Read the diplomat, understand the Asia-Pacific
Diplomat author Mercy Kuo regularly meets with subject matter experts, policy practitioners, and strategic thinkers around the world to obtain their different views on US Asian policies. This conversation with Dr. Brad Parks, Executive Director of AidData at the College of William and Mary in Virginia is the 298th in the "Trans-Pacific Perspective Series".
What are the three main points of AidData's recent report on China's overseas loans in the "Belt and Road" era?
First, since the announcement of the “Belt and Road” initiative, China has surpassed the United States by a ratio of more than 2 to 1. It does this through debt rather than aid, maintaining a loan-to-grant ratio of 31 to 1. Many of these loans are priced at or close to commercial interest rates.
Second, we found that the average [receiving side] government now underreports its actual and potential repayment obligations to China by an amount equivalent to 5.8% of its GDP.
Third, the signs of "buyer self-blame" in countries along the "Belt and Road" have become increasingly apparent. 35% of the “Belt and Road” infrastructure project portfolio has encountered major implementation problems—such as corruption scandals, labor violations, environmental hazards, and public protests—and the suspension and cancellation of projects is on the rise.
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What is the debt level of low- and middle-income countries to China, and how does Beijing manage the risk of repayment?
China’s debt burden is much greater than previously understood: 42 low- and middle-income countries now have public debt exposure to China more than 10% of GDP.
Learn about this week’s story and develop interesting stories in the Asia-Pacific region.
Chinese state-owned banks are implementing stronger safeguards to manage repayment risks. In the early 2000s, approximately 30% of China's overseas loan portfolio benefited from collateral, third-party repayment guarantees, or credit insurance. In the era of the "Belt and Road Initiative", this number soared to nearly 60%.
Beijing's preferred risk mitigation tool is mortgage: 40 of the 50 largest loans provided by Chinese state-owned creditors to overseas borrowers were mortgaged. However, Chinese state-owned banks are more willing to provide collateral for illiquid physical assets such as ports and power grids, which can be seized in the event of default. This is a myth in the media. Chinese lenders are smarter than this. They are more willing to mortgage their debts on fully liquid "buy and go" assets. Usually, they will require the borrower to maintain a minimum cash balance in an offshore, lender-controlled bank account. If the borrower defaults on repayment, the Chinese state-owned bank can directly deduct funds from its bank account without having to deal with the trouble of claiming overdue debts from the judge.
Explain your estimate of China’s “unreported debt” at US$385 billion
The “Belt and Road” initiative is a story about rising hidden debt and falling sovereign debt. Before the "Belt and Road" initiative was launched, most of China's overseas loans went to central government agencies (sovereign debtors). However, nearly 70% of China's overseas loans now go to state-owned enterprises, state-owned banks, special purpose companies, joint ventures, and private sector institutions. In most cases, these debts will not appear on the government balance sheets of low- and middle-income countries. However, most of them benefit from the implicit or explicit form of the host government’s responsibility protection, which blurs the distinction between public debt and private debt.
Our report also carefully studied the World Bank’s Debtor Reporting System (DRS), which has been the main mechanism for sovereign borrowers to voluntarily disclose their actual and potential repayment obligations to external creditors since 1951. We found that low- and middle-income governments underreported the true level of US$385 billion of Chinese debt exposed to DRS because in many cases, they were not the main borrowers responsible for repayment. However, these underreported debts still represent potential government repayment obligations, because if the main borrower goes bankrupt or defaults, the central government agency is likely to intervene in default.
The Jakarta-Bandung High Speed Rail (HSR) project illustrates why the hidden public debt risk deserves the attention of policymakers and taxpayers in developing countries. The Indonesian government hopes to finance this large-scale project of US$5.29 billion through an off-government balance sheet transaction, thereby solving the problem of the public debt ceiling. Therefore, it decided to provide funding for railway construction on the basis of public-private partnership (PPP). A group of Indonesian and Chinese state-owned companies created a special purpose company (SPV) called PT Kereta Cepat Indonesia China. The China Development Bank (CDB) provided SPV with a loan of US$4 billion. All remaining project costs should be paid by the SPV owner through equity contributions. Indonesian President Joko Widodo signed a decree prohibiting the use of government funds for the project.
However, during its implementation, the project encountered significant cost overruns worth approximately US$2 billion. Then, in October 2021, President Jokoh changed course, issuing a new decree and authorizing government assistance. The Indonesian government now plans to withdraw US$286.7 million from the national treasury in 2022 and inject these funds into PT Kereta Cepat Indonesia China.
The Jakarta-Bandung high-speed rail project reminds people of an important issue of hidden public debt risks: in infrastructure PPP, the host country government usually assumes the risk of bankruptcy in an opaque, indirect or even hidden way. The Indonesian authorities have repeatedly assured taxpayers that they will not be responsible for the debts of PT Kereta Cepat Indonesia China, which is correct in a very narrow sense: President Joko’s recent decision to authorize the provision of state funds to PT Kereta Cepat Indonesia China is not clear. It is stipulated that SPV can use state funds to repay its outstanding debt to CDB. However, funds are fungible, so the taxpayer-funded bailout for PT Kereta Cepat Indonesia China will help SPV maintain solvency—or at least liquidity—and allow the continued construction of the railway. PT Kereta Cepat Indonesia China Unless the railway is built and enough customers are willing to pay for its use, China cannot repay its outstanding debt to CDB. Therefore, any injection of Indonesian government funds into SPV actually represents an indirect (hidden) form of Public debt.
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Hidden debt is like a thief attacking the national treasury, do not knock on the front door to tell it; it sneaks in through the back door and pays special attention not to leave fingerprints.
What is the impact of the “Belt and Road” initiative as a geopolitical and geoeconomic platform for expanding China's global influence?
Competitors and critics in Beijing claim that the “Belt and Road” initiative is part of a grand strategy to build alliances, project influence, and reshape the international balance of power. But we found that Beijing is using its overseas loan program to solve domestic economic problems.
Due to domestic challenges, Beijing’s international loan program soared to record levels—especially the severity of the oversupply of foreign exchange, the overproduction of industrial inputs, and the need to ensure that the country lacks sufficient natural resources at home. In response, it has increased loans denominated in dollars and euros at or close to market interest rates; the contract requires its overseas borrowers to purchase project inputs from China (such as steel and cement); and allows countries to use them to obtain natural resources from exports to China To guarantee and repay the loan.
How did the Western powers respond to China's status as the preferred infrastructure financing institution?
The infrastructure financing market will soon have more options, which may lead to some high-profile “Belt and Road” abandonment. The United States, the United Kingdom, and other members of the G7 are increasingly positioning the “Belt and Road” initiative as a low-quality infrastructure option, while their own “Rebuild a Better World” (B3W) initiative is hoping for infrastructure The higher quality options for the project’s countries are based on sustainable and transparent financing, good governance, public sector mobilization of private capital, consultation and partnership with local communities, and strict adherence to the principles of social and environmental protection.
Mercy Kuo is the Executive Vice President of Pamir Consulting.