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.
Losing Steam
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.
Figure 1 China’s Annual Energy Finance from Policy Banks 2000-2019，Source: China’s Global Energy Finance, 2020. Global Development Policy Center, Boston University.
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).
Figure 2 China’s Outbound FDI in the Energy Sector，Source: FDI Markets, Dealogic, 2019.
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).
Figure 3 Chinese Development Finance and Commercial Finance in Overseas Coal and Renewable Energy
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).
Figure 4 Energy Investment in Selected Markets, 2015 and 2018，Source: IEA, 2019. World Energy investment.
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.
Figure 5 Development Bank Annual Lending in the Energy Sector，Source: Development Bank Annual Reports & Project Database. Note: EBRD has not published annual report or projects for 2019. The 2019 column does not include EBRD loans.
Future Outlook
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.
Ethiopia is tapping into both Chinese and Turkish financing for its railway ambitions. The difference illuminates the pros and cons of China’s model of overseas infrastructure development.
By Chen Yunnan
Chinese railways are crisscrossing the world. Driven in part by domestic competition in a saturated infrastructure construction market, Chinese state-owned enterprises (SOEs) are increasingly seeking projects overseas, constructing new transboundary high-speed rail projects across Southeast Asia, and in Africa, new standard gauge railway (SGR) projects in Nigeria, Kenya, and Ethiopia. These projects have become a way to offshore China’s excess capacity in its industrial sectors, boosting Chinese manufacturing through a ‘supply chain export’ model where railways, locomotives and equipment are offered as a package to recipient governments in Africa and elsewhere, and conditional on the generous loan finance from China Eximbank that supports them.
These projects have constituted some of Africa’s largest lending from China. Up to 2016, 31% of China’s total lending in Africa has been in the transport sector: of this, over a third went to the railway sector. Many projects feed into existing domestic and regional corridor plans, but they have also become absorbed into China’s Belt and Road Initiative (BRI), particularly in the east African region. Railways also hold symbolic power in the China-Africa relationship. The first Chinese-built railway, the Tanzania-Zambia (Tazara) cross-border ‘friendship railway’, was built in the 1970s, at the height of the Cold War and China-Soviet tensions, when China was on a desperate search for international allies. It remains a potent symbol of contemporary solidarity and cooperation between China and its African partners.
But as this case study of Ethiopia’s engagement with China’s railway financing shows, the “China model” of supporting railway expansion in Africa comes with both strengths and constraints. Though “debt sustainability” concerns loom large in conversations about railway projects, the difficulties experienced in Ethiopia’s railway projects are more directly linked to its creditor-debtor and employer-contractor relationships formed under those deals. A parallel case of a Turkish-financed railway project, constructed sequentially after a major Chinese-line, highlights the pros and cons of the politically-oriented China model vis a vis a more transactional, commercially-motivated project.
Research for this case study in 2018 and 2019 involved several months of fieldwork investigations, including site visits to operational and under-construction railways, as well as around 40 interviews with representatives from the Ethiopian Railway Corporation (ERC), Chinese and Turkish contractors, and other managing agencies working on the project. Interviews were semi-structured, and conducted in English and Mandarin Chinese.
Images: Chen Yunnan
Ethiopia’s Railway Ambitions
Ethiopia has had perhaps one of the most ambitious railway development schemes in Africa, leveraging Chinese as well as other foreign finance for its railway network. In 2007, the Ethiopian Railway Corporation (ERC) was created to oversee the construction of a new planned network spanning 5,000km. This network was seen as part of a wider industrialization and export-oriented growth strategy to connect major planned industrial zones across the country—many of which have Chinese involvement—to the sea port in Djibouti, which was also financed and constructed by Chinese institutions. Crucially, this is the justification on which the railway is supposed to make economic sense.
Economic potential—in generating trade and connectivity, and in encouraging technology transfer through foreign investment—is one of the main allures of railway technology. In China’s own domestic experience, the development of its locomotives industry benefited directly from German and Japanese technology. Further back, the construction of many of China’s main arterial railways, and the creation of professional railway institutions owed much to colonial-era foreign concessional railways by British and American companies. However, this form of technology transfer is not automatic. The Tazara railway’s decline after the departure of Chinese engineers showed a failure of management and the insufficiency of knowledge transfer.
As well as a new urban light rail project in Addis Ababa, Ethiopia has so far constructed two new standard gauge railway lines. The first, from Addis Ababa, crosses the border towards Djibouti (marked in red below) ; the second, a branch from the city of Awash northward to Weldiya, eventually to connect the trunk line to the north city of Mekele in Amhara (marked in green below). All these projects, including the light rail, are notable for being the first electrified railway projects in sub-Saharan Africa.
A Tale of Two Financiers
The Ethiopia case is particularly illuminating because at the same time, the country is tapping into two very different pools of funding and construction expertise to realize its railway ambitions.
Ethiopia’s first route, from Addis Ababa to the port of Djibouti, is Chinese constructed, by a joint consortium of China Railway Engineering Corporation (CREC) and China Civil Engineering and Construction Corporation (CCECC), and financed by China Eximbank through a loan of US$2.5bn. The second line from Awash to Weldiya, is a Turkish/European project, built by Yapi Merkezi, and financed by a consortium of lenders including Turkish Eximbank, who lent US$300mn, and Credit Suisse at a tune of US$1.1bn. While both are similarly financed through commercial loans and an EPC (Engineering, Procurement and Construction) contract, the different financiers and contractors at play has entailed a significant divergence in how the ERC and other agencies have been able to leverage their contractor and financier relationships, with implications for project implementation and for the agency and choice of recipient host governments.
One major material difference between the two railways’ construction are the different standards and technologies used between the two sets of contractors. The Chinese Addis-Djibouti line, completed in 2018, uses Chinese Class 2 technical standards, and CTCS (Chinese standard) signaling systems that controls locomotive speeds above 120km/h. The Turkish-built Awash-Weldiya line, meanwhile, employs European technical standards, including social and environmental safeguards, and employs ERMTS (European standard) signaling systems. As of 2019, the project was over 95% complete. It will likely require several more years for electrification and testing before it will become operational however, as well as a further challenge of integrating the operation of the two railway lines.
The two railway projects also show a very different creditor-debtor relationship, influenced by the nature of how the financing for the projects arrived. This in turn impacts the relationship between the ERC and the project contractors, as well as the implementation of the projects. For instance, the Turkish contractors Yapi Merkezi won the Awash-Weldiya project through a traditional competitive bid, where crucially, their promise to broker finance from European creditors for the EPC contract was key in winning them the bid. Meanwhile, the Chinese railway project was premised on a strategic bilateral relationship: financing was pledged first via high-level discussions between Chinese and Ethiopian governments. Contractors were subsequently determined on the Chinese side, through a selection process of the major national railway contractors—while this process is competitive, it is limited to only Chinese firms and decided in Beijing, not in Addis Ababa. Though the Turkish project also enjoyed export credit financing, the project due to its blended finance nature was far more commercial and transactional in its relationship between host and contractor.
The implications of this for the ERC’s scope of agency is significant. Contrary to common perceptions, the major advantage of choosing Chinese finance has been the flexibility in the financial relationship. Ethiopia has long-faced challenges in its foreign exchange that has seen it struggle to service external debts. With its Chinese partners, the ERC has been delaying payments on loans and on the management fees to the contractors for the first year since the project started operating. In September 2018, Ethiopia renegotiated the tenor of loan to 30 years from the original 15-year agreement, signalling a major concession on the part of China. With its European lenders, however, Ethiopia has never missed a payment.
In this area, Ethiopia has seen increased scope for maneuver. It has prioritized its European private creditors where it has less leeway, due to higher reputational and financial costs in non-repayment. Conversely, the strategic and political relationship that Ethiopia holds with China as a regional partner means it has been able to exploit the flexibility of Chinese finance that the bilateral Ethiopia-China relationship offers. Put simply, the political elevation of the railway as a ‘Belt and Road’ project means it is politically unfeasible to allow it to fail, giving the Ethiopian government significant leverage and flexibility over loan repayments.
The Double Edge of Chinese Loans
Despite the corollary of this, the ERC faced a bigger struggle when facing its Chinese contractors in applying pressure and getting compliance compared to the Turkish, where they had a more transactional commercial relationship. In this sense, the tied nature of financing has been a constraint to the exercise of agency. Firstly, in the inability to choose the contractor, which was a condition of financing in both Chinese funded light rail and standard gauge railways. Secondly, in the appointment of Chinese construction company representatives as the employer’s representative,, a position which generally takes the project owner’s side (in this case the ERC) in holding contractors to account on the project implementation and construction. This was the case in the Addis-Djibouti railway, where ERC were compelled to select CIEEC as the employer’s representative. This had repercussions for the level of trust and accountability between the ERC and contractors, as the ERC perceived the employer’s representative and contractors to be in a form of ‘collusion’, and not adequately representing the ERC’s interests.
