How will China handle multiple debt repayment crises?

By Ma Tianjie

As Covid-19 continues to ravage through the world, the global economy has been brought to its knees. The dominos fell one by one in a globalized and interlocked web of consumers, traders, suppliers, producers and financiers. “The spiral form of endless capital accumulation is collapsing inward from one part of the world to every other,” writes Marxist scholar David Harvey.

Nothing highlights this domino effect better than the tsunami of debt repayment difficulties currently experienced by developing countries in Africa, South Asia and Latin America. As global demand for commodities such as oil and minerals collapses, the revenue streams of resource exporter countries, many of which are concentrated in the Global South, have dried up. In the case of Nigeria for example, the country’s Finance Minister Mrs. Zainab Ahmed told reporters in late May that, with the country 31% off its Q1 oil revenue target, “COVID-19 [and] the collapse of oil price…has already started showing on the federation’s revenues and on the foreign exchange earnings.” The effect of dwindling revenues bears heavily on the balance sheets of these governments, who often rely on foreign borrowing, with debts often denominated in a foreign currency, to fund important domestic development plans. On top of that, countries like Nigeria had already witnessed their external debt blown to new highs in the past few years. Now they face a growing repayment crisis that threatens their creditworthiness for years to come.

China looms large in conversation about the debt tsunami. According to one calculation by the China Africa Research Initiative (CARI) at Johns Hopkins University, between 2000-2018, China extended USD 152 billion of loans to 49 African countries, a large portion of which went to oil rich countries such as Angola. Since Covid-19 hit the African continent, calls on China to ease debt service have been mounting. On 15 April, G20 countries agreed to a suspension of debt payments for the lowest-income countries that make such requests. China backed the agreement and announced later that it would freeze debt repayment for 77 developing countries.

The repayment standstill began on 1 May and will last until the end of this year. The move allows low-income countries to spend precious government funds, otherwise reserved for debt repayment, on fighting the pandemic. But experts have pointed out that the suspension merely kicks the can further down the road. Moreover, the G20 initiative risks being undermined if private creditors simply step in to seek repayment from freed up funds.

All eyes on China

Senegalese President Macky Sall welcomed the G20 debt moratorium but said it was only the first step and more must be done. Calls on China to outright forgive African debt have been collecting force.

Joining a multilateral call for debt relief is already a big step for the country and so far China has chosen to stick close to the G20 initiative while offering relatively small sweeteners beyond its scope. At the World Health Assembly on May 18, President Xi Jinping added another 2 billion USD of support for developing countries battling Covid-19, which, at some point, may be counted as a form of debt relief. On June 17, at the China-Africa special summit for fighting Covid-19, Xi further pledged to write-off all zero-interest loans owed to China by African countries that are due this year, and instructed Chinese financial institutions to conduct “friendly negotiations” with African countries on commercial-based sovereign credits.

This confirms assessments by observers that China’s participation in the G20 initiative only covers a very limited set of sovereign lending, while distressed loans disbursed by China’s two policy banks, China Development Bank (CDB) and China Eximbank, on relatively commercial terms are excluded from the debt standstill deal for concern with the health of the banks’ balance sheets. Zero-interest loans make up less than 5 percent of China’s lending to Africa between 2000-2018.

Analyses from researchers at the Brookings Institute, China Africa Research Initiative (CARI) and Rhodium Group converge on the point that China is unlikely to grant blanket debt cancelation to its debtors. As Brookings Institute’s Sun Yun puts it, “postponement of loan payments, debt restructuring, and debt/equity swap are more likely in China’s playbook.”

Beijing is expected to take on the matter on a bilateral, case-by-base basis, renegotiating loans depending on the prospect of each country and each project. In the past, such renegotiations resulted in deferrals, refinances and small write-offs for at least a quarter of Chinese loans to Africa, according to one account by Rhodium Group.

How concerned is China?

Starting from March, African debt issues began to feature in risk alerts compiled by Sinosure, China’s state-owned insurer of overseas ventures, which underwrites many of the loans extended by CDB and Eximbank. Its policy mainly covers political risks that may lead to non-payment or default and some commercial risks. In a March 19 country-specific alert about Angola, its analyst wrote that “by Jun 2019, Anglola’s outstanding foreign debt stood at 42 billion USD, 21.3 billion of which is owed to China.” The alert recommended that concerned parties should closely monitor Angola’s foreign reserve situation to “avoid liquidity risks and currency exchange risks.” In addition, they should keep an eye on the country’s crude oil reserve and oil price fluctuations to accurately assess its debt repayment pressure. Throughout April to May, the insurer published debt-related alerts on Zambia, Pakistan, Madagascar, Surinam, Ecuador and Gabon. All of those countries are suffering economic shocks from Covid-19 and the resultant global market downturn.

But despite being a hot topic internationally, debt relief gets very little air time on Chinese media and social media. The government has traditionally been cautious about openly discussing its foreign aid and lending programs, as the perceived “largesse” overseas contrasts sharply with talks of poverty alleviation domestically. But still, sporadic signs of anxiety emerge on the internet that offer a window into the Chinese mental frame about the thorny issue.

Even though the issue has largely been kept out of public view throughout the weeks when international calls on debt relief were most pointed, it still managed to draw the attention of some veteran online commentators on political and economic policy. In one of such Weibo threads, commentator Shenyeyizhimao, a former journalist, jokingly suggested that private Chinese companies such as Alibaba, JD and Vanke should take over and revitalize the economies of indebted countries, allowing them to generate enough cash for debt repayment. “Infrastructure alone does not generate economic activities,” he wrote, “if we do not at the same time export industry and urbanization, non-payment from recipient countries is inevitable.” Many Chinese Weibo users share that skepticism toward the wisdom of pouring money overseas, which is exactly why conversations about debt relief have to be carried out low-key inside China.

