The ‘debt-trap diplomacy’ debate: Are China’s loans predatory?

Foreign Affairs

China has poured mountains of cash into infrastructure projects abroad, leading smaller countries to worry about exploitation. But while there are real issues with transparency and corruption in Chinese loans, “debt trap” is not an accurate characterization.

Image Credit: Panda Paw Dragon Claw

On September 16, Beijing successfully picked off one of Taiwan’s few remaining diplomatic allies, the Solomon Islands, leaving it with only 16 official international partners.

Upon the diplomatic switch, the Financial Times reported that the “Solomon Islands’ Central Bank warned…that establishing diplomatic ties with China could drive the country into a debt trap similar to that seen in other nations that accepted loans for infrastructure projects from Beijing.” Two weeks before the break in relations, Taiwan’s foreign ministry had warned its ally, “China’s expansion in the Pacific has made many countries fall into the trap of debt.”

What is this “debt trap” that Taiwan and the Solomon Islands Central Bank are referring to?

Across the developing world for the past two years, there have been ripples of concern about Chinese loans that overburden the borrowers and end up in settlements that undermine local sovereignty. These loans, typically for infrastructure projects and often reaching massive size, need to be guaranteed with some type of collateral. For many poorer countries, the only collateral large enough at hand is land — a port, for instance. The smaller the country, the more lopsided the negotiations with China are perceived to be, so the anxiety is especially high in places like the Pacific island nations. SupChina published a brief guide to China and the Pacific island nations on SupChina Access last year illustrating how active the debate on debt is in these countries.

The center of these ripples of concern is Sri Lanka. There, the worst-case scenario for a nonperforming loan happened in December 2017 when the Sri Lankan government ended up leasing the Hambantota Port to China Merchants Port Holdings for 99 years — effectively ceding sovereignty over a piece of its territory. This incident led to widespread accusations of “debt-trap diplomacy.”

But development economists do not consider Sri Lanka’s case a “trap.” Here’s why.

Three Sri Lankan economists have written about their country’s experience with Chinese loans, and all concluded that China was not specifically to blame for the country’s debt problems. One economic researcher, Umesh Moramudali, wrote in The Diplomat, “It is true…the project certainly was not an economically sensible decision at the time given the fiscal constraints of the economy.” But he argues that it was those overall financial constraints, rather than any specific arm-twisting from China, that led to the port lease. He calculates that “debt repayments for the loans obtained for Hambantota port amount to only around 5 percent of Sri Lanka’s total annual foreign debt payments… By the end of 2017, only little over 10 percent of Sri Lanka’s foreign debt was owed to China and most of that was in the form of concessionary loans.” He writes that this is the true reason Sri Lanka chose to give away the port:

The economic reality is that Sri Lanka leased out Hambantota port to China largely due to a persistent balance of payment (BOP) crisis resulting from the reduction of trade over the years even while external debt servicing costs have been soaring. Sri Lanka faced a severe shortage of foreign reserves in light of the upcoming debt servicing payments, due to the maturity of international sovereign bonds. Therefore, the country had to look for various avenues to obtain foreign currency inflows. Leasing out Hambantota port was one of the ways to increase the country’s foreign reserves.

Dushni Weerakoon and Sisira Jayasuriya added in an analysis in East Asia Forum that “Sri Lanka’s debt repayment problems had very little to do with Chinese loans,” and that the real issue was Sri Lanka “meeting its obligations to international investors and commercial lenders.”

That doesn’t mean, however, that other political concessions haven’t been pried from Sri Lanka and other governments by Beijing in exchange for loans. A New York Times investigation of the Sri Lanka negotiations in June 2018 alleged that “intelligence sharing was an integral, if not public, part of the deal.” (The Chinese Foreign Ministry dismissed this as “fake news.”)

That is also not to say Sri Lanka hasn’t had a rocky trade and investment relationship with China in recent years. For example, the country angered China in June 2018 by requesting to review their free trade agreement after 10 years, but China did not want to renegotiate. SupChina published a detailed review of Chinese investments into the country since 2007, and the numerous related controversies, on SupChina Access (paywall).

The Rhodium Group reviewed a number of debt renegotiations, and found that “actual asset seizures are a very rare occurrence. Apart from Sri Lanka, the only other example we could find of an outright asset seizure was in Tajikistan, where the government reportedly ceded 1,158 square km of land to China in 2011. However, the limited information available, and the opacity of the process makes it difficult to determine whether this specific land transfer case was in exchange for Chinese debt forgiveness, or (as some observers argue) part of a historical dispute settlement between the two countries.”

This hasn’t stopped the U.S. from running with the “debt trap” narrative.

