Tuesday, February 7, 2023

Embrace of the Dragon: China’s Predatory Loans and Instability in South Asia

Washington, DC – A lot has been said about Chinese predatory economic policies vis-a-vis cash-strapped low and middle-income countries in Asia and Africa. Most of it is understandably attributed to Western propaganda by Chinese media and officials, who insist that Chinese loans to such countries are only a tiny portion of their overall debt portfolios. These claims are substantiated by the openly available information on government-to-government loans from China. But that is only half the story. The information on the actual liabilities or outflows of the borrowing countries on account of guaranteed returns on investments and commercial loans is not readily available. One look at the deep financial crisis that has shaken the foundations of the governments in two countries – Pakistan and Sri Lanka – is enough to understand the risks associated with an over dependence on China for economic development. It is not a coincidence that these two countries have been the biggest beneficiaries of economic “assistance” from China. But instead of becoming more resilient, they folded up in the wake of the global economic crisis brought about by a pandemic many suspect originated in Chinese laboratories.

In the case of Pakistan, Beijing has maintained that its loans comprise only around 10 percent of the nation’s total loans, and 26 percent of its overall external debt. Chinese debt comprises $5 billion out of a total of $38.7 billion. But this figure does not include currency swaps, foreign currency term facility agreements, and loans given by Chinese state-Owned Enterprises. Project-specific loans provided by the Chinese EXIM bank are estimated to be $4.8 billion, out of which only $1 billion carries a concessional interest rate of two percent while the remainder carries a whopping six percent. 

In Pakistan, the Chinese EXIM Bank has loaned $11 billion (concessional) at an interest rate of 1.6 percent for infrastructure projects and another $15.5 billion (commercial) carrying 5-6 percent interest for power projects under the CPEC. All debts are denominated in US Dollars which hedges the Chinese exposure to exchange rate fluctuations but increases the cost of hard currency for the borrowers. Pakistan’s debt burden has been consistently growing due to the regular depreciation of the rupee at an average of six percent per year. In Sri Lanka, the LKR has collapsed in a matter of days, sharply increasing the cost of hard currency.

All the blame, of course, cannot be passed on to the Chinese. Some of it rests with the leadership of these countries. They have been lured by the easy availability of cash from China to finance ambitious infrastructure projects that give the impression of rapid economic development. Unlike Western financial institutions and creditors who look closely at the viability of projects before committing money for them, Beijing encourages the unstable, and sometimes corrupt regimes to avail of its loans. Political expediency often leads to ignoring conditions that later come back to haunt them.

The cases of Hambantota Port in Sri Lanka and Gwadar in Pakistan are exemplary. Both are located strategically but are commercially unsustainable as there is just not enough cargo traffic. China has already acquired the Hambantota Port, and it will not be surprising if it acquires Gwadar too. Some cargo traffic is being directed to these ports from Colombo and Karachi Ports, respectively, just to keep the ports operational. Overall, there is no real income from these ports, and not likely to be in the foreseeable future. But the best example of such Chinese allurement is the Mattala International Airport near Hambantota in Sri Lanka, which has the dubious reputation of being the least used airport globally. At one point, its facilities were even used to store paddy. No creditor in the world would have loaned money for a project like that, but Beijing did. 

In response to a question from GSV on the financial instability being faced by Sri Lanka and Pakistan, and the role of China’s predatory loan practices, a State Department spokesperson said, that the Sri Lankan government has certainly “taken some questionable loans from the PRC in the past, but we are hoping that, going forward, we can support a diversification of sources of credit and investment.” The spokesperson said that the US supports the courageous decision of the government to work with the IMF on a debt sustainability programme, and all of Sri Lanka’s friends need to be offering support now, as they go through some difficult economic challenges.

China is the world’s biggest creditor, with loans worth $170 billion to lower and middle-income countries, but its lending practices are shrouded in secrecy.

AidData conducted a study on How China Lends with data from 100 contracts between Chinese state-owned entities and  government borrowers in 24 developing countries. The study shows that China’s contracts have sweeping confidentiality clauses, “which prevent borrowers from revealing the terms or sometimes even the existence of the loans.” The study shows that China’s contracts have become more secretive, with a confidentiality clause in every contract in the dataset since 2014. “These confidentiality restrictions hide loans from the people who are bound to repay them via taxes.”

The provisions in the contracts place Chinese state-owned banks as “senior creditors whose loans should be repaid on a priority basis.” Nearly a third of the contracts mandated borrowing countries to maintain significant cash balances in bank or escrow accounts, allowing Chinese banks to access funds to collect unpaid debts. 

The study found that China’s contracts give it sweeping powers to cancel loans or accelerate repayment if it disagrees with a borrower’s policies. “For example, China Development Bank (CDB) treats termination of diplomatic relations with China as an “event of default”. Expansive cross-default and cross-cancellation provisions also provide Chinese lenders with more leverage over borrowers and other creditors than was previously understood.”

The authors of How China Lends caution that secrecy around loans makes it difficult for citizens in borrower countries and creditor countries to hold their governments accountable, and call for loans to be made public.

There was a leaked Power Producers Report in April 2020, which examined, among others, two thermal power projects – Sahiwal and Port Qasim – executed by Chinese companies in Pakistan. For these two projects worth $3.8 billion, the report found an over-payment of Rs.483.64 billion or approximately $3 billion.

Commenting on background to GSV, a State Department Spokesperson said that the United States is a key partner for Pakistan’s private sector, and has been Pakistan’s largest export market for decades.  “While the U.S. is not matching the [People’s Republic of China] PRC dollar for dollar in Pakistan, the United States distinguishes itself from other approaches to development by underscoring the importance of sustainable development and high quality and transparent investments.” The spokesperson further said that the “PRC should engage in its global investment lending in ways that meet the highest international standards of openness, inclusivity, transparency, and governance.  Unsustainably high financial obligations that are at odds with those standards might undermine Pakistan’s economic stability and limit opportunities for Pakistani workers and businesses.”   

Chinese loans have come at a hefty cost for Pakistan and Sri Lanka. The slow bleeding would have continued for a few more years without the extent of the damage being recognized by them. While the warnings by experts have been ignored by Colombo and Islamabad alike, the pandemic, followed by the Ukraine-Russia conflict, has exposed how vulnerable both economies had become due to indiscriminate borrowing from China. Two countries going down almost the exact same way is not a coincidence. Other countries tempted by the Chinese-inspired dream of rapid economic progress need to think twice before embracing economic engagement with the dragon. Whether it will make them more resilient or vulnerable to shocks is the question they need to ask.

 

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