The political model of finance, despite its advantages in terms of loan repayment, has led to an ineffective employer-contractor relationship. One example of this can be seen in when the project owner (ERC) tried to push the contractor CREC to fulfil a commitment to procure and provide spare parts for maintenance work on the light rail. Pushing the contractor directly was ineffective. Contractors were slow to respond to demands and, with the ERC behind on payments to the contractors for railway operations and management fees, their leverage over the firms was limited. Instead, according to the ERC’s manager on the light rail, they had to pull on political levers, calling on the Chinese embassy and economic counsellor’s office, who then applied direct pressure to the firms to order and pay for parts, and to pay for a new maintenance workshop.
This poor relationship between host and contractor also has implications for the long-term sustainability of the project, particularly for skills and technology transfer. Interviewees at the ERC expressed a sense of missed opportunity in the construction phase of the Addis-Djibouti railway, in terms of the potential for learning and knowledge transfer on railway construction for local staff. There is also a distrust of the firms’ interests in technology transfer on the part of Ethiopian respondents, who see genuine capacity building as a conflict of interest with the incentives of the Chinese companies to hold onto their intellectual property and knowledge, ensuring their continued involvement in the railways’ management. ERC has since learned from this experience and built in an engineering skill transfer component in its Yapi Merkezi deal.
The very fact the two contractors—specialists in construction, not operation—remained in the first place to take over the operations and management signals a failure of capacity building during the early phase. Significantly, CREC and CCECC were both pressured to extend their operation and management role beyond the initial six years agreed in contracts..
Under pressure from China’s Ministry of Commerce (MOFCOM) and the ERC, the firms have later set up a capacity building center outside of Addis Ababa, conducting in-house training sessions themselves for staff in maintenance, engineering, and even driver training. Further funding via Chinese aid have supported student exchange for ERC workers at several Chinese universities with railway specializations, and in 2018, MOFCOM pledged funds for a new railway academy, which will specialize in railway vocational training.
In this, the flexibility of this coordinated Chinese model abroad compensated for the poor employer-contractor relationship. The Chinese contractors have continued to fulfil the operation and management parts of the contract, despite late loan payments on the part of the cash-strapped ERC. The comprehensive breadth of skill transfer initiatives involved from both state actors and contractors, in financing new colleges, student exchanges and training courses, are advantages that competitors like Turkish Yapi Merkezi, cannot fulfil, and do not have an interest in.
Furthermore, these state-led and firm-led training and technology transfer initiatives offers not only the transfer of technology, equipment and contractors, but also whole systems of management: the dissemination of China’s own railway technical and managerial standards, operating procedures and protocols, all of which will have a similar impact on the development of Ethiopia’s young railway bureaucracy—in the same way that China’s own railway borrowed from European and foreign partners. This can generate potential path-dependence effects that can ‘lock-in’ advantage for Chinese firms and technology in the future. This can already be seen in the case of the Turkish-built railway, where despite the use of European construction techniques, the design of the railway itself had to conform to Chinese locomotives, and the signaling system to be integrated with the Chinese system that carries the rest of the network.
Railpolitik
The burst of Chinese lending overseas following the global financial crisis has been a boon for the development of Africa’s nascent railway sector, and a means to offshore China’s domestic capacity and promote its own railway technology. After this initial exuberance, however, the tide has been slowing down. Debt sustainability has become a keenly politicized issue in Ethiopia and elsewhere, particularly given the railway’s operational challenges. Low uptake, power supply issues, and regional ethnic grievances have complicated the operation of Africa’s first electric railway. This has become a risk to its economic profitability in the long-run—and thus the sustainability of the debt that financed it.
Notably, none of the China-financed railway projects have had independent financial feasibility studies conducted. They were driven instead by the interests of winning contracts for Chinese firms and technology manufacturers overseas, and to satisfy the infrastructure ambitions of Ethiopian political elites. However, the lingering question of the projects’ financial feasibility has induced greater risk aversion on the part of both Chinese and Ethiopian partners, seen in the skeptical comments from state insurer Sinosure, and also puts into question the future expansion of the railway network. A branch extension from the Turkish-built line from Weldiya to Mekele in the North, contracted to the China Communications Construction Corporation (CCCC), for example, has also stalled due to lack of financing. Further loans from China Eximbank will not be forthcoming until the Addis-Djibouti line can be proven to work.
As China’s Belt and Road Initiative continues to broaden in scope, the case of Ethiopia’s railways illustrates the strengths and pitfalls of China’s coordinated model of infrastructure finance. Compared to the European and Turkish project, the advantage of Chinese lending for Ethiopia’s railway infrastructure has been significant leniency and flexibility in the creditor-debtor relationship. This has enabled the ERC to expand its agency in the relationship and ability to manage and prioritise its multiple lending partners. However, there is a trade-off to this flexibility: it has not necessarily lead to a better project. In the case of the Addis-Djibouti railway, it has undermined the ability of host government agencies to oversee and control foreign contractors, which is crucial for new institutions like the ERC, as it seeks to build its own experience and capacity through working with foreign partners.
Chen Yunnan is a Senior Research Officer at the Overseas Development Institute (ODI) and PhD Candidate at Johns Hopkins School of Advanced International Studies. She was previously a Global China Initiative fellow at the Global Development Policy Centre, Boston University. At the SAIS China Africa Research Initiative (CARI), her research focused on the rise of China in global development, particularly infrastructure finance in Africa. She has worked at the Institute of Development Studies, Sussex, and China Dialogue, London. She holds an MA in political science from the University of British Columbia, and a BA in politics, philosophy and economics from the University of Oxford.
Research teams at Chinese and international institutions collectively shed light on the practices and thinking of CDB and Exim Bank.
In the past few weeks, reports released by teams at UNDP, China Development Bank, the Boao Forum for Asia and NRDC-Tsinghua University open windows into the operation of China’s policy banks when it comes to overseas financing.
None of the reports, even those compiled by China Development Bank itself, are particularly revealing in their description of practices and policies of the state controlled banks, underscoring the general opaqueness of those financial institutions. Most of the information presented in the reports is based on already published materials (policy papers, case studies, news reports etc), and only the Tsinghua University team’s report involved interviews with policy bank executives, providing fresh, first hand information on the banks’ sustainability policies.
Nonetheless, in this desert of accessible information on Chinese state actors, the reports’ compilation of information on the banks’ operations provides some interesting additional insights into how the two policy banks attempt to align their investments with Belt and Road goals and the global sustainability agenda, if you read carefully between the lines. In particular, we get a sneak peek into their differing approaches to environmental and social standards, and how loans for risky but much needed development projects are made secure, at least from the banks’ perspective.
Policy Banks on the Belt and Road
There is already an existing literature on the roles played by China’s main policy banks, China Exim Bank and China Development Bank(CDB), in China’s overseas industrial build-up. It is still worth highlighting, however, the distinctive roles of the two banks, as described in the UNDP-CDB “Harmonizing Investment and Financing Standards towards Sustainable Development along the Belt and Road” report (hereafter as “UNDP-CDB report”). CDB, being the world’s largest national policy bank, offers mainly mid-to-long term non-concessional, commercial loans on the Belt and Road, while China Exim Bank provides mostly concessional loans and export seller’s/buyer’s credit based on market interest rates. According to the UNDP-CDB report, by the end of 2018, CDB had provided financing for over 600 Belt and Road projects with accumulated value of USD 190 billion (USD 105.9 billion still outstanding). The Exim Bank’s Belt and Road portfolio is larger in size, with outstanding loans over 1 trillion RMB (about USD 143 billion) spread across 1800 projects.
A key observation made by the UNDP-CDB report is that loans still occupy a dominant share of Belt and Road financing, as opposed to equity investment. This may be due to the fact that most Chinese financial participants of the Belt and Road Initiative are banks, whose mandate is to provide lending (especially for commercial banks). Nevertheless, the UNDP-CDB report notes that Chinese financing may have also tilted toward loans for their relatively low risk and ability to pool resources for supporting large projects, while equity investment involves longer term exposure to risks over the entire lifecycle of projects and higher transaction costs. But, as a previous blog post on this site has shown, this preference might be changing for some Chinese Belt and Road players as they become more attracted to the higher and sustained return of projects funded through equity investments.
