Overseas energy finance from China’s policy banks has been declining since 2017 due to a combination of demand and supply constraints. A rebound in 2020 is unlikely.
By Xinyue Ma, Kevin P. Gallagher
After a decade-long surge in Chinese development finance into the global energy sector, China’s policy bank lending continued to trickle in 2019. This could largely be due to a lack of demand capacity in host countries and less financing available on the China side.
According to the annual update of the ‘China’s Global Energy Finance database’ at Boston University’s Global Development Policy Center, China’s overseas development finance from the China Development Bank (CDB) and the Export Import Bank of China (CHEXIM) in the energy sector dropped to a lowest level in a decade (Figure 1). This may seem surprising given that overseas finance was a centerpiece at the Second Belt and Road Forum in 2019, but there are number of demand and supply side factors that led to the dimming of such prospects for 2019.
As shown in Figure 1, according to information collected from public sources, in 2019, China’s policy banks issued a total of $5.3 billion to overseas energy projects, down 52 percent from the $11.08 billion in 2018. As of the end of 2019, we record a total of 272 loans given in the energy sector to other countries by these two banks since 2000, totaling approximately $241 billion and concentrated in oil, coal, hydropower, and gas.
The downturn could be due to a handful of key demand and supply side factors. Perhaps most importantly, emerging market and developing countries have hit their demand capacity. While these countries face an enormous need and financing gap for sustainable infrastructure, they have reached their limits in their ability to absorb new projects. In part this is due to the governance capacity to handle so many projects (Indonesia has 21 coal projects from China’s policy banks alone). More important however is the fact that, even before the COVID-19 crisis, many emerging market and developing countries had started to approach unsustainable levels of dollar denominated debt. According to the IMF, about half of all emerging market and developing countries were close to or already undergoing debt distress.
On the supply side China has heralded the BRI and outward finance in general, and has faced overcapacity on the mainland. So one might think there would be a surge in 2019. However, the level of dollars for outward finance has diminished in recent years. China has financed the BRI and overseas expansion through large current account surpluses, which are dwindling. Of course, 2019 was plagued by the US-China trade dispute, which slowed Chinese exports and investment into China. China’s current account balance was over 10 percent of GDP in 2007, but slid to 1 percent of GDP by 2019.
Faced with increasing risk and uncertainty, China has been tightening the reigns on the financing, including overseas financing, by strengthening its financial regulations, emphasizing prudent and sustainable lending. Since 2016, the China Banking (and Insurance) Regulatory Commission (CBIRC), People’s Bank of China, Ministry of Finance, etc. have issued a series of regulations which emphasize risks control and green finance practices. For policy banks in particular, capital adequacy regulations, monitoring and evaluation, and aligning the banks’ operations with their roles of policy and development banks are highlighted. The Guidelines for Establishing the Green Financial System published in 2017 and the Debt Sustainability Framework for Participating Countries of the Belt and Road Initiative issued in 2019 laid stress on environmental and financial sustainability of overseas financial activities. Over these years, CDB and CHEXIM leadership also frequently emphasized the caution they are practicing regarding debt sustainability, environmental impact, and risk management.
However, it is hard to attribute China’s overseas lending decrease to external or internal political or regulatory drivers alone. Chinese policy banks are market-based financial institutions, and largely respond to market dynamics and tracks a similar decline in China’s outbound Foreign Direct Investment (FDI) in energy (Figure 2).
According to Global Energy Monitor’s coal projects data and BNEF’s clean energy cross-border investment data, we find commercial bank investments in the power sector has slowed as well (Figure 3).
Globally, this downward trend of Chinese overseas energy finance has been concurrent with stagnant global energy investment and decreasing energy investment in the emerging markets – the main target of Chinese development finance (Figure 4).
Western-led multilateral development banks (MDBs) have followed a similar trend. Total energy loans from six MDBs had been much smaller than the amount provided by CDB and CHEXIM, and only surpassed CDB and CHEXIM in 2018 after two years of decline from the two Chinese banks (Figure 5). Given these global and domestic trends of financial supply and demand of the past few years, the slowing down of China’s overseas energy finance seems to be a systematic phenomenon.
An increase in Chinese global energy finance seems even more unlikely in 2020 but could form an important part of the global recovery effort if it is re-calibrated toward the needs of the post-COVID-19 world.
China has signed a G20 agreement to freeze bilateral loan repayments for low-income countries until the end of the year, even though diplomats said that the process of identifying which loans in which countries would be eligible has only just begun and that negotiations were being undertaken with China on a bilateral basis. The Ministry of Commerce and the CDB issued a joint notice announcing potential relief for Chinese firms and projects in the Belt and Road Initiative that have been impacted by the COVID-19 pandemic. The CDB will provide low-cost financing and foreign exchange special working capital loans, set up reasonable repayment grace period, open up “fast lanes” for credit granting, and provide diversified support in foreign currency financing services to “high-quality” BRI projects and enterprises impacted by the pandemic.