International opinion

Compared with domestic public opinion, which is relatively malleable under the state’s sophisticated control of cyberspace, international public opinion is much more worrying for China. On 7 June, a research team led by Pan Yufeng and Zhang Yan at Peking University’s School of International Studies published an interesting analysis of international narratives of Chinese debt, using data analytical tools provided by Tencent. The analysis acknowledged that debtor countries are making debt relief demands, and highlighted that “a few” of them were linking Belt and Road financing with “debt traps” (Nigeria’s congressional inquiry into Chinese loans was used as an example) and, in the more extreme cases, were legitimizing debt relief by blaming Covid-19 on China (Kenya’s former Vice President Musalia Mudavadi’s comment was used as an example). The authors warned that a coordinated push from African countries for debt cancelation is in the making: “a global consensus on debt relief is forming.”

The analysis also pointed out that Western countries, particularly the United States, are using the issue to drive a wedge between China and other developing countries. It particularly highlighted the fear of China coming to grab strategic assets as collateral for debt, noting that references to Sri Lanka’s Hambantota port in international media tripled from March to May. The Hambantota Port is often used by BRI opponents as an example of China’s malicious leveraging of a country’s financial plight to gain control of strategic assets such as ports and railways, a claim that has been disputed by scholars such as Debra Brautigam of CARI, who sees it as a regular debt-to-equity swap that allows host countries to tap capable private investors to vitalize problematic assets. The research team advised Chinese decision makers to actively disperse misunderstandings such as those surrounding Hambantota and explore debt relief solutions on a country-by-country basis, carefully considering the necessity, feasibility, scale and design of those relief measures.

“The biggest challenge yet to the BRI”

While the country’s top political elites are playing their cards close to the chest, those slightly further away from the center are beginning to air their worries and offer advice.

An article co-written by the chairman of CITIC Group’s board of supervisors, Zhu Xiaohuang and Zhang Anyuan, the Chief Economist of CSC Financial, a CITIC Group subsidiary, asserts that the debt repayment crisis is “the biggest challenge faced by BRI since its creation.” CITIC, a state-owned financial conglomerate, is itself deeply involved in overseas adventures. One of its most well known projects is the Kyauk Phyu Special Economic Zone (KPSEZ) Project in Myanmar.

The two authors were blunt about their concern with China’s massive debt exposure overseas, to the tune of 250 billion USD by their calculation. They estimate that the majority of these outstanding loans fall outside the G20 pledge and will be subject to further requests for relief. “For us not to respond to such pleas would be unreasonable,” the authors write, “but response will create a precedent for a flurry of renegotiation requests that we may not be able to handle.”

The authors proposed a 5-step approach to address the debt repayment crisis: extension, RMB denomination, write-down, debt-to-equity swap and write-off. The underlying principle is to preserve as many assets as possible. If cancellation becomes inevitable in the end, China should at least leverage it to get payback in other forms.

A key component of the advocated approach that is not being featured in most international discussions about possible Chinese response is the re-denomination of Chinese debt to RMB, as a precondition for writing-down any loan. “Covid-19 has essentially reinforced the dollar’s standing in the world economic system,” claimed Zhu and Zhang, “the dollar-denominated Chinese loans only strengthened the linkage between USD and local currencies along the Belt and Road.”

Dollar-denominated Chinese loans along the Belt and Road have been a sore point for Chinese observers of BRI. As early as 2017, Zhang Anyuan, one of the above authors, has warned about how the practice would eat into China’s seemingly abundant but fragile foreign reserves. By adding on to a host country’s dollar-denominated debt stock, BRI is essentially making those countries more dependent on dollar liquidity that is ultimately at the mercy of the Federal Reserve at the source. Zhu and Zhang noted that amid the Covid-19 crisis, the Fed has set up liquidity swap lines with a dozen of central banks in Europe, Asia and Latin America, playing the role of “the world’s central bank.”

The “internationalization of RMB” through the Belt and Road Initiative has always been an aspiration but limited by multiple constraints such as the lack of RMB reserves on the side of host countries, exchange rate risks and the uncompetitiveness of RMB-denominated loans. The authors argued that debt restructure could be an opportunity to advance that cause, offering loan write-downs in exchange for RMB denomination, therefore uncoupling some BRI debts with dollar supremacy.

It is hard to assess how practical this advice is in debt renegotiations. Zhu and Zhang themselves concede that now probably is not the best time for such a move, but insist that it’s worth trying. Shifting those debts to RMB-denomination also allows for easier debt-to-equity swaps at a later stage, the authors argued. Domestic RMB funds can be more easily tapped to take on some of the distressed assets as equity investment to preserve asset value as much as possible. And equity investment “guarantees a long-term presence of Chinese commercial interests in Belt and Road countries.” Though such swaps would, as noted above, be controversial and potentially very damaging to the BRI.

All of the prescriptions look good on paper. But as requests pile up on China to respond to relieve countries of debt burdens, it might not have the luxury to patiently go over its overseas lending stock on a loan by loan, country by country fashion, as Scott Morris, Center for Global Development told Euromoney. President Xi’s announcement last week looks like both an instruction to Chinese commercial lenders to start looking for debt restructuring solutions and a play to buy some time for creditors to work that out.

The tsunami is likely on its way however and how China will manage will be a key test of its international diplomacy skills, finance savviness and of the BRI in general. Offering realistic debt relief solutions while not falling into the narrative of “debt trap” and keeping a check on anti-foreign-aid sentiment domestically will be a difficult but necessary balancing act.