The Diplomat author Mercy Kuo regularly engages subject-matter experts, policy practitioners, and strategic thinkers across the globe for their diverse insights into U.S. Asia policy. 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 View Insight Series.”
What are the top three takeaways of AidData’s recent report on China’s overseas lending during the BRI era?
First, since the BRI was announced, China has outspent the U.S. on a more than 2-to-1 basis. It has done so with debt rather than aid, maintaining a 31-to-1 ratio of loans to grants. Many of these loans are priced at or near commercial rates.
Second, we find that the average [recipient] government is now underreporting its actual and potential repayment obligations to China by an amount equivalent to 5.8 percent of its GDP.
Third, there are growing signs of “buyer’s remorse” among BRI participant countries. Thirty-five percent of the BRI infrastructure project portfolio has encountered major implementation problems – such as corruption scandals, labor violations, environmental hazards, and public protests – and project suspensions and cancellations are on the rise.
What are the debt levels of lower and middle-income countries to China, and how is Beijing managing repayment risk?
Chinese debt burdens are substantially larger than previously understood: 42 low-income and middle-income countries now have levels of public debt exposure to China in excess of 10 percent of GDP.
Chinese state-owned lenders are managing repayment risk by putting in place stronger safeguards. In the early 2000s, roughly 30 percent China’s overseas lending portfolio benefited from a source of collateral, a third-party repayment guarantee, or credit insurance. During the BRI era, this figure has soared to nearly 60 percent.
Beijing’s go-to risk mitigation tool is collateralization: 40 of the 50 largest loans from Chinese state-owned creditors to overseas borrowers are collateralized. However, the notion that Chinese state-owned lenders prefer to collateralize on physical, illiquid assets — like ports and electricity grids — that can be seized in the event of default is a media myth. Chinese lenders are savvier than that. They prefer to collateralize their debts on fully liquid, “grab n’ go” assets. Typically, they will require that their borrowers maintain a minimum cash balance in an offshore, lender-controlled bank account. If a borrower falls behind on its repayments, the Chinese state-owned lender can simply debit funds from its bank account without having to deal with the hassle of going before a judge to recover overdue debts.
Explain your estimate of $385 billion of “unreported debts” to China
The BRI is a story about the rise of hidden debt and the fall of sovereign debt. Prior to the introduction of the BRI, most of China’s overseas lending was directed to central government institutions (i.e., sovereign debtors). However, nearly 70 percent of China’s overseas lending is now directed to state-owned companies, state-owned banks, special purpose vehicles, joint ventures, and private sector institutions. These debts, for the most part, do not appear on government balance sheets in low-income and middle-income countries. However, most of them benefit from implicit or explicit forms of host government liability protection, which has blurred the distinction between public debt and private debt.
Our report also takes a close look at the World Bank’s Debtor Reporting System (DRS), which has served since 1951 as primary mechanism through which sovereign borrowers voluntarily disclose their actual and potential repayment obligations to external creditors. We find that low-income and middle-income governments are underreporting their true levels of Chinese debt exposure to the DRS by $385 billion because, in many cases, they are not the primary borrowers responsible for repayment. However, these underreported debts still represent potential government repayment obligations because it is central government institutions that will likely be expected to step into the breach in the event the primary borrowers go into bankruptcy or default.
The Jakarta-Bandung High-Speed Railway (HSR) Project illustrates why hidden public debt exposure merits the attention of policymakers and taxpayers in developing countries. The Indonesian government wanted to work around its public debt ceiling by financing this $5.29 billion mega-project through an off-government balance sheet transaction. So, it decided to finance the construction of the railway on a public-private partnership (PPP) basis. A group of Indonesian and Chinese state-owned enterprises created a special purpose vehicle (SPV) – called PT Kereta Cepat Indonesia China – and China Development Bank (CDB) lent $4 billion to the SPV. All of the remaining project costs were supposed to be covered by the owners of the SPV via equity contributions. Indonesian President Jokowi signed a decree, prohibiting the use of government funds for the project.
However, during implementation, the project has encountered major cost overruns worth approximately $2 billion. Then, in October 2021, President Jokowi reversed course, issuing a new decree and authorizing a government bailout. The Indonesian government now plans to take $286.7 million out of state coffers in 2022 and inject the funds into PT Kereta Cepat Indonesia China.
The Jakarta-Bandung HSR project calls attention to an important point about hidden public debt exposure: In an infrastructure PPP, the host government usually bears insolvency risk in opaque, indirect, and even surreptitious ways. The Indonesian authorities repeatedly assured taxpayers that they would not be responsible for the debts of PT Kereta Cepat Indonesia China, which was true in a very narrow sense: President Jokowi’s recent decision to authorize the provision of state funds to PT Kereta Cepat Indonesia China does not explicitly state that the SPV can use state funds to repay its outstanding debts to CDB. However, money is fungible, so a taxpayer-funded bailout of PT Kereta Cepat Indonesia China will help the SPV remain solvent – or at least liquid – and thereby allow for the continued construction of the railway. PT Kereta Cepat Indonesia China cannot repay its outstanding debts to the CDB unless the railway is completed and there are sufficient customers willing to pay for its use, so any injection of Indonesian government funds into the SPV effectively represents an indirect (hidden) form of public debt.
If hidden debt is like a thief coming to raid the public treasury, it does not knock on the front door and announce its arrival; it sneaks in through the back door and takes special care to leave no fingerprints.
What is the impact of the BRI as a geopolitical and geoeconomic platform to expand China’s global reach?
Beijing’s rivals and critics claim that the BRI is part of a grand strategy to build alliances, project influence, and reshape the international balance of power. But what we find is that Beijing is using its overseas lending program to solve internal economic problems.
Beijing’s international lending program has soared to record levels because of domestic challenges – specifically, an oversupply of foreign currency, high levels of industrial input overproduction, and the need to secure natural resources that the country lacks in sufficient quantities at home. It has responded by ramping up dollar- and euro-denominated lending at or near market rates; contractually obligating its overseas borrowers to source project inputs (like steel and cement) from China; and allowing countries to secure and repay loans with the money they earn from natural resource exports to China.
How are Western powers responding to China’s position as the infrastructure financier of first resort?
There will soon be greater choice in the infrastructure financing market, which could lead to some high-profile defections from the BRI. The U.S., the U.K., and the other members of the G-7 are increasingly positioning the BRI as the low-quality infrastructure option and their own Build Back Better World (B3W) initiative as higher quality option for countries that want to undertake infrastructure projects based on principles of sustainable and transparent financing, good governance, public sector mobilization of private capital, consultation and partnership with local communities, and strict adherence to social and environmental safeguards.