Nevertheless, the COVID-19 related economic crisis inflicted serious damage on emerging market and developing economies. Capital flight has been over $100 billion and exchange rates plummeted by up to 25 percent. This has increased dollar debt burdens and over 100 countries went to the IMF for finance given the collapse of global trade and remittances. The vast majority of external debt is due to private creditors and multilateral lenders, but China is a significant bilateral creditor to many countries. While Chinese finance has been relatively patient relative to the private sector finance that has fled the developing world over the last few months, China’s borrowers will be hard pressed to service their debt to China for the foreseeable future. This lack of debt service on existing loans, and the limited ability to negotiate deals due to social distancing and travel bans, prepares us with a foreseeable shortage in Chinese energy finance in 2020.
Along with multilateral institutions and other development financiers in the world, Chinese development finance will be much needed as the world begins to develop recovery programs from COVID-19, which has revealed the need for more resilient and sustainable infrastructures. Energy infrastructure is a major pillar of economic development, and therefore sustainable infrastructure should be a cornerstone of recovery efforts. Moreover, China needs to make sure that any of its debt relief efforts are aligned with sustainability and climate standards, and continue to shift its overseas development finance into cleaner and more resilient energy sources, so that this crisis does not accentuate the climate crisis.
Xinyue (Helen) Ma is the China Research and Project Leader at the Global Development Policy Center (GDP Center) at Boston University.
Dr. Kevin P. Gallagher is a professor of global development policy at Boston University’s Frederick S. Pardee School of Global Studies, where he directs the Global Development Policy Center.
Behind the politicized and moralizing tone of the “debt trap diplomacy” narrative is a question over “debt sustainability”, a question which concerns the economic health of both borrower and lender. Before labeling China’s Belt and Road financial behavior as a “trap,” this complex issue deserves diving into.
This prompts us to ask some sets of questions. Firstly, is China actually creating debt sustainability issues? If so, what’s the scale and nature of the problem? Secondly, how does the BRI-DSF absorb and differentiate from the existing debt sustainability frameworks? How sound is this framework? And lastly, what is the implication of this framework on China’s overseas presence? Will it solve the problem and alleviate risks of debt sustainability? If not, what else does it take?
“Debt trap” or “creditor trap”?
China’s debt financing to other countries in the world have mounted since the end of the financial crisis in 2009. In the energy sector alone, China Development Bank and the Export and Import Bank of China have lent $245 billion to other countries between 2009 and 2018, based on calculation from Global Development Policy Center. A newcomer to the scene of development finance, China indeed brings striking volumes of loans and investment.
The “debt trap diplomacy” narrative interprets China’s overseas finance behaviors as state-driven political leverage to gain influence over other countries by bankrupting its partners and bending them to its will (see for example, John Pomfret’s 2018 opinion piece in the Washington Post). A “snappy phrase invented by an Indian polemicist”, as Chas Freeman, the former U.S. diplomat to China puts it, the narrative has been popularized by media and politicians, especially in the U.S., criticizing the Belt and Road (e.g. Mike Pence, 2018; John Bolton, 2018). The most frequently referred to case is the Hambantota Port project in Sri Lanka, which was handed over to a Chinese company on a 99-year lease. Concerns about Chinese loans have also been raised in regards to the Maldives, Pakistan, Venezuela, and many more.
Such arguments have been refuted by the Chinese government as well as some recipient country governments. Both the Central Bank of Sri Lanka and Government of Pakistan that these two countries’ debt to China are only about 10% of their external debt, a fair share of which are concessional loans lower than market rates. Officials from the Philippines, Uganda, and Sri Lanka – to name a few – have also publicly defended their debt from China. Some scholars have also exposed the narrative.
The Center for Global Development – a Washington D.C.-based think tank – made the first systematic attempt to assess the debt implications of the BRI. Using a list of BRI lending pipeline deals compiled from public sources, they estimated immediate marginal impact of potential BRI projects on countries’ debt to GDP ratio – a “worst-case scenario of future debt,” and identified eight countries where debt to China might push their debt to GDP ratio beyond thresholds of 50-60% of GDP. It also listed a compilation of debt renegotiation and relief given by China since 2000, which were further explored by reports from Rhodium Group and Oxford Africa China Consultancy – even though the debt cancelation is said to have only been for overdue zero-interest loans, which are part of China’s foreign aid program.
The China-Africa Research Institute at Johns Hopkins University (SAIS-CARI) and the Global Development Center at Boston University (BU-GDP Center) published similar but empirical analyses of the debts of Africa and Latin American and the Caribbean countries to China based on their debt profiles and recorded debts to China. These reports found that, in the majority of cases, debt to China takes up a small share of countries’ total public debt, although in a handful of debt troubled African countries (Zambia, Djibouti, for example), debt to China does take up a significant share of their external debt, and they are also among the biggest borrowers from China.