Source of information: UNDP-CDB report
BRI’s heavy infrastructure focus means that the banks’ Belt and Road portfolios tilt heavily towards energy, transportation and construction, with the energy sector the largest recipient of bank financing. The go-to data source for BRI researchers – even for established and connected Chinese research teams, such as at Tsinghua University – Boston University’s Global Economic Governance Initiative shows that coal makes up the majority of the two bank’s BRI financing between 2000 and 2017, followed by oil and gas financing.
Sustainability, Sustainability, Sustainability
One question that observers of the BRI often have is how come Chinese policy banks, despite a domestic emphasis on sustainable development, continues their funding of overseas projects with questionable sustainability, both environmentally and financially. Many analyses approach this question by looking at the banks’ “safeguard policies”, i.e. to what extent can mechanisms at the banks rule out financing “bad” projects. But an interesting insight from the NRDC-Tsinghua report “Research on Green Investment and Financing Standards for Policy Banks in the Belt and Road Initiative” (hereafter as “NRDC-Tsinghua report”) is that domestically, Chinese policy banks, particularly CDB, approach sustainability not so much from a safeguard point of view, but rather from an industrial policy point of view. China’s “green banking” policies are essentially an extension of the central government’s industrial policy. Its central components are sector-specific or client-specific credit guidelines. Through those sector-specific policies, CDB systematically channeled more than RMB 1.6 trillion (about USD 229 billion) into supporting China’s domestic green transformation agenda, which involves the set-up of low-carbon cities and smart cities, pollution control and environmental rehabilitation, renewable energy development and circular economy. In the process, CDB sets up a regular communication channel with the Ministry of Industry and Information Technology (MIIT), a key maker of Chinese industrial policies, to screen and create a pool of bankable industrial energy saving projects.
Without the same level of industrial policy coordination and strategic guidance, Chinese policy banks have a much less clear green mandate when financing overseas, and have to resort to basic safeguards based on host country policies. According to the NRDC-Tsinghua report, this approach has clear limitations. The idea of deferring sustainability standards to host country regulations seems to have been deeply rooted in the thinking of bank executives. The NRDC-Tsinghua team’s interview indicates that those executives are fully aware of the “strictness of environmental and social safeguards developed by the World Bank and Inter-American Development Bank”. But they also believe that strict standards “limit where banks can go in terms of their businesses”, as they require too much on the side of the recipients. These executives nevertheless conceded that when local standards “prove inadequate”, they are willing to bring in Chinese standards (if more robust) as a stopgap. The rationale for applying Chinese standards is to elevate their global acceptance for future technological exports.
The deference approach also applies to grievance mechanisms, where Chinese policy banks demonstrate a clear preference for complaints to be directed to recipient country authorities rather than themselves. Addressing the issue of deference, the UNDP-CDB report recommends governments and financial institutions to assess host country standards and identify countries lacking the ability to implement standards or those lacking standards altogether. Based on such assessment, capability enhancing efforts can be made in the form of technical support or modest grant financing. “Defer to the host country on standards that are already aligned with best-practice standards,” the report prescribes, “but work with the host country to boost implementation, compliance and monitoring capabilities.” This approach can “substitute practices received with limited enthusiasm”, a subtle criticism by report authors of the Bretton Wood institutions’ “conditionality” methods.
Both the NRDC-Tsinghua report and the UNDP-CDB report outline how environmental and social review is embedded in the policy banks’ internal procedurals, with slight differences, as shown in the table below. Before delving into the table, one should note that neither bank currently has dedicated offices or teams to handle environmental and social standards. The safeguard is therefore scattered ( or “embedded)” in bits and pieces across the banks’ due diligence and approval processes without any overarching overseers of how green their lending is. Interviews by the NRDC-Tsinghua team also shows that Chinese bank interviewees have little comprehension of the “Environmental and Social Covenant” approach commonly practiced by international development financial institutions, which would put clients’ environmental and social commitments into loan agreement to become legally binding.
Source of information: UNDP-CDB report and NRDC-Tsinghua report
The above table might give the impression that safeguards are available and working at the Chinese policy banks, as the banks themselves often argue. But as report writers pointed out, the reliance on recipient country standards mean that in regions with weak governance, such as Southeast Asia, poorly-designed projects might get greenlights. And the lack of a central policy, a dedicated staff and clear project-level standards for environmental and social issues means they are at the risk of being treated as secondary concerns at each of those steps wherein their consideration is supposedly “embedded”.
Green Loan
If the bank’s safeguards seem a bit underwhelming, the Boao Forum for Asia’s “Belt and Road Green Development Case Study” report (hereafter as “Boao report”) brings to the fore interesting details of a solar mill project that CDB financed in Zambia. At Panda Paw Dragon Claw we love graphs and flowcharts that illuminate the workings of Belt and Road actors. The Boao report did a nice job of drawing the below diagram of the parties involved in the CBD solar mill loan:
Source of diagram: Boao Forum report
Based on the report authors’ description, Zambia’s hydro-powered mills for cornmeal, a staple food for the country, faced curtailed power supply due to a lack of rainfall in 2014, leading to rising food prices. President Edgar Lungu launched the Presidential Solar Milling Initiative to construct 2000 solar mills around the country to ease the pressure on cornmeal supply. The initiative, with a total estimated cost of USD 200 million, was financed through a CDB loan worth USD 170 million. The rest would be paid by Zambia itself.
Despite its green merits – the mills are solar powered and have a public livelihood objectives at its core – the loan also has clear CDB features. Based on the description of the report and news reports from Zambia, the loan appears to be non-concessional (interest rate is unknown), although CDB waived all other fees associated with the loan. It is sovereign guaranteed from Zambia’s Ministry of Finance. A Chinese EPC contractor gets the contract to build the solar mills. And Sinosure, China’s policy insurer, provides mid to long-term insurance for the loan.
Touted as green finance, the loan nonetheless shows both the advantages and limitations of CDB debt financing. Zambia is considered “high risk” in World Bank/IMF’s debt sustainability assessment, and would be advised to avoid or limit non-concessional borrowing. This may restrict the country’s ability to raise funds from international lenders, making CDB’s offering highly attractive. (In cases like this, multilateral development banks would only offer concessional loans with very low or zero interest. And market rate lending will be made to private companies without sovereign guarantee.) While the solar mills may be fulfilling a genuine development need and have a viable future revenue stream (local cooperatives would pay to use the mills), a non-concessional loan inevitably adds to the overall financial stress of a country whose 2018 debt stock stood at USD 10 billion. On the China side, CDB has thoroughly risk-proofed its loan (sovereign guaranteed and Sinosure insured) and the Chinese EPC contractor will reap the benefit of a major construction deal. But Zambia has to figure out how to make the project work in the next 15 years so that the loan can be serviced.
In Zambia, there are already signs of trouble: the President has openly expressed dismay that some of the solar mills have become “white elephants” and is urging provincial officials to take action. Vandalism and theft (of solar panels) also plague the project. “Government borrowed money which has to be paid back with interest,” says Zambia Daily Mail, “Zambia cannot afford to waste resources in that manner (referring to the non-working solar mills).”
If providing financing and construction help get projects like the solar mill initiative off the ground, there is still a distance from a true “win-win” if one side bears a disproportionate risk of project failure while the other side enjoys the safety of near-term benefits. If the latest reports collectively highlight one thing, it is the disproportional burden Chinese financing is putting on the weak shoulders of its Belt and Road partners, be it environmental governance or debt sustainability. If BRI is to be genuinely “mutually beneficial”, fine tuning that risk-benefit equation would be a first step.
China’s power infrastructure investment comes in multiple forms, all of which entail different risks
By Wang Yan and Li Danqing
Over the past twenty years, China’s ‘going-out’ strategy has built Chinese companies an international role as the major suppliers of infrastructure around the world. Within the growing stock of infrastructure that China is building up, power infrastructure, especially coal power plants outside China’s borders, is attracting increasing attention both for their contribution to energy accessibility in developing countries, particularly South Asia and South East Asia, and for their climate impacts for decades to come (“carbon lock in”).
Articles, reports and academic papers have been written about this phenomenon as the world seeks a way to engage China in a dialogue about its coal build-up overseas. But before any serious conversation can happen, understanding the true nature of Chinese power companies’ operations overseas is key. Chinese companies’ role in supporting the development of coal power plants overseas comes in multiple forms, ranging from design and construction to part-ownership. Since 2013 Chinese companies have had an increasing preference for equity investments, a form of investment that entails both increased potential profit and increased risks. This blog tries to illuminate the landscape that the multiple forms Chinese coal power investments are made in.
Types of investment
A commonly overlooked aspect of Chinese – or for that matter any country’s – overseas infrastructure investments is that there are a range of investment model options available for companies and banks. Each option entails different types of contracts, partnerships, responsibilities, potential profit margins, and, inevitably, risk. To get a true understanding of how Chinese coal plant construction companies operate overseas operate, it is important for us to understand these different models.
