The Bottom Line.

In this Asia-Pacific insight, HEC Eurasia Institute Founder and Honorary Chairman Jacques Gravereau analyses recent trends relating to the debt generated as a result of the heavily discussed Belt and Road Initiative (BRI). Whilst the BRI is probably China’s most strategic undertaking, the question of its medium and long-term impacts on the partnering countries deserves to be explored. In reality, Jacques Gravereau writes, the issue is not just black or white. At the end of the day, China is not just taking over the world: it bears the cost of significant business mistakes and it learns. By imprudently developing its BRI project, Beijing is indeed likely to create political misconceptions which it will sooner or later have to manage, on top of the serious financial risks which are gradually emerging.

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Partner countries in trouble: the new debt roads?

[By Jacques Gravereau]

Over the past few months, mentioning that the massive Chinese funds irrigating the “Silk Roads” (Yidaï Yilu) projects – also known as the Belt and Road Initiative or BRI – could cause the debt of weak countries to explode has been very sensitive. Even Christine Lagarde, the IMF’s highly respected boss, has paid the price for publicly saying in the spring that the surge of Chinese funds could lead to a “problematic increase in debt” and that there was no “free meal” for the recipient countries.

All is not just black or just white, and the issue of BRI-related debts is delicate. On the one hand, the Chinese Deputy Finance Minister Mrs Zou Jiayi insisted during the last IMF and World Bank forum in Bali – last October – that “BRI projects are first and foremost commercial projects and host countries are free to develop them or not”. On the other hand, most projects are largely financed by loans rather than by grants, which implies that repayment and profit considerations must be taken into account.

As a result, it seems legitimate to explore the ‘behind the scene’ aspects of the Belt and Road Initiative and to ask what countries such as Laos, Tajikistan or the Maldives can do against a powerful Chinese iron pot weighing 12,000 billion USD of GDP.

This insight therefore explores the strategic nature of Belt and Road Initiative-related debts with the ambition to draw a big picture and explain some operational aspects of the BRI. At the end of the day, indeed, the problem goes largely beyond a purely debt-focused discussion and needs to be considered holistically.

Many debt examples to talk about.

The discussion has been around for a while, but we are no longer in a fictional scenario anymore. The Centre for Global Development (chaired by Larry Summers, former President at Harvard) has already identified twenty-three target countries on the “Silk Roads” that are already in the process of debt distress.

Among them, eight countries almost strangled: in the last two years alone, public debt largely inflated by BRI loans has risen from 50 to 90% of GDP in Djibouti, from 50% to 80% in Tajikistan, from 38% to 70% in Kyrgyzstan, from 48 to 68% in Laos, from 26 to 68% in the Maldives, from 40% to 60% in Mongolia, from 15% to 50% in Montenegro simply because of a Chinese highway, not to mention Pakistan.

In Papua New Guinea, a loan of USD 2 billion alone represents a quarter of the country’s debt. In Zambia, Chinese banks hold $6.4 billion of receivables on a total debt of $8.7 billion. In Kenya, the recent inauguration of the Nairobi-Mombasa railway leaves open the question of the repayment of USD 7 billion in loans accumulated in the country by the Exim Bank, a direct vector of the Chinese government, including USD 3.2 billion for the railway line alone. Loans from the same bank can also be found in Ethiopia (USD 7.2 billion), Angola (USD 6.9 billion), Sudan, DR Congo (25% of the country’s debt), or Mozambique (also 25%). (Source: see down the page)

Chinese-owned debts: a very disparate loans landscape.

Is there a deliberate strategy, then? The question is complex and difficult to answer, if only because the BRI loans landscape is overall very disparate.

An article by the eminent New Delhi professor Brahma Chellaney in January 2017 set the powders on fire. Its title, “China’s Debt-trap diplomacy”, suggested that there was a Machiavellian Chinese plan pushing weak countries into excessive debt, by explicitly denouncing a pledge-grab by creditors and the return into force of colonial behaviors.

