Faced with an external debt crisis, will China change its ways?

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Fnew times better encapsulate the hope and hubris of China’s Belt and Road initiative, a global infrastructure frenzy, than the inauguration of the port city of Colombo in Sri Lanka in 2014. plans to build a high-end offshore financial center technology with a marina, hotels and luxury homes on 665 acres (269 hectares) of reclaimed land off Sri Lanka’s capital. Local officials compared the project to Dubai and Singapore. Mr Xi (pictured during his visit to Sri Lanka) called it the ‘hub’ of the 21st Century Maritime Silk Road – the part of the Belt and Road that aimed to reshape maritime trade in financing ports and related infrastructure without the pesky conditions that the West and multilateral lenders demand.

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Fast forward to August 2022 and the future of Sri Lanka – not to mention the port city of Colombo – hangs in the balance. Crippled by fuel and food shortages, the country is seeking a bailout from the International Monetary Fund after having defaulted on its debt in May. Pakistan, another big borrower, is also in the midst of a IMF bailouts and dozens of other Belt and Road countries are facing debt overhang. The extent to which China, the world’s largest official creditor, bears responsibility is hotly debated. But what matters now is how he reacts. Sri Lanka will be a critical test of China’s willingness to coordinate with other lenders, potentially to the detriment of Mr. Xi’s original geostrategic goals.

At the center of the issue are China’s relations with the Paris Club of 22, mostly Western, creditor countries. He is an “ad hoc participant” in the group but has declined invitations to join. One reason is the club’s close ties to the IMF and the American-dominated World Bank. Another is its commitment to consensus, information sharing (China likes to keep loan terms secret), and “comparable treatment” for all creditors. China wants to be a priority and favors the bilateral negotiation of debt relief: many of its loan contracts include clauses to this effect. Furthermore, adopting the group’s standards would undermine Mr. Xi’s rhetoric of a superior alternative to Western development financing.

Yet there are signs that China is slowly, albeit reluctantly, adjusting this stance, as covid-19, inflation and the war in Ukraine amplify the debt problems that many poor countries faced before. 2020. In May of that year, the g20, which includes China, established the Debt Service Suspension Initiative (dsi), under which official bilateral creditors temporarily suspended interest and principal payments from one of the world’s 73 poorest countries that requested such relief. China said in late 2020 it had deferred at least $2.1 billion in payments from dsi countries.

In November 2020, China also supported the “Common Framework” agreement between the g20 and the Paris Club to cooperate on the treatment of the debt of poor countries. The first agreement under this framework came in July 2022 when, after months of tense negotiations, official creditors agreed to relieve Zambia, releasing $1.4 billion. IMF bailout, although the details have yet to be finalized. China, Zambia’s biggest official creditor, initially resisted coordination with other lenders but agreed in May to co-chair a creditors’ committee with France. The two countries also co-chair a creditors’ committee for Ethiopia.

China’s shift appears to be driven, in part, by the scale of the problem and growing international scrutiny of its lending. Chinese data is murky, but the World Bank provides debt statistics for 68 countries eligible for the dsi, of which approximately 60% are at high risk of over-indebtedness or already in a situation of over-indebtedness. In 2020, these countries owed China $110 billion, more than all other official bilateral creditors combined, according to researchers at Fudan University in Shanghai. They say that in 2022, China should receive 26% of the debt service payments from these 68 countries. Eight, like Angola and Laos, will spend more than 2% of their gross national income to make these payments to China (see chart 1).

There may also be many more “hidden” issues related to China. Economists from the World Bank, Harvard University and the Kiel Institute, a German think tank, estimate that half of China’s overseas loans go undeclared and that between 2008 and 2021 the country has quietly organized 71 distressed debt restructurings, more than the Paris Club. — often after a long period of default. Restructuring almost always involved extending maturities or grace periods, rather than reducing principal. Some countries, including Venezuela and Zimbabwe, have restructured Chinese loans five or more times (see chart 2).