Engineering, Procurement, Construction (EPC) was the dominant form of overseas investment for Chinese companies until 2018. An EPC contractor will carry out the detailed engineering design of the project, procure all the equipment and materials necessary, and then construct a functioning facility or asset as specified in the EPC contract. EPC+Finance (EPC+F) is one common derivative form of EPC, in which the project owner also wants the contractor to solve project financing.
Build-Operate-Transfer (BOT) and Build-Own-Operate-Transfer (BOOT) are typical types of public-private partnerships (PPP). In a BOT or BOOT project, normally large-scale, greenfield infrastructure projects, a government will grant a company the right to finance, build, own and operate the project with the goal of recouping its investment. Once investment has been recouped, the control of the project will then be transferred to the government after a specified time, normally 20 to 30 years.
Equity investment refers to companies’ investing in other projects or companies in the form of cash, tangible or intangible assets, in order to obtain an intended return in the future.
In the power sector, EPC revenues come from project payment as the plant function fulfills the contract, while BOT/BOOT rely on power purchaser’s continuous buying electricity from the plant during the project period, which is ensured by a Power Purchaser Agreement (PPA). Thus, long-term and steady project revenue is a determining factor in securing project financing.
In many cases, Chinese companies will set up a special purpose vehicle (SPV) via equity investment, registering it in the host country. The SPV becomes the project operator and engages with local and day-to-day businesses.
Chinese companies, therefore, play multiple roles in overseas power plant development – as investors, owners, designers, contractors, and operators.
From EPC to equity
Since 2013 Chinese companies have significantly increased equity investment in overseas coal power. In 2018 equity investment for the first-time outpaced EPC, the traditional investment avenue, in terms of newly-installed capacity. In the past decade, a total 10.8 GW of coal capacity had gone online with the backing of Chinese equity investment, 96% of which came after 2013 (Fig. 1). This shift from EPC contractors to equity investors with strong financing capacity appears to be the trend for future overseas coal power investments.
Fig. 1. Coal power projects (capacity) with Chinese equity investment and EPC over the past decade.
Why the shift?
The transition from EPC to equity investment fits into the broader arc of China’s ‘going-out’ strategy, which began in 1999 and increasingly encouraged outbound investment, besides merely product and service export. The Belt and Road Initiative (BRI) has spearheaded China’s ‘going out’ since 2013, and in that time China’s outbound direct investment (ODI) in BRI countries has occupied a growing share of China’s total ODI, with 12.5% of China’s direct investment going to BRI countries in 2017. Despite a 19.3% year-on-year decrease in China’s total ODI in 2017, direct investment in BRI countries witnessed a 3% growth.
Equity investment brings more return for investors. As owners of a project, equity investors can potentially get higher returns in the long term. Equity investment also brings flexible options to investors. They can invest not just with cash, but also with current assets like materials and fixed asset. This offers both flexibility and lower cash flow risks.
In addition, equity investment, especially from state-owned companies, plays a credit checking role. It tends to enhance borrowers’ credit and lenders’ confidence and willingness, as well as attracting other types of lenders for project financing, such as seed banks and foreign capital banks. This means that equity investment can help a project to raise more money in less time, potentially lowering the overall cost. Lastly, with ownership of the project, equity investors take initiative for project management and risk control, and receive more rights to local resources, which also serves to lower the cost of the project.
In terms of coal plants, there are three key drivers underpinning the transition: global market trends, the company’s transition needs, and China’s top-down support.
1) The long-term benefits of exploring new markets, integrated industry chain and decision making power brought by equity investment. Equity investment allows companies to lock in long-term partnerships, acquire local resources in a lower-cost way, and ensure quick or steady growth in a foreign market.
Many Chinese companies are currently transitioning from EPC contractor to whole industry chain service providers. China Machinery Engineering Corporation (CMEC), one of China’s oldest and largest coal plant constructors, noted in its 2018 yearbook that the company has tried to diversify and widen its industry chain in recent years, with more projects conducted via ‘EPC+Investment+Corporation’ model. As part of this transition, the company has also formed partnerships with GE in multiple overseas equity investment projects.
2) A more competitive environment for the EPC-driven model meets the rising need for private investment in public projects. Driven by a desperate need to ease power shortages, while worried about tighter public funding and debt burdens, host countries are embracing private investment into public projects, or EPC contractors with its own financial support.
For example, in 2015 Pakistan updated its 13 year old electricity investment policy to allow for 100% foreign capital ownership of project companies, increased allowed return of investment, and “take or pay mechanisms”, an electricity payment mechanism which will ensure investors’ returns. The updates were all intended to increase potential profit margins for foreign companies, attract foreign capital, and reduce electricity generation cost.
3) Top-down financial support and policy signaling for equity investment overseas. Boosting overseas equity investment in power sector markets has been highlighted in a number of China’s diplomatic agreement and official BRI documents.
For example, in China’s new cooperation with Africa on infrastructure development, the integration of investment, construction and operation has been underlined in developing power, transport and communications projects. These investments are supported either by loans from China’s policy banks, or from commercial banks. China’s concessional loans require Chinese companies’ holding shares in overseas projects.
More equity investment, more risks?
But higher returns come with a higher risk profile. Along with the responsibilities of designers, constructors, or equipment-providers that normally come from the EPC model, the equity model also brings Chinese investors in on feasibility study, business negotiation, financing plan, construction, to long-term operation and management with a variety of foreign and domestic stakeholders. Chinese companies, along with banks and insurers who give financial support, are more attached to long-term steady returns and interlocked in multiple project stages, exposing them to complex risk patterns. Fig. 2 illustrates the risks exposed at each stage of an equity power project.
Fig. 2. Stages and risks in project development (see Feb 2018 article in Infrastructure Economics 《建筑经济》
Most of China’s overseas coal power investment is in developing country markets (Fig. 3), which frequently present higher investment risks due to financial insecurity, political unrest, sovereign debt or uncertain business environment, causing uncertainties for China’s overseas investment.
Fig. 3. Total capacity of coal plants with Chinese equity investment in different regions. South and Southeast Asia are hotspots for China’s overseas coal investment, and together host 94% of Chinese equity-invested coal plants.
One of the most pressing challenges is changing or stricter electricity investment policies, which are already leading to project delays or cancellation. In Indonesia, for example, a gap between forecast electricity growth rate (8.3% for the period 2017-26) and actual growth rate (3.6% in 2017) has resulted in the postponement of 22GW of planned electricity generation projects.
In addition to electricity sector regulation changes, investors should not underestimate the risk posed by strengthening environmental regulations. As the principal culprit for air pollution and climate change, coal plants are in a particularly vulnerable position as governments race to strengthen their environmental regulations as they develop. This is also likely to cause project delay or cancelation, resulting in companies’ breach of agreement, economic loss or reputation loss. Meanwhile, many countries are aggressively making strides to speed up their energy transition and incubate renewables markets with ambitious policy goals, as in Vietnam for example. Public opposition, including protests and court cases, are also a major risk that can lead to project postponement or even cancellation, as happened to the Lamu coal plant in Kenya, for example.
Chinese companies’ investment in coal power plants overseas comes in multiple formats and is evolving as both domestic and international dynamics change. To become forward-looking investors, Chinese companies must raise their awareness of regional energy transitions and ongoing climate change action, and incorporate such aspects into their investment decisions. Beyond that, Chinese banks, insurers and supervisory bodies should also pay closer attention to the risks their overseas projects tie them to.
For anyone working on the issue of Chinese overseas energy investment – a “make or break” issue for global climate efforts – these types of investment arrangements and the opportunities and risks they entail are essential details. Policy makers, researchers, students and journalists should all take note.
Wang Yan and Li Danqing are both climate campaigners with extensive experience in Chinese overseas energy investment
Ma Xinyue argues that debt financing along the Belt and Road is as much a “trap” for debtors as it is for China
One of the most significant and anticipated outcomes of the second Belt and Road Forum held in Beijing this April, was the Debt Sustainability Framework for Participating Countries of the the Belt and Road Initiative (BRI-DSF) issued by China’s Ministry of Finance (MOF). Developed on the basis of the IMF/World Bank Debt Sustainability Framework for Low Income Countries (LIC-DSF), the framework offered some response to the barrage of accusations of China’s use of “debt diplomacy” along the Belt and Road.
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.
Figure 1. Changes in PPG debt by source for Bolivia, Ecuador, Guyana, and Jamaica 2004-2016, Source: Rebecca Ray and Kehan Wang’s calculations using Gallagher and Myers (2019), World Bank IDS and MDB annual reports
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.