Unsurprisingly, this vocabulary has bothered the Chinese leadership, which consistently repeats that the “Silk Roads” are built on win-win partnerships, and that “they are not a Chinese club” (Xi Jinping at the China-Africa FOCAC Summit, early September). In reality, in fact, the term “debt diplomacy” fails to illustrate the multifaceted nature of the situation.

Bad deals.

For starters, various BRI projects have turned into bad luck and probably ought to be considered a matter of profit and loss as far as China is concerned.

From 2007, in the middle of Hugo Chavez’s presidency, China for instance discussed oil and gas trade with Venezuela. The talk led to a win-win deal: China would provide capital to modernize oil drilling systems suffering from a lack of maintenance. In exchange, massive supply contracts would be secured, on a long-term basis. On paper, a large USD 60 billion agreement, mainly financed by the China Development Bank. In reality, however, the collapse of Venezuela under Nicolas Maduro led to a full stop and to the cancellation of China’s loan.

The same scenario occurred with Cuba’s communist regime in 2011, but for an amount ten times smaller and a debt-waiver of USD 6 billion. It also occurred in Nepal or Mozambique.

Objectively, however, the situation is a textbook case study. Since the 1930s, many American and European investors have faced the same types of creeping bankruptcies, some of which have resulted in outright debt write-offs, others in rescue packages shared by the Paris Club or the IMF. They have since then learned how to exercise with caution, whilst the World Bank no longer favours large contracts as the basis of its development-oriented policy.

In other words, the Chinese investments may be ambitious, but they are facing the same issues that many have faced over the years. China still has to learn the lesson, however.

Hazardous financing issues.

“Silk Roads” business is complex on other aspects. There is not much talk about it, but in Algeria, where Chinese companies have captured the lion’s share of construction sites (roads, bridges, offices, etc.), there has been a serious decline in Chinese contracts. The same is true in Sudan, where Petrochina was the first historical oil operator to obtain business before the country’s division. Or in Libya, Chad or Central Africa.

In effect, the overall volume of Chinese BRI financing has actually declined since 2015 by around six percent per year, starting with the commitments of Chinese “commercial” banks, whose bad debts, both at home and around the world, are beginning to reach worrying levels, thus raising concerns as to the existing portfolios.

The issue of handling political risks.

Chinese investments have also faced significant political risks. In Sri Lanka, at the end of the 2000s, President Rajapakse, convinced China to invest in his fiefdom on the southern coast of the island. The hinterland was desperately empty, but Beijing identified the strategic interest of this location, in the immediate vicinity of the major maritime routes of the Indian Ocean. The opportunity would decisively complement the “pearl necklace” of bases it is deploying along the ocean surrounding India.

Economic considerations were therefore secondary and feasibility analyses were botched. Amongst the construction projects were a very large container port, Hambantota (USD 1.5 billion), with a motorway, a 500-hectare industrial park, a 35,000-seat cricket stadium. An international airport was also prepared for Matalla, the country’s second largest city, with the idea to carry one million passengers a year.

However, with a dozen passengers a day Matalla soon became known as “the emptiest airport in the world”. As for Hambantota, the brand new port, it only welcomes about thirty ships in good years. Of course, the interest on the loans (6.3% on average) is running, but the Chinese have not fully appreciated the business issues which come along with democratic hazard.

China had to face even more complications. An extremely bitter election campaign focusing on the Chinese presence in Sri Lanka has led the leader of the Sri Lanka Freedom Party, Mr. Sirisena, to oust Mr. Rajapakse in January 2015. The new President has set the record straight, but what can a small country with so many permanently insolvent “white elephants”? At the end of 2017, a massive debt remission was negotiated, alongside the sale of Hambantota to the China Merchants Group for ninety-nine years. The news propagated noisily throughout the Indian subcontinent, which has a very free press and a still lively memory of colonization.

Do BRI debts contribute to building a de facto Chinese influence?

Hambantota is not an isolated case. In northern Myanmar, China has built the port of Kyaukpyu, designed to be the bridgehead of a pathway to China’s Yunnan province aimed at lifting the maritime constraints of the Malacca Strait. But Kyaukpyu also became a Chinese field following the renegotiation of Burma’s debt to China (USD 9 billion), dug notably by the huge Myitsone dam in Kachin territory.