The shared conclusion from these reports is that BRI will not likely be plagued with widescale debt sustainability problems, even though it is also unlikely that the initiative will avoid any instances of debt problems among its participating countries. A more recent working paper published by the World Bank also attempted to evaluate the long term debt dynamics impact of China’s loans, taking BRI investment related growth into account. Availability of credible data remains a constraint for these papers. Yet of the 30 countries included in their long-term debt dynamic simulations, in only in 2 countries BRI debt financing would result in increasing debt vulnerability.
Worth noting, however, is that debt relief and restructuring is both relatively common (recorded instance of relief so far reach $9.8 billion) and tends to favor the borrower country. In this light, the “debt trap” might seem more of a “creditor trap” for China than for the borrowing countries, as Stephen Kaplan puts it when analyzing the case of Venezuela. Indeed, from a geopolitical perspective, it is strategic for China to hold leverage in security choke points in case of fundamental disruption of global stability or an outbreak of war. However, financial leverages do not automatically translate into political leverages. Venturing to confiscate its debt-financed assets would mean risking all credibility and reputation for any other international engagement.
On the contrary, China faces more risks giving away debts in financially vulnerable countries. In cases of real financial distress such as Venezuela, China’s debt renegotiation might come with more loans issued in the same country in the hope of generating revenue and recovering the previous loans. Deutsche Bank was recently reported to have confiscated 20 tons of gold that backed Venezuelan debt, but we don’t see Chinese financial institutions making similar moves.
The Challenge for Development Finance
Public debt financing is a common practice in all countries across the world, even though typical practice of each country varies by a great deal. For example, according to IMF, as of 2017, the general government debt to GDP ratio ranges from 9% (Estonia) to 238% (Japan). As stated in the Addis Ababa Action Agenda, borrowing is an important tool for financing investments critical to sustainable development and covering short-term imbalances between revenues and expenditures. Government borrowing can also allow fiscal policy to play a countercyclical role over economic cycles.
Nevertheless, whether high debt to GDP ratios have an impact on a country’s economic performance is much-debated. Most economists agree that there are no certain thresholds or ideal levels of debt to GDP. Rather, it is the dynamics of debt that matters more. The simple logic of debt sustainability is that, as long as the rate of public debt increase does not continuously exceed the growth rate of the government fiscal balance, public debt is sustainable and will not affect economic activity in general.
Then comes the dilemma: given the urgent need to address the Sustainable Development Goals, public expenditure has to increase, but in many countries, the government’s fiscal space is cramped. Scaling up public expenditure requires debt finance, which in many cases would consume primary balance that could have been used for urgent public investment such as physical and social infrastructure development. But if done right, such financing should serve to strengthen the primary balance by facilitating economic and social development and by increasing tax revenue in the long run.
Debt Sustainability Frameworks for the Belt and Road
To “promote economic and social development of Belt and Road countries while maintaining debt sustainability”, China’s Ministry of Finance published its Debt Sustainability Framework (BRI DSF) at the April Belt and Road Forum. The BRI DSF is almost exactly based on the 2017-reviewed version of the IMF/World Bank framework for debt sustainability analysis.
As part of the IMF’s efforts to better detect, prevent, and resolve potential crises, the Fund introduced a formal DSF in 2002. To guide borrowing activities in low-income countries (LICs) in a more nuanced manner, the World Bank and IMF also launched a joint framework for debt sustainability assessment for LICs in 2005. The World Bank and IMF now jointly produce Debt Sustainability Assessments (DSA) for the applicable countries at least once every calendar year, and provide templates for these exercises. Chinese lenders could therefore use the IMF/World Bank assessments as a baseline to guide their activities.
The IMF/World Bank DSF – to which the BRI DSF is aligned – operationalizes debt sustainability management by assigning different thresholds of multiple debt indicators for groups of countries according to their debt carrying capacities, and provides risk ratings based on evaluations of the baseline projections and stress tests relative to these thresholds combined with indicative rules and staff judgment. The 2017 revision adjusted the thresholds with an effort to eliminate conservative bias. It incorporates more factors into the country classification methodology to estimate countries’ debt-carrying capacities.
All of these improvements are also incorporated in the BRI DSF. The only difference in the BRI DSF is in the stress test element. The BRI DSF includes an additional “new borrowing shock” stress test, adding greater stringency to the test.
Both frameworks adopt the same standards for identifying low income countries (based on their eligibility for concessional financial resources). As of May 31, 2019, 47 of the 131 countries that have officially signed BRI cooperation agreements with China are included in the List of LIC DSAs for PRGT-Eligible Countries. The graph below shows the distribution of debt stress risk ratings of these LICs from low to in distress. In addition, another 11 BRI countries not in risks of debt distress have been assigned suggested debt limits in General Resources Account (GRA)arrangements.