Figure 2. Risk Profile of BRI Countries with IMF/WB Debt Sustainability Assessment, Source: IMF
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.
Figure 3. China’s Annual Overseas Development Finance in the Energy Sector (million$), Source: Boston University, Global Development Policy Center, China’s Global Energy Finance Database
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.
The 2nd Belt and Road Forum in Beijing ended with a set of software patches to BRI 1.0
The 2nd Belt and Road Forum ended on Apr 27 with one message that everyone watching seemed to have picked up: change is needed. In the official parlance of the Chinese government, change is expressed in terms of traditional Chinese painting: from a big stroke, impressionist approach (大写意) to a style of precision and craftsmanship that focus on minute details (工笔画). In the words of Christine Lagarde, the head of IMF, change means “BRI 2.0”, with a focus on increased transparency, open procurement with competitive bidding, and better risk assessment in project selection. And in the words of Pakistan’s Prime Minister Imran Khan, a recipient country leader, change points to a new phase of the signature China-Pakistan Economic Corridor (CPEC) that places “greater emphasis on socioeconomic uplift, poverty alleviation, agricultural cooperation, and industrial development.”
International coverage of the high-profile event depicts such rhetoric as a sign of China “allaying fear” of the BRI or “rehabilitating” the initiative’s image. Indeed, President Xi’s keynote speech at the forum indicates that China is responsive to external views of the initiative and its policies in general. In fact, the second half of his speech was widely read as sending messages to the West on key trade-related issues. In that sense, the shift can be regarded as an operational system upgrade responding to customer demand. But rather than a major upgrade as Lagarde’s 2.0 metaphor suggests, the changes made are far from a complete overhaul or reinvention.
For one thing, contrary to what leading BRI pundits and think tank experts have been advocating, there is still no sign that China is going to develop an actual “operating system” (permanent institutional structure with explicit mandates/rules) for the trillion-dollar initiative. Those advocates argue that the “under-institutionalized” BRI will be too easily hijacked by narrow economic interests of players involved. And the only thing close to an institutional upgrade coming out of the Forum is a set of recommendations made by the international advisory board to the Belt and Road Forum, which suggests China to consider turning the liaison office of the Forum into a full-blown secretariat for the BRI, or following the examples of G20, OECD or the Financial Stability Board to set up inter-sessional mechanisms to ensure coordination and continuation during intervals of the biannual Forum.
Absent of a major shift of the BRI’s modus operanti, the dozens of initiatives announced at this year’s Forum are more like patches to fix “bugs”. Below are some of those patches.
The new analysis framework was developed based on the IMF and World Bank’s Debt Sustainability Framework for Low-income Countries (LIC-DSF). It rates a country as low, moderate, or high in terms of its risks of being in debt distress, taking into account its debt coverage, macroeconomic projections, debt carrying capacity, among other factors.
Despite being modelled on the IMF-World Bank framework, the MoF tool applies some customization to the methodology that carries a distinct “BRI signature”. For example, when it comes to the relationship between public investment, economic growth and debt, the MoF framework is distinctively bullish about the potential for productive public investment to drive up economic growth in the long run, “while increasing debt ratios in the short run.” In comparison, the IMF, in a 2017 Guidance Note about the LIC-DSF, sounded more cautious on that same topic:
“Proponents of scaling up public investment maintain that productive investment, while increasing debt ratios in the short run, can generate higher growth, revenue, and exports, leading to lower debt ratios over time. At the same time, high economic returns of individual projects do not always translate into high macroeconomic returns. DSF users should therefore carefully assess the impact of a scaling-up of public investment.”
The view that large-scale debt-driven infrastructure investment is “worth the buck” is at the center of a Chinese developmental model that is being promoted through the BRI. And it is not without its value as Bretton Woods institutions like IMF and World Bank moved away from large-scale infrastructure building, leaving a gap in the developing world. And China’s engagement with established multilateral financial institutions is in fact less antagonistic than conflict-filled news reports tend to depict. In April 2018, the People’s Bank of China launched a capacity building center in collaboration with the IMF, providing training for leaders and officials from countries involved in the BRI. One of the training courses the Center offers is on managing debt sustainability. According to the People’s Bank’s website, countries responded very positively to the course, in particular those that are already using the LIC-DSF: Bangladesh, Cambodia, Ghana, Ethiopia, Djibouti, Tajikistan, Uzbekistan, Myanmar and Vanuatu.
But like other patches that are offered at the Forum, the MoF’s framework is a voluntary tool. It is not clear how the analysis can be integrated into lending decisions in the future, except for the possibility that a Multilateral Cooperation Center for Development Finance might adopt it.
Environmental governance of the BRI
Another area where the Forum is clearly responding to external pressure is how it handles the BRI’s massive environmental footprint. “Green” elements were given very little attention two years ago at the first BRI Forum. But the situation is noticeably different this time, as “green” elements were reflected in both the leaders’ speeches and the final ‘list of deliverables’. While criticism of China “lacking real will to address the challenge of climate change as it relates to the Belt and Road” still abounds, climate factors are being incorporated into initiatives announced at the Forum, albeit (again) on voluntary basis.
The “Green” updates rolled out this time include the formal launch of the International Coalition for Green Development on the Belt and Road and the signing of the Green Investment Principles.
The controversial Coalition, first conceived by the Chinese Ministry of Ecology and Environment in collaboration with the UN Environment, was one of the green highlights this year. Consisting of 26 countries, 8 international organizations, 65 non-governmental organizations and academic institutions, and 30 businesses (as of Apr 2019), the Coalition is an “open, inclusive and voluntary international network” to ensure that the Belt and Road brings “long-term green and sustainable development” to all concerned countries, according to the UN Environment’s description.
China’s environmental policy for the Belt and Road has been criticized for being vague and rhetorical. The formal launch of the Coalition at least provides some articulation on what aspects of “green” is China considering for the BRI. According to a Terms of Reference (ToR) circulated to participants of the Forum, the Coalition’s main mission consists of the creation of 3 platforms: a platform for policy dialogue, a platform for environmental information, and a platform for green technology transfer. The activities (divided into core and thematic) are mainly facilitative in nature: policy dialogue workshops, sharing best practices, publishing regular “BRI green development reports”. The structure of the Coalition, with its 10 thematic partnerships, opens a channel for external stakeholders to influence the environmental governance of the BRI on issues from climate change to biodiversity. After all, China’s Minister of Ecology and Environment is its co-chair. But actual mechanism for it to give policy inputs or affect project decisions is unclear. As one participant puts it: “All the measures will probably lead to more green projects, but not necessarily less bad projects.”
Structure of the International Coalition for Green Development on the Belt and Road, from the Coalition’s Terms of Reference
The Green Investment Principles, co-developed by the China Green Finance Committee and the City of London, and signed at the Forum, follow the same facilitative style. According to a People.cn report, the initiators of the Principles will establish a secretariat that offers services for the signatories, which has the China Development Bank, China Exim Bank and Silk Road Fund among them. The services include a database for green projects under the BRI, a carbon emission calculator for development and investment projects, and a knowledge sharing platform.
Project portfolio
One of the most direct tests of all the upgrades and safeguards would be an examination of the actual portfolio of projects that China is supporting in the countries involved. The 2nd Belt and Road Forum provides a glimpse of where BRI is heading in this regard, even though it is understandably too soon for all the initiatives announced at the Forum to translate into tangible influence on project decisions.
Wang Yan from Greenpeace’s China office created a nice list of project deals signed during the Forum. Not surprisingly the list tilts heavily towards conventional infrastructure, comprised of mostly energy projects (concentrated in coal and hydro), railway and urban complex development. It is worth pointing out, though, that within the full list of outcomes, items do show renewable energy projects in the pipeline (e.g. a trilateral cooperation agreement signed among China, Ethiopia and Sri Lanka on renewable energy development).
The thing with infrastructure is that their long shelf life means projects built today will have long lasting effect for decades to come. Well-intentioned policy initiatives and safeguards are only useful if they kick in as early as possible in a project’s lifecycle. Five years and hundreds of projects into the BRI, we are getting a major update from the App provider that will likely only fix bugs of future features if components of the update get activated in a timely fashion.
Alvin Camba develops a conceptual model to explain why certain Chinese overseas projects progress while others get stalled
By Alvin Camba
Why do some Chinese large-scale projects progress while others have been unable to do so? By interviewing political elites, Chinese officials, and members of various social movements, my ongoing research is currently examining four comparable cases of Chinese railway projects in Southeast Asia: South Rail in the Philippines (2017-), Sino-Thai high-speed railway (2013-), High-speed rail (HSR) in Indonesia (2016-), and the East Coast Railway in Malaysia (2016-2018). My preliminary research finds that the continuation or progression of China’s major railway projects depend on the coalition that Chinese actors form with host state actors. The success of these coalitions depend on (1) whether or not they hold the power resources to implement the project, which depend on the institutional structures of the state; (2) or how immediately vulnerable to electoral cycles or political turnover they are, which could usher in a new regime that reneges on the previous agreement with China.
