Will China stall new plurilateral debt rescheduling or gain status in a new international framework?Many developing economies have been pitched into dire financial circumstances by the toxic mix of the Covid-pandemic, high prices for food and commodities, a stronger US dollar and heightened financial uncertainties. In the last three years, there have been as many sovereign defaults as in the previous decade, which already had a substantial number of default in the aftermath of the global financial crisis . These simultaneous crises have reactivated international discussions among creditors on how to develop a coordinated approach to international debt rescheduling. Amid the pandemic, the G20 and official lenders groups (the Paris Club) launched the Debt Service Suspension Initiative (DSSI) at first, and later the Common framework in 2020 to provide more structural debt relief in close coordination with IMF programs.
The novel feature of these debt rescheduling negotiations is that a “developing economy” – China – is a participant on the lender-side. China is not just a creditor. In most cases it is the largest creditor. And, true to its revisionist approach to the international economic order, Beijing has its unique approach to international lending and debt restructuring. For international development lending, it favors higher rates, has higher appetite for risk, less transparency and bigger loans. Its debt restructuring is also uniquely opaque and bilateral. The world of official lending has its faults, but past crises have pushed traditional lenders to establish some constraints, especially some transparency, for loans and restructuring, to avoid chaotic, standalone restructurings.
The biggest external risk to China’s economy is a novel one
In a decade, the People’s Republic of China (PRC) has become the major bilateral lender to developing countries (which with market-debt, mostly bonds on foreign markets, makes up for the external debt of countries). China went from being marginal actor to the number one official creditor, investing USD 450 billion in net lending.
Now, 60 percent of this funding is at risk of default. An extreme scenario of total financial meltdown in emerging economies would put those official loans at risk. Certainly, there would also be a substantial hit to the roughly USD 200 billion of net paid-in development financing that Beijing has provided to developing countries as well as the USD 843 billion of Chinese direct investment in developing economies. For Beijing, somewhere around USD 1.5 trillion of assets could be at risk. Although this scenario is unrealistically extreme, it illustrates why a leading Chinese economist, Cao Yuanzheng (曹远征), has characterized the developing economies’ debt difficulties of as “the biggest external risk to the Chinese economy”.
Beijing lends at higher interest rates than most development finance loans
Chinese lending is remarkable not only for its scale, but also for the longer payment period for the principal, longer grace period and larger volumes. Interest rates are closer to market rates (i.e. 5 percent and above) than the preferential rates typical of traditional development financing (around 2 percent). Perhaps most importantly, Chinese loans are also abnormally opaque, which explains the significant variations in the estimates already given. As China is not a member of the Paris Club or the OECD, it has no obligation to publish the numbers. Furthermore, the blurred line between China’s public and private spheres (particularly opaque in the financial sector) makes it hard to distinguish between commercial and official lending. In Zambia, Ethiopia and Ghana, the total amount of Chinese loans that needs to be considered within their official restructuring would be doubled if loans from China’s state-owned commercial banks backed by official export insurance (Sinosure) were counted, in line with “Paris Club” standards.
Besides, most Chinese financing comes with uniquely tight non-disclosure obligations and explicit exclusion-clauses from coordinated debt-relief initiatives.
After 2017, the sudden decrease in new Chinese funds, which had made up a very substantial source of external financing, amplified the external shocks for low income countries. Countries that were heavily reliant on major Chinese investment are particularly prone to financial difficulties since then. In fact, in the past decade Beijing has already conducted more than 75 percent of international “credit events” (default and debt restructuring).
Chinese financing is part of Beijing’s narrative that it champions developing countries
China has a strong preference for bilateral and opaque management of default and restructuring. Re-negotiations are also characterized by a preference for debt-deferrals over write-offs, and the over-hyped risk of asset seizures remains extremely rare in practice. Even if the most extreme version of the “Belt and Road debt trap” theory is not backed by facts, it is true that such a concentration of external debt creates serious concerns about the degree of agency that debtor countries possess in dealing with China, especially given the opacity around loans and Beijing’s tendency to leverage economic dependencies.
Internationally, the PRC has long positioned itself as the champion of developing economies, an argument that stands at the core of its domestic legitimating narrative. And to anyone who might see a tension with China’s own high speed development, the party’s media mouthpiece recently stated, “China will always be a developing country”. This narrative is now being stress tested by China’s role as the leading creditor in a wave of defaults by developing economies.
Zambia, Sri Lanka, Ethiopia, Ghana, Ecuador, Chad and Suriname have already formally defaulted: Chinese loans account for more than 60 percent of their official external debt. Chinese finance has a similar footprint in many countries – Pakistan, Afghanistan, Sudan, Maldives, Argentina, Kenya – where the financial situation is not much rosier.
Beijing’s stance is causing debt restructuring negotiations to stall
China first participation in a plurilateral effort on international debt was initially quite a success, with 65 percent of the deferred payments (under the DSSI), while representing only 25 percent of the due payments over the period. The discussions defined – in an initial way, at least – who is a Chinese “official bilateral creditor” and included most lending by Chinese policy banks. (There is no agreed international definition of official bilateral creditors.)
Discussions on debt restructuring, under the Common framework, ran into trouble around the extent of Chinese debt to be submitted to debt restructuring so an IMF program could be initiated. Things got worse when Beijing added an unusual demand, creating unprecedented delays for such discussions.