Some are picking up echoes of the emerging market debt crises of the 1980s and 1990s, when Paris Club members hid loan details and repeatedly rescheduled loans, leading to a lost decade of low growth. The shift to debt reduction only came after the US Brady Plan in 1989 and the Heavily Indebted Poor Countries Initiative in 1996. In a recent article, Ye Yu and Zhou Yuyuan of the Institutes of International Studies of Shanghai (if) called for a “new version” of the Brady plan, urging China to be more transparent about its loans and to coordinate more with America and other Paris Club members to ensure “a fair and just sharing of the burden between all categories of creditors”.

China’s changing position may also be linked to its recent efforts to provide emergency loans, as some borrowers struggled to repay their infrastructure loans. China’s state-owned banks have provided nearly $24 billion in balance-of-payments loans to Pakistan and Sri Lanka over the past four years, according to AidData, a research lab at William and Mary, a US university. “China has touched on this idea that they could be an alternative to IMFsays Bradley Parks of AidData. “What we’re looking at now is a period of learning and adapting in real time, where I think they have doubts.”

In Sri Lanka, alarm over Chinese infrastructure loans first erupted in 2017, when the government, struggling to repay its debts, awarded a Chinese state-owned company a 99-year lease on a port. that China helped fund and build. As other Chinese projects failed, China’s state banks turned to emergency lending, providing $3.8 billion between October 2018 and March 2022, according to AidData. Most observers agree that China’s loans did not cause the crisis: they blame the Sri Lankan government for cutting taxes in 2019 and crushing tourism in 2020. But d Sri Lankan officials say China’s cash injections persuaded them to reject approach advice IMF Much sooner.

The hope now for Sri Lanka is that Zambia’s deal has set a precedent for China to coordinate with other creditors, even if the island’s middle-income country status excludes it from the framework. common. Ranil Wickremesinghe, the new president of Sri Lanka, declined to discuss details in an interview with The Economist but seemed confident of a deal. One proposal being discussed is that China, as Sri Lanka’s largest bilateral creditor, co-chair a creditors’ committee with Japan, the second largest (and Paris Club member). India could also join. The aim, according to one adviser, is an “ad hoc” treatment of the Common Framework.

The geopolitical landscape, however, is even trickier than it was for Zambia. China’s relations with Japan and India are at an all-time low: in August, China fired missiles into waters near Japan during drills around Taiwan, and its forces clashed with Indian troops over disputed border since 2020. America continues to accuse China of ‘debt trap’. diplomacy,” citing Sri Lanka as evidence. China denies this, noting (correctly) that most developing countries, including Sri Lanka, borrow more from multilateral and private lenders. He also points to his bilateral debt relief, including an Aug. 18 promise to cancel 23 interest-free loans to African countries (he didn’t specify their value, but China’s interest-free loans are generally small).

Sri Lanka also faces many of the same issues that delayed the deal with Zambia. Both America and China fear that the restructuring will favor the other. The Paris Club wants more transparency from China and more Chinese bank loans treated as official debt. China wants multilateral and Western commercial lenders to take a bigger haircut. He is also wary of setting a precedent for other borrowers and incurring public anger at home. “China’s money does not fall from the sky: it is earned through the hard work of the Chinese people,” said Liu Zongyi of if told a Chinese nationalist news site on August 15.

To avoid the delays Zambia has faced, some advisers are urging Sri Lanka to start debt restructuring talks with China at an earlier stage, and before the Paris Club. The IMF called for such talks, but it’s unclear if they started at a high enough level. Zambia is “a warning and a lesson,” says Shanta Devarajan, a former World Bank official who advises Sri Lanka. “We always apply the same principles and try to achieve this equity between creditors. But the order in which you discuss them can be important. He predicts a IMF bailout by the end of the year. Others expect a longer wait.

The IMF says his staff are traveling to Sri Lanka from August 24-31 to discuss the reforms needed for the next step – a staff-level agreement on a bailout. But the fund also stressed that final approval of the bailout will require “adequate assurances” from creditors that debt sustainability will be restored. Even the personnel-level deal will require painful reforms, possibly including adjustments to Colombo Port City, such as the removal of tax breaks for investors. This may confuse Mr. Xi’s vision of a Silk Road maritime metropolis. But it would arguably offer more hope to Sri Lanka and dozens of other debt-ridden countries.

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