To demonstrate the framework, this blog post focuses on the East Coast Rail Link (ECRL) case in Malaysia, which was started by former Prime Minister Najib Razak, suspended by the new Prime Minister Mahathir, and recently resumed ahead of the 2nd Belt and Road Forum in Beijing. The case is for critics a classic example of a developing country “pushing back” against China’s debt-driven Belt and Road Initiative. But my analysis will show that it is more of a case where a recipient country tries to leverage the BRI for economically viable and politically strategic projects that are with international credibility and domestic legitimacy.
The ECRL will link the wealthier Malaysian states to the developing eastern regions. Source: Alvin Camba
In the ECRL case, a political elite coalition between Najib Razak and the Chinese firm (China Communications Construction Company, CCCC) was initially formed, which concentrated power resources in the hands of the United Malay National Organization (UMNO). Even though the project only began in 2016, it has made substantial gains in terms of land acquisition, rail track construction, and project coordination with state governments. Due to the centralization of power in the hands of the federal and state governments, the ECRL has made great progress relative to projects that have started earlier, such as Indonesia’s HSR and Thailand’s Sino-Thai Railway. Some officials of the “Alliance of Hope” (Pangkatan Harapan) attempted to derail the project but Najib’s power resources and UMNO’s control of the government limited these contentious activities.
Nonetheless, since the ECRL started seven years into Najib’s term, the project became very vulnerable to electoral turnover. This made Mahathir and the Alliance of Hope concentrate their efforts on winning the national elections, which capitalized on the 1MDB scandal, and the complicity of Chinese firms to corruption.
Numerous Chinese-financed projects were later linked to a massive rent-seeking venture for Najib. For instance, the MPP Malacca-Johor pipeline and Trans-Sabah Gas Pipeline (TSGP) were most likely used to illicitly transfer funds into the 1MDB fund by overpricing the project cost, which would have burdened Malaysia’s coffers, constraining medium- to long-term benefits and limiting welfare gains.
When Mahathir won the election, the state’s juridical power and political power resources were transferred to the new government. This led to the cancellation of both pipeline projects. However, the Malaysian government needed to compensate the contractors $2 billion USD or 88 percent of the total worth of both projects for just 15% of project’s completion rate.
The ECRL was more difficult to scrap because of the actual economic need to link the wealthier Malaysian states to the developing eastern regions. Furthermore, the Kuantan Industrial Park, which houses the Chinese firm Alliance Steel’s investment that employs locals and generates a multiplier effect on the state’s local economy, stands to benefit from the ECRL’s construction. These considerations led to the negotiations to bring down to cost by roughly one-third. As of April 2019, the project is back on track.
Alvin Camba develops a conceptual model to explain why certain China-financed rail projects progress when others get stalled
The fates of rail projects in three other Southeast countries are all different depending on how a coalition between China and host state actors negotiate their way through political dynamics involving multiple obstructing and rent-seeking local elites. In Indonesia, Jokowi Widodo’s Jakarta-Bandung High-Speed Railway (HSR) started early in his term and China offered better project terms in order to win the deal over Japan. Project timing, limited geographical coverage, and Jokowi’s political position enabled the project to progress. In the Philippines, the project started at the beginning of Rodrigo Duterte’s tenure, forming a coalition between the Duterte administration and the Chinese firm. However, regional-local elites lobbied the Duterte government for train stops in their own provinces. For the elites, economic activity and political gain will cluster cities or province who receive the stop. The Duterte government and the Chinese firm mediated these conflicts, promising livelihood projects and electoral support in return. In Thailand, a coalition between the Yingluk Shinawatra and the Chinese state agreed on a train project in 2013. However, Thailand’s internal political dynamics, particularly Prayut Chan-o-Cha’s coup and the emergence of the military regime, effectively deposed Yingluk and delayed all the major projects. The Chinese government was willing to renegotiate with Thailand, but Prayut wanted better term than the ones that Yingluk acquired. Recently, new terms are being renegotiated.
In sum, the progression and delays of these major railway projects depend on the coalitions that the Chinese government and firms form with host state elites. Contrary to perceptions of China “dictating” tough terms, host countries do have some agency to decide which projects to finance, terms to accept, and conditions to execute.
Alvin Camba is a China Initiative Fellow at the Global Development Policy Center and a Ph.D. Candidate at Johns Hopkins University. He works on the political economy of Chinese foreign capital and elite theory. His works can be found at alvincamba.com
Interviews with banks and SOE executives shed light on what motivates Chinese players to (not) go green in BRI projects.
By Huang Wei and Tom Baxter
When it comes to issues arising from the Belt and Road Initiative (BRI), be they debt burdens, local community engagement or environmental sustainability, external stakeholders are often more confident with prescribing what China “should” do than offering convincing arguments about “how” Chinese actors can be made doing the right thing. One of the key barriers of translating visions into actions is the lack of access to the actual thinking of Chinese actors involved in the BRI, thanks to the opaqueness of the Chinese political, business and financial institutions.
With the aim of overcoming that very barrier, my team and I recently conducted a round of intensive interviews with practitioners who are at the forefront of China’s overseas endeavors, with a focus mainly on energy investment. The interviewees include large state-owned construction firms; financiers and insurers; and third party consultancy firms that provide accounting and legal services to the Chinese companies. We would like to use this rare window to understand more about the driving forces and roadblocks for greener investment along the Belt and Road.
The Chinese government appears to be increasingly willing to engage in discussion on the environmental sustainability of BRI, with numerous high level officials, including President Xi himself, calling for the Belt and Road to be a “green” initiative. In May last year a government document containing “green belt and road” guidelines was issued to promote such a vision. The document, however, consists of non-binding “guidance”, rather than legally enforceable regulations. In addition, being issued by multiple government departments, it left confusion more than guidance in its wake.
In the twenty months since that document was issued, advocacy groups, think tanks and even industrial associations have worked to flesh out and clarify the government’s intention, producing a proliferation of “voluntary compliance standards” and initiatives targeting everything from banking practices to corporate social responsibility.
But to what extent are such policies actually “greening” the BRI? Are “voluntary standards” and “initiatives” shaping the behavior of Chinese actors participating in the initiative? What is the real impetus for green investment along BRI? These are crucial questions that need to be addressed.
The interviewees were asked a set of questions that focus on their decision making process with regard to environmental standards, the motivations behind those decisions and their perceptions of “Green BRI” in general.
This article will not list out their answers in full. Rather, it attempts to pull out some of the main insights and common themes in order to shine a light on the thinking of key Chinese players when it comes to introducing higher standards for sustainability in BRI projects.
The Chinese government appears to be increasingly willing to engage in discussion on the environmental sustainability of BRI, Image: cbcgdf.org
The Profit Equation
The most evident conclusion from the interviews was that banks and companies generally don’t have motivation to go beyond recipient countries’ local standards and regulations as they still operate within the simplest market logic of profit maximization.
When we posed the question: How do you decide on your choice of environmental standards for a project? The majority of interviewees would understand the question as, what do higher environmental standards mean for profit.
During the initial process of bidding and negotiation for an overseas power plant, for example, companies need to come up with a project design plan that is both most economically desirable and that ticks the boxes of local environmental requirements and electricity demand. It is an extremely practical process, similar to solving a maximization problem under constraint that economics students are often faced with at school — choices are computed based on input of numbers into a standard formula. Inputting a higher standard will automatically shrink the profit margin and absorb capital that would have been earning money elsewhere. This serves to weaken a company’s competitiveness in a highly competitive field.
It is often argued that environmental risk need to be factored into this calculation for its potential negative impact on profit. But, as was evident from our interviews, when companies and banks talk about “environmental risks”, they are in fact referring to costs and penalties arising from non-compliance, which are real monetized indicators. “Risk” would only influence choice if it is considerable and tangible enough to be input into the profit formula, such as the risks of fines and penalties many heavy industries in northern China face since the introduction of strict emissions standards.
Shielding against market risks
A commonly used argument by critics of fossil fuel-based BRI energy projects is the potential risk of “stranded assets.” Expensive projects may end up as facilities inutilizable as environmental standards and climate change mitigation measures become more restrictive over time. Companies and banks are therefore urged to look beyond short term profit calculus. To many of our interviewees, however, this argument did not ring any alarm bells.
