fund, New Development Bank, Asian Infrastructure Investment Bank (which is at absolute pains to tell anyone who’ll listen that it is not a Belt and Road policy institution but a globally funded multilateral), and other multilateral investment funds and green bonds.

But it is hard to pin down $100 billion of BRI projects so far, and the vast majority of the funding for those is not yet deployed.

Debt distress issues are mostly going to be several years down the track. But it would be no surprise at all to find China gaining access, leases, assets and swathes of land as a quid pro quo for easing debt burdens.

That leads to another issue. “With high debt levels locally, China’s financial sector is in a weak starting position and some BRI projects carry the risk of low investment returns,” Nomura notes.

If we accept that China is prepared to “pay an economic price in its quest to realise geopolitical goals through the BRI,” as Alavan Business Advisory director Alastair Newton puts it, then that’s going to increase the burden on China’s financial sector if banks are encouraged to forgive debt for the sovereign’s greater good.

What would that mean for, say, Bank of China, which claims to have participated in over 500 BRI projects and extended $100 billion in credit to BRI countries? Or for China Construction Bank, with its strength in infrastructure finance, or ICBC?

In truth, most of the capital coming from China will be at a policy bank level, especially for longer-term debt. But still, the effects of BRI – of debt levels in recipient countries, of swaps to alleviate debt distress, of commercial considerations coming second to geopolitics, of domestic banks being expected to do their bit – will ripple long after the first roads, ports and railways are built.

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