In the Maldives, another strategic point of the Chinese “pearl necklace”, the tiny archipelago owes seventy percent of its public debt to Chinese creditors, while three Chinese projects represent 40% of the country’s GDP. The local political system is democratic, yet the financial equation has led to giving away the management of the port of Male to Chinese interests. Surprisingly, the Indian government of M. Modi just offered to the Maldives 1.4 billion USD to reimburse the loans owed to the Chinese… not without political ulterior motives.

Elsewhere in the Indian Ocean, the Chittagong economic zone in Bangladesh has become a de facto Chinese-managed zone, whilst the country’s debt with Chinese banks is estimated at USD 35 billion.

In Cambodia, the large port of Sihanoukville has practically become a Chinese city. In Central Asia, Tajikistan’s unsustainable debt is being discharged by transferring large areas of land to Chinese interests.

In Greece, after successive financial and commercial negotiations accelerated by complex monetary troubles, the port of Piraeus is now almost exclusively managed by of the Chinese company COSCO.

Some smart financial engineering, and some opposition.

The loans landscape is complex, but China is overall managing it very efficiently. Rather than taking over sensitive real estate assets, Beijing is considering new, less problematic instruments inspired by financial engineering methods. The idea is to set up long-term financing vehicles, in the form of securities (shares, bonds, etc.) with a maturity of 30 to 50 years backed by infrastructure projects, using part of China’s reserves for acquisition purposes.

Some countries are resisting, however. In Malaysia, Mr. Mahathir has returned to power at the age of ninety-three and canceled a USD 20 billion of Chinese projects committed under his predecessor businessman Najib Razak. But Mr. Mahathir who has been operating in Asian politics for forty years did not make Beijing lose face, stating instead that “the country would not be able to pay”.

In Africa, Sierra Leone announced on 23 October that it was abandoning a USD 318 million airport project, and other countries are following the path. In Nigeria, the construction of a 1,400 km railway line has cost USD 11 billion, but although Nigeria is a major oil country there is no guarantee that it will be able to repay. On China’s direct borders, Laos (USD 1,700 of GDP per capita) is also facing criticism with regard to the endless construction of a railway line supposed to serve all of Southeast Asia and valued at USD 7.6 billion for the Laotian segment.

Silk Roads debt creating concerns?

All in all, the debt attached to the Silk Roads developments is creating a variety of concerns. In particular, China’s relentless pursuit of raw materials could lead to ignoring original considerations as to the win-win nature of partnerships.

Natural resources at stake.

For instance, in Guinea-Conakry aluminum giant Chinalco is trying to get hold of the huge Simandou iron resources, with or without tenders. This would be a USD 23 billion project (two and a half times Guinea’s GDP!), including a 650 km railway (USD 8 billion), thirty-five bridges, a deep-water port, etc. The case has been delayed because iron prices are currently low, but when they rise, the magnitude of Guinea’s debt could likely rise to the ceiling. In the meantime, Chinalco (103,000 employees) and his competitor Shandong Weiqiao are investing massively in bauxite mining, still in Guinea. At what cost?

Geopolitics at stakes.

Pakistan is probably the country of the “Silk Roads” where the risks related to debt are the highest, not only economically but also politically. Pakistan is a democracy, with real (fierce) election campaigns. But in August, Imran Khan became Prime Minister and found a USD 95 billion debt to manage. Yet, the country has nothing to export but cotton, therefore, he called on the IMF to help with a bailout plan of up to USD 12 billion.

Nothing very new here, as this is the thirteenth time in thirty years that Pakistan has called on the IMF. Yet, whilst the United States is the country’s main creditor since 2013 the Pakistani debt landscape is characterized by the emergence of a gigantic “China-Pakistan Economic Corridor” (CPEC) which the latest estimate puts at USD 62 billion. Proportionally, it is as if France was embarking on a 500 billion euro project when it currently struggles to find 10 billion to settle social issues.