Companies tend to already see themselves as shielded from such long-term risks through the means of contracts at the project planning stage. One example of such a contract is the Power Purchase Agreement (PPA) signed during the initial stages of investment in power plant projects. The PPA provides certainty in future price, volume and time period for electricity sold, meaning that any further cost of retrofitting would be borne by the recipient country government, not by companies. Whether or not local governments are aware of the risks that are left on their shoulders in signing such agreements is another question, and one that certainly deserves digging into.
In addition, the most common form of Chinese investors’ participation in overseas project is a short term, “turn-key” EPC (Engineering, Procurement and Construction) contract, which ends immediately upon construction completion. Under an EPC arrangement, long term risks are not a consideration. Longer term contracts, such as Built, Operate, Transfer (BOT), do exist and entail a different set of considerations where longer term risk is a more important factor. The BOT model tends to be more common in investments in overseas hydropower projects.
As for the banks, lending is prioritized in capital structure and potential risks are usually covered by insurance companies such as Sinosure, meaning that banks are sheltered from revenue shock, significantly eroding the effect of the stranded assets argument.
Reputational risks
Advocates for a greener Belt and Road have also argued that companies’ potential reputational gains or losses, and political recognition that could confer, are a key factor in project decision making. Given the state-owned nature of the vast majority of Chinese companies and banks involved in Belt and Road projects, China’s domestic politics, including image and reputation, no doubt do play a role. Our interviews showed, however, that such factors have yet to be seen as tangible indicators for companies to enter into their profit formulas. In fact, contrary to conventional belief, going beyond market norms would put a company under greater scrutiny, which may or may not lead to greater recognition, but certainly adds extra risk to company operations.
Who holds the keys to change?
What and who can motivate for greener investment then? Well, it’s a billion-dollar, and potentially billion tons of carbon, question. But the interviews did uncover some of the key players and factors that are most influential over Chinese companies’ behavior. In my experience, the below “keys to change” are generally not well understood in the communities working to green the BRI.
SASAC:
The State-owned Assets Supervision and Administration Commission (SASAC) is an institution under direct management of China’s State Council. It is authorized to act as a shareholder of SOEs with responsibility over their performance evaluation. The SASAC performance evaluation is, then, the closest thing to a tangible measure of SOE reputation. It also gives SASAC distinct power over the career progression of heads of SOEs.
According to interviewees, the performance evaluation (which is not publicly available) still relies heavily, if not entirely, on profit indicators, leaving SOEs with zero incentive to jump out of the profit maximization mindset. Indicating SASAC’s influence over SOE investment behaviour, one interviewee said: “If SASAC could incorporate ‘green’ as quantitatively assessable criteria into the performance evaluation, it would be implemented in no time among SOEs.”
Sinosure:
Sinosure is the single Chinese state-owned insurance corporation that provides export credit insurance. The fact that many advocacy groups categorize Sinosure insurance as financing is somewhat misleading, as insurance is actually more like the pre-requisite of financing during real investment cycle.
More often than not, Sinosure’s involvement in a project is what gives it the green light. Banks would rarely say yes to an overseas project without the nod from Sinosure to assure that political and market risks associated with projects far away from home are covered. With few alternatives on the market, Sinosure holds a near monopoly over “life or death” insurance for Chinese companies’ overseas investments and, by end of 2017, had enabled over 2.9 trillion RMB of overseas financing.
Given their vital role as risk-covering agent, there is huge potential to lobby Sinosure to be more attentive to environmental risks.
MSCI:
Morgan Stanley Capital International Index (MSCI) is the most commonly used equity market index for investment portfolio managers around the world. Since 2017, MSCI has been going through a long process of integrating China A-shares (Shanghai and Shenzhen stock exchange traded RMB shares) into its Index. It is a milestone for China as the integration would enable publicly listed Chinese companies to gain access to international capital.
Significantly for our purposes, after being included in MSCI a company would be required to undergo Environment, Social and Governance (ESG) assessment and classification. Good performance would allow that company to be included in an ESG index called “the Green Leaders Index”. Any underperforming companies would be removed from that index. This would help portfolio managers who are wary of the risks behind bad ESG performance in emerging market to come to informed decisions. Given MSCI’s large client base, the impact of this indicator on a company could be significant.
Currently, many listed companies that underperform on ESG are seeking solutions from consultancy firms who provide advice on how to improve. This dynamic is not only an engagement chance for those who work on greening BRI, it also has broad implications for environmental advocacy within China.
Signs of Change
Despite the seemingly unbreakable profit calculus of Chinese SOEs, there have been some cases of projects adopting standards higher than the bare minimum required. Three special circumstances stand out:
When there is willingness of a recipient country to go beyond average standards, such as for a flagship project. An example would be the ultra-supercritical Hamrawein coal power plant soon to enter construction in Egypt. For this mega-scale project, the Egyptian government has required higher standards and promised to pay for a higher electricity price. In return, the Chinese financier will give a discount on loan terms.
When a project is backed by a syndicate loan that involves international banks, the project will have to reach the highest standard within the syndicate group (normally that of multilateral development banks such as the World Bank or European Bank for Reconstruction and Development). This effectively forces Chinese financiers to adopt higher standards than they would normally be required to.
Some projects with extremely handsome rates of return will consider raising standards for a win-win outcome on both profit and reputation, according to one interviewee.
Where next for Green BRI?
No systematic change will come from special circumstances, however. To effectively leverage for a genuinely green BRI, stakeholders will have to consider closely how they engage with the dynamics of Belt and Road investments as well as carefully consider what exactly they are advocating for. As one interviewee bluntly put it, his company would only act differently if green requirements are translated into “departmental rules from the government, SASAC performance evaluation criteria, and clear reward-penalty mechanisms.”
The takeaways from the interviews are clear:
Firstly, stakeholders must always be mindful of the communication gap. In order to influence investors, advocates for a greener BRI must be able to speak to them in their language. This requires us to question our assumptions and make sure to study the nitty-gritty of the investment process.
Secondly, “profit” is clearly front and center in investors’ decision-making process. We should not put “green” on balance, hoping that it would outweigh “profit”. Instead, we need to put “profit” on balance, and think about how “profit” can be outweighed by environmental and other factors.
Lastly, outside of profit calculus, there are two strangleholds for investors: one is an assessable “green” benchmark and a clear reward-penalty mechanism from supervisory bodies; the other is a requirement for higher standards from capital providers. This has put the keys to unlocking “green Belt and Road” in a selected few players’ hands. Advocates would do well to focus their efforts on those who hold the keys.
This blog is co-authored by Huang Wei and Tom Baxter. Huang Wei was a Climate & Energy campaigner with Greenpeace East Asia. Her expertise is in China’s overseas energy investment, coal and air pollution in China.
** This article was updated on 27 December to clarify that ESG assessment for a company would occur after inclusion in MSCI, rather than as a prerequisite for inclusion. **
FOCAC exposed tension between Chinese overseas involvement and domestic public opinion
The Forum on China-Africa Cooperation (FOCAC) was a highlight of the past month and once again put China’s overseas involvement under domestic spotlight. Held in Beijing from Sep 3-5, the extravagant event brought high-level representatives from 53 African countries to two days of dialogue, deal making and celebration of China-Africa friendship. In his opening speech, President Xi Jinping announced a $60 billion package to finance development in Africa and spelled out the “5 NOs” and “4 CANNOTs” principles (五不四不能) that would lay the foundation for China-Africa relationship in the coming years. The principles mainly served as a re-affirmation of China’s long-standing non-interference, “no-strings attached” aid policy and a warning to third-party forces trying to undermine the relationship.
In many senses the forum delivered what was intended of it. Politically, it confirmed China’s commitment to the continent as a benevolent partner. Economically, it produced a long list of major infrastructure and investment deals between African stakeholders and their Chinese counterparts. And it even paid environmental dividends for the host city by bringing a week of sapphire blue sky (dubbed “FOCAC blue” by the city’s residents) which ended as soon as the forum was over.
But the high-profile forum also exposed a chronic tension between China’s overseas engagements and its domestic public opinion, a pitfall that policy makers usually strive to circumvent. As soon as China’s $60 billion pledge to Africa was made public, the Chinese Internet was buzzing with murmurs and whispers of disbelief and sarcasm. Under Weibo posts that featured President Xi Jinping’s speech announcing the renewed pledge, where comments were often censored or outright blocked, netizens reacted with emojis of dismay and disapproval.
Under Weibo posts that featured President Xi Jinping’s speech announcing the renewed pledge, netizens reacted with emojis of dismay and disapproval.
“The controversy around aid to Africa is not so much about whether such investments deliver good returns. It’s a way to express domestic frustrations. The Chinese public can be generous if their own lives are comfortable,” said one commentator on Weibo.
