Jessica C. Liao
China’s Belt and Road Initiative (BRI) has once again become a lightning rod for criticism following AidData’s newly released report, which found China’s overseas lending was worth $843 billion, including $385 billion of “un- and under-reported debt.” Media headlines seized on BRI’s “hidden debt” and news articles evoked the “debt trap diplomacy” slogan that political pundits and the Trump administration popularized in commentary critical of BRI.
Whether Beijing seeks to use debt as a tool to expand its influence and leverage over other countries remains under debate. However, what is mostly absent from the current discourse on BRI is discussion on the historically high risk plaguing all international creditors and the specter of this risk for China as it faces new challenges in sustaining its debt-fueled state-led growth model. Understanding this point can help Washington turn its stale narrative on BRI into a more convincing argument and be more effective in persuading other countries, as well as China, to shift course on BRI.
Critics pushing the debt trap diplomacy slogan often downplay the fact that BRI debt is as much a problem for China as it is for borrowing countries. International lending has always been a risky business. Information asymmetry between lenders and borrowers incentivizes the latter to misuse loans, while lenders lack credible enforcement power over international loan contracts. From Africa and Latin America in the 1970s and ‘80s to Asia in the 1990s, history has shown that over-exuberant lending on the part of transnational banks and investors regularly contributes to the boom and bust cycles of what many have termed “casino capitalism.”
Similar to these historical episodes, China’s excessive capital supply and saturated domestic markets led many Chinese lenders to look outward for new borrowers in the Global South, despite the high risks. What is distinct about the BRI is that it is a state-led lending initiative aimed at exporting not only China’s excess capacity and capital, but also the Chinese economic growth model centered on infrastructure investment. However, expanding this model internationally entails a high degree of financial risk, particularly in the Global South where many countries have a record of debt defaults.
Adding to this risk are loans to entities such as state-owned enterprises and banks as well as special purpose vehicles that come with only implicit government guarantees from borrowing countries – namely, the hidden debt AidData highlighted in its recent report. From the white-elephant Hambantota Port project in Sri Lanka to delays and cost overruns in Indonesia’s Jakarta-Bandung high-speed rail, problematic BRI projects demonstrate the lack of due diligence in China’s campaign style international lending. These projects also show that Beijing’s reliance on implicit guarantees by borrowing governments for project viability and loan repayment has proven to be ineffective, if not reckless, in hedging against lending risk. They have also frustrated Beijing’s broader diplomatic goals of demonstrating its “good neighborliness” and generated accusations that China seeks to use debt as a tool to gain leverage over countries in the Global South.
However, labeling the BRI a debt trap is not only insulting to the borrowing countries, who feel they are being accused of gullibility, but it also neglects the domestic root of this debt problem. Although China often claims that it is not exporting its system of governance, the BRI’s “hidden debt” is an offshoot of the public-private partnership (PPP) trend that took off within China over the past decade as more and more local governments leveraged capital from the business sector to help fund large infrastructure projects.
To be sure, China is not the only country spreading the PPP gospel, which began in Western countries and gained support from multilateral development banks as a solution to the Global South’s infrastructure gap. Still, whether in the West or China, PPPs have not proven to be a silver bullet. Many projects suffered heavy losses that eventually required a public bailout.
In China, PPPs are particularly problematic given that state-owned enterprises, with their privileged access to China’s state-controlled financial system, often act as the local governments’ “private” partners in PPP projects. This off-balance-sheet financial arrangement, coupled with inevitable moral hazard problems, has perpetuated China’s string of inefficient domestic investments, such as the infamous “ghost towns” that blight many parts of the country. While Beijing-backed overseas PPP projects have caught the U.S. foreign policy circle’s attention, it is important to keep in mind that China’s domestic hidden debt is a much bigger concern for Beijing. A September 2017 report estimated China’s PPP projects at around $2.7 trillion.
With China’s growth model due for a reckoning, Washington should focus on Beijing rather than the Global South when formulating its policy response to the BRI. Instead of telling the Global South to avoid the BRI, Washington should articulate why the BRI is bad for China. In fact, signs of Beijing’s BRI reckoning started to appear after 2017, which was also the last year of AidData’s statistics on China’s overseas lending. According to more recent data compiled by Boston University’s Global Development Policy Center and the American Enterprise Institute’s China Global Investment Tracker, China’s overseas lending and investment has slowed down since 2018 and dropped further after the COVID-19 outbreak.
This trend indicates two things. First, problematic BRI projects have attuned Beijing to the risk of international infrastructure financing. Second, and more importantly, with growing concerns over its own domestic debt, Beijing has less appetite for overseas lending. Indeed, since the National Party Congress in late 2017, Beijing has taken a more aggressive stance in tightening credit and restricting PPP projects as well as their related lending activities. Likewise, Chinese banks became more selective with overseas lending after China’s financial regulators imposed more due diligence requirements on new loans and Chinese firms were told to deleverage, particularly their unproductive overseas assets. It was no coincidence that at the Belt and Road Forum in 2017 and 2019, Beijing stressed the importance of “quality” rather than “quantity” in BRI projects.
With challenges both at home and abroad, Beijing seems to have realized that infrastructure diplomacy is easier said than done. However, while China has already begun repositioning the BRI for a more credit constrained future, Washington’s approach and policies appear to remain stuck in the past, with an undue focus “debt traps” or “debt for equity” swaps. In talking with the Global South, Washington should highlight the unsustainability of the BRI and the repercussions of copying China’s growth model, while offering support to help developing countries make efficient and accountable infrastructure investments. In talking with Beijing, Washington could feed Xi Jinping’s desire to demonstrate that China is a “responsible great power” and emphasize why walking away from BRI’s infrastructure fueled and debt-laden past could be similar to what Tocqueville called “self-interest rightly understood.”
With Evergrande’s looming collapse and Beijing’s heightened vigilance against asset bubbles, the time is ripe for Washington to adopt a new narrative on BRI.
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