Invariably, proponents of the debt trap narrative cite the Sri Lanka case. They typically also throw in speculation, without providing evidence, that the Hambantota Port could become a base for the Chinese military.In October 2018, Vice President Mike Pence said that China engages in “debt-trap diplomacy,” and elaborated,

China uses so-called “debt diplomacy” to expand its influence. Today, that country is offering hundreds of billions of dollars in infrastructure loans to governments from Asia to Africa to Europe to even Latin America. Yet the terms of those loans are opaque at best, and the benefits flow overwhelmingly to Beijing.

Just ask Sri Lanka, which took on massive debt to let Chinese state companies build a port with questionable commercial value. Two years ago, that country could no longer afford its payments — so Beijing pressured Sri Lanka to deliver the new port directly into Chinese hands. It may soon become a forward military base for China’s growing blue-water navy.

Mark Green, the administrator of the U.S. Agency for International Development, is another proponent of the “debt diplomacy” narrative. He wrote in Foreign Policy:

When cash-strapped developing countries fail to pay back the loans for multibillion-dollar projects, it can result in a loss of strategic assets, major hurdles to economic development, and a loss of sovereignty.

For example, unable to repay China for a loan used to build a new port in the city of Hambantota, in 2017 Sri Lanka signed over to China a 99-year lease for its use, potentially as a strategic base for China’s navy. In Djibouti, public debt has risen to roughly 80 percent of the country’s GDP (and China owns the lion’s share), placing the country at high risk of debt distress. That China’s first and only overseas military base is located in Djibouti is a consequence, not a coincidence. Elsewhere in Africa, Burundi, Chad, Mozambique, and Zambia are all either in debt distress or at high risk of it, a situation China’s predatory lending practices are exacerbating.

Secretary of State Mike Pompeo has repeatedly criticized Chinese loans as “debt traps,” like when Italy joined China’s Belt and Road international development initiative, and also by insisting to Latin American countries, “When [the Chinese] show up with deals that seem to be too good to be true it’s often the case that they, in fact, are.”

What are the actual risks of taking Chinese loans?

No one disputes that Chinese loans have risk. All loans entail risk, and Chinese infrastructure loans are notoriously opaque, so it is difficult to determine exactly what was intended in each different case.

But, again, the preferred word of U.S. officials — predatory — is not the most accurate way to describe these loans. Rather than pouncing on developing countries when the money comes due, China has in fact renegotiated debt in many cases. Development Reimagined counts 96 cases of debt cancellations or restructurings by China since 2000, with the largest numbers occurring in Eastern Africa.

In many ways, the evidence is still coming in as to whether Chinese loans were fairly negotiated, because many projects are only in their early years and payment periods may not have even started. The Rhodium Group says, “Key cases to watch include loans to Pakistan, Turkmenistan, Djibouti, Montenegro or Kenya, among others, which we would expect to start renegotiations soon.”

However, it is widely suspected that corruption plays a large role in many Chinese loans. Deborah Brautigam, one of the top scholars on Chinese investment in Africa — and someone highly skeptical of the “debt trap” narrative — has said that this is perhaps the most important issue with Chinese loans:

In one of Africa’s cleanest countries, which is Mauritius, I actually sat down with a former minister once, and he described to me how this works. And he wasn’t talking about the Chinese in particular, but he said it was just standard practice there to have a 5 percent kickback on every construction project that the companies just know — they kick that back to the government in power, and the government puts it into their election campaign funding.

In Malaysia, the Wall Street Journal uncovered what may be the largest single case of corruption related to Chinese overseas investment. The Chinese-funded East Coast Rail Link, which turned into a $16 billion project, was originally estimated by a Malaysian consultancy to cost just $7.25 billion, the WSJ said. At least some of the padding was meant to “settle the 1MDB debts,” referring to the government fund at the center of a massive corruption scandal associated with the previous Malaysian government. The new Malaysian government is investigating, and has negotiated with China to reduce the cost of the East Coast Rail Link to $10.7 billion, but it is unclear how the 1MBD situation will resolve.

More reading on China’s infrastructure loans and the Belt and Road

What is described above is just the tip of the iceberg when it comes to China’s massive overseas infrastructure funding, and the Belt and Road Initiative that Beijing uses as an umbrella term for practically all of it. This complexity is part of the reason that misinformation about China’s loans has spread so rapidly. Here is a selection of further reading:

  • Pakistan: Indications of troubled investments
    Squeezed by debt and the US, Pakistan slows Belt and Road projects / Nikkei Asian Review
    “Even Beijing knows that the China-Pakistan Economic Corridor (CPEC) is on hold at the moment,” said one Pakistani official as his government faces “a prolonged financial crisis, and [tries] to balance ties between China and the U.S.”
    CPEC is dead. Somebody tell Beijing. / Medium
    Farooq Tirmizi wrote in this May 29 piece that there was an “emerging consensus” within Pakistani elites that “the more Pakistanis learn about the true costs of the China Pakistan Economic Corridor (CPEC), the less inclined they are to want to participate any further than we already have.”