FOCAC happened at a tricky time when the Chinese public was anxious over a series of domestic measures on taxation and social insurance that would affect the pockets of millions of Chinese enterprises and individuals. Among those policies rolled out briefly before FOCAC, shifting the collection of pension fund deposits to the tax authority, widely perceived as more stringent in its efforts, was interpreted by the media as the government’s attempt to fill an enlarging national pension hole which would result in a net reduction of many people’s monthly take-home salary. China’s high social benefit charges have been a burden on enterprises hiring large number of employees. For years, corporates try to dodge their share of pension payments by lowering the reported salaries of their employees, while worker are more than happy to pocket more take-home salary that they can dispense on their own terms.
The government’s revenue-grabbing move touched off widespread complaints from the society, and the high-profile $60 billion pledge to Africa (equivalent to almost 400 billion in RMB) understandably received a fair amount of trolling. To some extent this represents the worst nightmare of Chinese policy makers: Chinese financing overseas is pitched directly vis a vis its domestic fiscal policies. For a long time, the Chinese government has been low-key (to the extent of being secretive) when it comes to releasing its foreign aid figures, largely because of concern over domestic criticism. Senior aid workers have openly complained about the public’s hostility towards Chinese aid overseas. The Chinese Political Compass, an online survey that maps Chinese ideological spectrum online, lists the foreign aid question in its questionnaire as one of the 50 issues dividing and polarizing the Chinese Internet.
Experts believe that the Chinese public is misguided. Wang Yiwei, a scholar at Remin University in Beijing and an expert on the BRI, claimed in a Weibo post that majority of China’s pledged financing would require return on investment. It’s not free lunch. And based on China’s track record, returns on Chinese investments in Africa are “unparalleled” by its investments elsewhere. “Chinese are not stupid. They won’t rush to a place if it doesn’t mean economic opportunities for themselves,” Wang proclaimed, “those who spread rumors about Chinese involvement in Africa are trying to create tension between the public and the leadership.”
Wang was mainly referring to the previous round of Chinese pledge made at the 2015 Johannesburg FOCAC, which also amounted to $60 billion. Within that package, only $5 billion was grant money that did not require repayment. The rest was either concessional loans (loans with below-market interest rates), or injection into equity funds that are largely market-based and generally seek (modest) profits. The new $60 billion package announced on Sep 3 is made of $15 billion of grants and no-interest/concessional loans, $20 billion regular loans, $10 billion private investments and another $15 billion dollar injection into special funds.
Information from Africa seems to bear out the claim that China talks more serious business in Africa than people generally perceive. Bright Simons, president of the Ghana-based MPedigree Network, wrote that while China appeared generous with pledges, it was strict with actually unlocking them into real financing. Of the 2015 pledge, only 2/3 (45 billion) had actually come through, most of which “in the form of sovereign-backed, natural resource securitized loans.” Zimbabwe was particularly bad at translating Chinese pledges into actual financing, redeeming just 2.5 billion of Chinese funds from over 33 billion promised over the past two decades. Angola did much better in this regard largely due to its oil reserves that allowed a reliable means to service its loan payments to China.
Weibo commentators who consider themselves endowed with a long term view urge policy makers to disregard public sentiments and stay on course of its African strategy: “You should stick with things that are fundamentally right.”
On the other hand, the Global Times‘s editor in chief Hu Xijin reminds readers that they should equip themselves with a “great power mentality:” “China will not be able to maintain its global stature today if it does not fulfill its obligations as a great power,” he wrote, “the idea that foreign assistance is immoral as long as you still have poverty inside the country represents agrarian era thinking and cannot guide our grand practices today.”
Like it or not, the architects of China’s grand schemes along the Belt and Road would probably have to tango with domestic public opinion for a while.
African leaders, more than a “benevolent” China, should set the tone for Africa-China relations, argues Kofi Gunu
By Kofi Gunu
When I first became aware of China’s growing influence in Africa, I was only ten years old. Ghana was set to host the 2008 African Cup of Nations, the continent’s biggest soccer competition, and work was progressing steadily on a new multipurpose stadium in my hometown, Tamale—one of the tournament’s host cities. Our remote savannah town swirled with rumors about the Chinese construction firm undertaking the project and the files of Chinese foremen who marched chain gang-style to the construction site each morning. I recall my Catholic priest explaining once that the contractor, apparently frustrated with the negative work ethic of his Ghanaian laborers, had replaced all but a few of them with convict labor imported from China.
Later I would learn that this was nothing more than a myth, one of many urban legends concocted by locals trying to make sense of the strangers in our midst. But for a long time afterwards, the imposing Tamale Stadium stood in my young mind as a symbol of China in Ghana and Africa, at once shrouded in mystery and impossible to ignore.
The scale of China’s involvement in Africa is a point of surprising contention. Western politicians and media, alarmed at the significant diplomatic, economic, and military roles China has assumed on the continent, often exaggerate its efforts. Chinese experts, eager to assuage these fears, hasten to cite studies which show that Chinese investment and aid to Africa is safely smaller than the West’s.
However, nothing can obscure the truth that China is Africa’s biggest economic partner now and into the foreseeable future. China is currently Africa’s largest trading partner. Additionally, according to the Bilateral FDI database and McKinsey, China is poised to surpass the US as Africa’s largest source of foreign direct investment (FDI) stock within the next decade Chinese official development assistance (ODA) and other official flows (OOF) to Africa together added up to 6 billion USD in 2012, making China the third largest country donor to the continent. Besides, since 2012, loan issuance by Chinese institutions to African governments has tripled accounting for approximately one-third of all new sub-Saharan African government debt.
A recent groundbreaking report from Mckinsey & Company, that sought to evaluate Africa’s economic partnerships globally, showed China among the top four partners for Africa across five key dimensions: trade, investment stock, investment growth, aid, and infrastructure financing.
Source: Dance of the Lions and Dragons, McKinsey & Company, Jun 2017
To objectively analyze China’s footprint in Africa, we must first arrive where reality is. The reality is that China is indispensable to Africa’s development agenda.
This reality is one that many on the continent acknowledge but with mixed feelings. A recent large-scale public opinion survey showed that ordinary Africans appreciate the infrastructural development that closer ties with China has brought. Chinese-led projects and businesses also employ several million people across Africa. African policymakers, a growing number of them Chinese-educated, increasingly look to China, rightly or not, as a model for catalyzing growth and eradicating poverty.
These positive reviews notwithstanding, legitimate questions persist about the motives behind Chinese assistance. Resource-for-infrastructure deals, which may make perfect financial sense to Chinese bankers, set off loud alarm bells on a continent whose vast mineral wealth has been used to enrich everyone but its own people. Citizens decry a political elite that appears incapable of looking beyond narrow political considerations to safeguard Africa’s interests. With a few notable exceptions, African governments lack defined China strategies, master plans for translating increased investment in priority sectors into sustainable development or for ensuring technology and skills transfer. They are waiting for Chinese firms to take the initiative. This lack of confidence in our leaders, far more than a crisis of explanation as proposed in a blog entry by Shou Huisheng earlier this week, is the main reason Africans remain apprehensive about this budding partnership.
Take, for instance, tensions sparked by the influx of hundreds of thousands of Chinese migrants to Africa in recent years. In Ghana, these tensions are felt most acutely in the small-scale mining sector, where the arrival of Chinese prospectors with machinery and heavy equipment has transformed a hitherto unsophisticated industry into a major driver of ecological catastrophe. Galamsey, as the practice is commonly known, has caused irreversible damage to protected forests and polluted vital water bodies. Matters got to such a point that the government was forced to impose a blanket ban on small-scale mining last year and to arrest several Chinese operators, over the objections of the Chinese ambassador. But far from being placated, many Ghanaians continue to point fingers at the authorities for permitting Chinese nationals to flout the country’s laws in the first place. To quote a caller on a Ghanaian radio program: “The Chinese government will never allow us to go to their country and trash it. Why does our government allow it here?”
The fate of China-Africa relations depends on Africans like this caller who are willing to hold African governments accountable for protecting the continent’s interests as they engage with China. As African heads of state convene in Beijing next month for the Forum on China-Africa Cooperation (FOCAC), ordinary Africans are expecting them to show more agency in articulating a clear and well-prioritized China strategy. China’s presence in Africa will produce win-win dividends, not because benevolent China pre-ordains it, but because farsighted African leaders insist on it.
Kofi Gunu is from Ghana. He graduated from Tsinghua University’s Schwarzman College in 2018 with a master’s degree in global affairs and public policy. Prior to that, he held roles at the Council on Foreign Relations and the Global Green Growth Institute. He is currently completing a year of national service in Accra.