The CPEC was launched by both countries in euphoria. Local flowery rhetoric has described it as “higher than the Himalayas, deeper than the ocean, sweeter than honey”. China has planned to build a 2,700 kilometre-long pathway starting from the port of Gwadar and developed especially in the west of the country, near Iran and the Persian Gulf, to reach the Chinese city of Kashgar, Xinjiang, with motorway, railway line, pipeline, fibre optics, power plants, dams (Mirani) etc.

Gwadar’s infrastructure is already very advanced, the rest of the gigantic construction site is in progress under heavy protection, because the strategic project must pass through Balochistan (the Taliban areas) and the steep peaks of the Hindu Kush. Yet, concerned have been raised by local populations that the project would have a very little positive economic impact on the country. Whether these arguments are rational or not is irrelevant: it has become a political problem.

Influence-building concerns.

It is worth noting that the conditions of Chinese loans to Pakistan are soft (5-year grace period, 25-year maturity, 2% interest rate). Yet, concerns have been raised as to the question of Pakistan’s financial (in)dependence. A significant question of influence for Beijing considering the context of disengagement of the United States which surrounds the project, and the existing tensions between Pakistan and India. To keep things short, the historic “grand game” between India, Russia, the West, and China has crystallized on the side of Islamabad.

In retrospect, it is estimated that USD 240 billion of contracts have been signed since 2006 to date in countries that have gradually been labeled “OBOR”, “BRI”, “B&R”, after the launch of the Yidaï Yilu slogan by Xi Jinping in 2013.

Of these, USD 150 billion are in Africa, including 90 in the heavy sectors (rail, road, energy, mining). The Fitch rating agency has estimated, by collating the available data, that current or already planned medium-term contracts amount to USD 900 billion. USD 340 billion would concern the construction of heavy infrastructure (trains, roads, etc.), largely by the major Chinese state groups.

BRI debt: what to think?

These numbers are the best estimates available, considering the existing forest of unverifiable figures and comments that go in all directions. Yet, do “Silk Roads” developments obey an organized and rigorous plan, a little bit like a secret Soviet-style project? Or is it a multifaceted, more or less elusive, more or less consolidated set of diverse and varied Chinese corporate strategies?

Reading China’s strategy as an open book.

In sectors vital to China, the reality is that far from Machiavellian tactics, the Chinese companies which operate along the BRI are nothing but the advanced vectors of a national strategy which can be read almost openly.

>> Read also: Daniel Van de Scheltinga’s commenting on China’s 2025 plan.

Securing supplies raw materials or hydrocarbons from Africa and the Middle East is part of the strategy, but major investments are also taking place in relation to technological modernization.

In 2018 alone Tsinghua Unigroup bought the French Linxens in smart cards (USD 2.5 billion); Wingtech bought the Dutch company Nexperia in semiconductors (USD 4 billion), after Midea acquired the German robotics champion Kuka (USD 5 billion) in 2017; Tianqi took 24% of the Chilean SQM (USD 4 billion) to exploit the world’s first lithium deposit (essential for batteries) in the Atacama desert.

>> Related reading: China tech, where do we stand?

A large capacity-building project.

These countries are not clearly on the path of the “Belt & Road”, although the Chinese definition is surprisingly elastic (68 countries formally listed, a hundred mentioned). Since President Jiang Zemin launched the “go out policy” (zou chuqu) in 1999, however, Beijing’s purpose has been capacity-building.

McKinsey counts, for example, that 10,000 Chinese companies are present in Africa today, ranging from the opening of a shop to a labor factory. There is simply business to be done.

For Chinese companies in the “heavy” sectors, the BRI is a celebration of major road, rail and energy infrastructure projects for major Crown corporations. The most strategic of these, which now number at 96 around a hundred, is owned and managed by the SASAC (State Assets Administration Commission, or Guoziwei), which reports directly to the Prime Minister.

These can be found in all the major “Silk Roads” projects, such as Petrochina (303,000 employees), China Energy Engineering-Gezhouba Dam Group (160,000 employees), China Minmetals, China Merchants Group etc… Or China Railways Rolling Stock Corporation (CRRC, 183,000 employees), a direct global competitor of Siemens and Alstom, generating more than twice the combined sales of the latter.