For countries in debt stress or at high risk of debt stress, including some countries with moderate risks of debt stress, IMF and the World Bank would advise them to avoid or limit non-concessional borrowing (NCB) (or only accept in exceptional cases), and provide limits for concessional borrowing to some countries, leaving space for grants. For countries with moderate or low risks of debt distress, borrowing would be advised to be assessed on a loan by loan basis, with the option to request borrowing ceilings.
Of the 39 BRI countries subject to IMF/World Bank Group debt limits conditionality, 15 are subject to zero-NCB limit, 8 are subject to non-zero NCB limits, and another 16 are not subject to debt limits or have targeted debt limits, showing a rather balanced risk distribution. (Note that this does not represent the amount of loan granted to each group country, and thus does not accurately reflect actual risk portfolio of China’s overseas development finance.)
The Future with “Cautious Capital”
The DSF risk assessments already inform lending policies of other creditors including many Multilateral Development Banks (MDBs). With the issuance of the BRI DSF, China seems ready to adopt the mechanism too. For China, this is unequivocally a critical step in risk management for Chinese creditors and constructive response to the debt trap diplomacy theory.
According to very rough estimates using the available second hand compiled databases for the stock of China’s overseas debt finance, about 14% to 18% of China’s overseas development finance in BRI countries goes to LIC countries with debt limits, while the number of these countries (39) account for 30% of the BRI countries, indicating that those countries already receive less finance on average from China than non-LIC countries. Given that these estimates are based on flows of commitment rather than debt outstanding, some of these loans are likely to have already been paid off. Nevertheless, considering the sheer volume of China’s overseas finance, this would have been enough of a risk portfolio for China to manage, and also significant enough debt burdens for the recipient countries as well. Future credit making will require much prudence so as to gradually improve these situations.
Such caution has already been shown in the recent trend of China’s overseas development finance flows (See Figure 2 taking China’s overseas development finance in the energy sector as an example). Observers have witnessed a clear downward trend in China Development Bank and Export-Import Bank of China’s overseas energy finance since the peak in 2016. Where there is relatively reliable data, similar trends are also seen in the cases of all-sector official loans from China to Africa and Latin America. This trend also coincides with recent downward trends over all in the emerging markets and development countries, China’s stagnant FDI flows and overseas contracting activities, as well as strengthening domestic and cross-border financial and capital account regulations.
While the strengthening risk-management mechanism demonstrates China’s willingness for responsible engagement with the Belt and Road countries and better alignment with multilateral efforts, this trend also further stresses the inherent challenge of development finance, which carries the crucial function of correcting market failures and providing countercyclical financial resources while maintaining the ability to provide financial resources sustainability. As global financial regulation mechanisms such as the Basel Accords and credit rating agencies step up their scrutiny over development finance in the same way as commercial finance, it seems to be increasingly hard to channel sufficient financial resources to places and in times that need them the most – places where risks are also often higher.
Meanwhile, there is probably no perfect framework for debt sustainability analysis. As the effort of a DSF is to provide judgements about future macroeconomic dynamics in a scenario of debt stress, estimates of the discount factor and feedback effects of fiscal policies would inevitably be subjective, even if empirical analysis of historical data is full incorporated.
Moreover, a framework alone is far from enough. At the end of the day, what sustainable debt positions and sustainable development in general requires is nothing but soundness and sustainability of projects – financially, socially and environmentally. Risk management mechanisms cannot ignore project and social risks, as well as potential physical and policy impacts of climate change, which pose substantial risks to a bank’s carbon intensive energy portfolio.
Instead of hindering the scaling up of development finance, risk management should enable development finance to strengthen vulnerable economies and generate multiplier effects over the long term to improve the status of public finance, and insure timely debt repayment. This is by no means an easy task, and requires coordination and trust between governments and the private sector.
Even though debt to China remains a relatively small share in the public debt portfolio of most countries, China has emerged as an important international creditor as the Belt and Road Initiative unfolds, and deserves to be part of the multilateral engagement in debt sustainability control. Meanwhile, given the challenges and imperfect nature of development finance risk management, a diversity of approaches could create healthy competition to get it right.
Xinyue (Helen) Ma is the China Research and Project Leader at the Global Development Policy Center (GDP Center) at Boston University. Ma has experience researching different aspects of China’s international investment with China’s National Development and Reforms Commission (NDRC), Control Risks, and China Daily. She received her Bachelor’s degree in International Politics and History from Peking University, Beijing, and her M.A. in International Economics and Energy, Resources and Environment from Johns Hopkins University, School of Advanced International Studies (SAIS), with a specialization in Infrastructure Policy and Finance.