When outright defaults emerged, China and the Paris Club opened a formal communication channel with the IMF potential bail-out programs. The programs are conditional on all major bilateral lenders restructuring external debt towards a sustainable path, under a soft standard established by the Paris club on the principle of the “comparability of treatment” among creditors (i.e. similar treatment of all official debt, irrespective of the identity of the issuer/holder). It means official lenders must accept a cost for setting the debtor back on sound financial tracks. The debtor commits to some structural reforms to prevent another debt pile up, before the IMF agrees to pour in more resources.
The cases of Zambia and Sri Lanka, the first two major debtors for which IMF programs were ready, unfortunately did not go as smoothly as the opening DSSI round had, so they could not access IMF bail-out programs. After months of negotiation and high-level pressure, Beijing has yet to formally accept the inclusion of its policy bank loans in the restructuring effort.
On top of this, China also awkwardly demanded that loans from multilateral development banks (MDBs, such as the World Bank) be included in the official restructuring. This demand runs counter long-standing practices that exclude MDB financing from restructuring in order to make debt repayment and restructuring more stable. The IMF/WB Spring Meetings in April revived hopes of a functional structural solution, but so far nothing has yet been confirmed.
In summary, for the IMF to intervene and get struggling recipient countries back on a sustainable path, it requires bilateral lenders like China to write down a significant portion of their debt holdings. However, China has so far refused to do for the all its bilateral credit and demand that the MDBs commit to writing down their debt holdings as well – which is not an equal move since MDBs issue loans at far lower rates than China’s banks have. If that happened, China's banks with their higher rates would then recover far more of their losses than the MDBs with their lower rates would – an obvious issue for MDBs.
China’s goals are unclear but the implications of dragging out negotiations are bleak
China’s challenging stance in the restructuring discussions, coupled with a lack of clear communication, has left partners and analysts guessing at the reasons behind China’s positions. Some see genuine policy mismanagement while others see opportunistic delays to minimize direct financial costs.
Policy mismanagement is plausible reason, given the complex domestic political and administrative structures for such discussions. The People’s Bank of China (PBOC) holds the seat at IMF discussions, the Minister of Finance (MoF) holds the one in the G20 body supervising the DSSI and the Common framework. Moreover, the large state-owned banks, especially the policy banks, like China Development Bank (CDB) and the Export Import Bank of China (Exim) are owned by a web of institutional entities, mostly with the PBOC and the MoF as final owners. The head of those powerful institutions often has a high political standing, sometimes outranking their regulators. The result is a conflicted relationship with their regulators.
The PRC’s still immature domestic framework on debt write-off is another plausible factor. Standard regulations to smooth debt write-off are a recent development. Unlike OECD countries, China has no specific regulation on foreign debt write-off.
On the top of all this, debt forgiveness to developing economies is a topic that gets a rather negative reception from domestic audiences uncomfortable with aid to “poor” foreigners while poverty remains at home. With China Exim holding the chair for China in both the DSSI and the Common Framework, it is possible that China’s position overly represents its banks’ reluctance to take losses. Internal disagreements were acknowledged by the head of the PBOC international department in a recent webinar. The PBoC governor said in December that “for overseas claims, in accordance with the principle of ‘who invests bears the risk, and who makes the decision is responsible for risk compensation’, financial institutions and enterprises bear the main responsibility”. As the PBoC’s swap lines seem to have been extensively mobilized to bail-out international “commercial” loans by Chinese banks, it seems likely banks are trying to avoid losses because they have already taken a hit.
Or Beijing may be deploying opportunistic arguments to minimize its financial losses. The Suriname case, where an escrow account was hidden from the IMF and continued making some interest payments to Exim (in breach of the pause agreed on by creditors) has fueled this hypothesis. Recent findings that China used its official swap lines (usually excluded from restructuring) to bail out some loans by Chinese banks, also fed mistrust.
The final resolution of those cases will say a lot of Beijing’s preferences on the international economic order
On the 22nd of June, the IMF and the main creditors announced to have secured a three-year-in-the-making agreement on the restructuring of the Zambia’s bilateral international debt . Surely good news, the details had not been made public at the time of writing and no formal agreement had been signed yet. If Beijing has dropped its unusual demands on the treatment of MDBs, it seems likely that the amount of debt finally restructured will be lower (by ~20 percent) than previously estimated. Given China’s holdings made up 60 percent of Zambia’s total debt, the lower number likely indicates that Beijing has been able to exclude at least some of its credits from the more stringent agreement on the official lending. This exclusion dents the previously established soft-standard of including all State-guaranteed bilateral debt, and it indicates further troubles down the road to establish a clear set of standards for international debt restructuring.
If Beijing keeps delaying, it will undermine its reputation in the EU and globally
The lack of positive engagement from Beijing risks seriously degrading China’s international image in both advanced and developing economies. The longer the IMF programs are put on hold, the harder the impacts on local populations further down the road.
Europeans should give their Chinese counterparts a clear message about the importance of a plurilateral and transparent framework to deal with international debt restructuring, especially at high level. A positive move from Beijing would provide a focus for positive cooperation for the greater good, bolstering the possibility of considering Beijing as partner. If there are no positive results, Beijing will be seen more as a systemic rival. Either way, the outcome of such approaches would be a helpful input for European thinking on how and why to engage China.
By facilitating international restructuring and preventing the weaponization of already difficult negotiations, such a framework would benefit the greater good, and developing countries in particular. At a time of heightened geopolitical tensions, such cooperation would likely generate positive spillovers.
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