CRRC, as its name does not imply, builds trains, but also infrastructure of all kinds, including roads and office buildings. SASAC directly oversees all these projects identified by its companies. It guides them or gives them guidance on their management, for example by requiring them for the past three years to submit an annual report on their local governance, particularly in Africa.

More practically?

Projects are identified worldwide with an extremely organized capillary information capacity, which leaves one stunned. Labeled Yidaï Yilu, they get access to preferential access to Chinese funds. Companies come with a tied-up scheme and a ready-to-use bank loan package.

Big is beautiful! Countries hypnotized by the flood of seemingly attractive offers that could solve their recurring infrastructure and poverty problems are being dangled as “bigger than the belly” projects. The Chinese have funds and are less careful than Western countries, corseted by their solvency ratios or by OECD codes of conduct.

The Chinese side of things.

The Chinese side of things is interesting. These loan-backed projects are almost exclusively allocated to Chinese state-owned companies, for which profitability is not really a concern.

Hence, these projects, at home and abroad, are also largely responsible for the explosion of China’s domestic debt (260% of GDP today for non-financial companies). Just as China, they invest first and see later. The BRI is a big, big business. A little messy, but strategic and irresistible.

And since the (relative) slowdown in Chinese growth is weighing on domestic activity, exposing it to appalling industrial overcapacity and resulting in a war of infernal prices at home, state companies are looking elsewhere for business. To some extent, the BRI is an excellent recycling opportunity and an infallible recipe for effectively “exporting” the Chinese overcapacity which ultimately benefits China.

The question of the impact.

A question remains. Recipient countries will certainly benefit from the new infrastructure, but at what cost?

At the moment, the win-win situation mainly benefits Chinese companies. That major Chinese projects are pushing poorly equipped countries into debt is at the very least an unintended collateral damage of poorly calibrated enthusiasm on both sides for excessive projects.

Yet, comparing the sums committed and the risks generated for the recipient countries should perhaps ring the alarm. On both sides! At the end of the day, too much debt does not benefit anyone: neither, of course, the countries concerned, nor China, which has to manage bad luck, bad business, geopolitical tensions and a variety of issues which hardly appear on the paper business plans.

By imprudently developing its BRI project, Beijing is furthermore likely to create political misconceptions which it will sooner or later have to manage, on top of the serious financial risks which are gradually emerging.

President Xi Jinping himself has just admitted this. In the People’s Daily, he indeed called for “the improvement of the quality of projects”, which must increasingly “meet the needs of local populations, so that they can concretely feel the benefits of these constructions”. Phase 2 of the “Silk Roads” is therefore underway, earlier than we could have imagined.

Originally published in « La Lettre de la Chine Hors Les Murs » n 26, 21/11/2018.

Sources:

• Center for Global Development – Examining the Debt Implications of the Belt and Road Initiative from a Policy Perspective (March 2018)
• McKinsey – Dance of the lions and dragons (June 2017)
• World Bank – Africa Economic Outlook 2018
• Fitch Solutions – One Belt One Road financial estimates
• NY Times – Malaysia pushes back against China’s vision (20/8/18)
• The Guardian – The $900Bn question: What is the Belt and Road Initiative?
• Reuters – Fearing debt trap, Pakistan rethinks ‘Silk road’ projects.
• Reuters – Chinese highway to nowhere haunts Montenegro
• JeuneAfrique – on Simandou project in Guinea
• Donnelly, L. – Africa’s debt to China is complicated (M&G Online, 9/18)
• CADTM – Is Pakistan falling into China’s debt-trap?
• Project Syndicate – China’s debt trap diplomacy (Brahma Chellaney, 23/1/17)
• Asia Times – South Pacific waking to China’s debt-trap diplomacy? (7/9/18)
• Carnegie – Tsinghua Center for Global Policy – China, Venezuela and the illusion of debt-trap diplomacy (16/8/18)
• Daily Nation – Kenya must avoid China debt-trap or fall into Sri Lanka (9/5/18)

Photo by Pop & Zebra on Unsplash

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