The double-edged trap of China’s Belt and Road debt

China, the world’s largest bilateral lender, is facing the challenge of dealing with the debt crisis of some of its Belt and Road Initiative (BRI) borrowers. Whether China can support these debtors and avoid falling into unpaid debt will depend on policy choices.

China’s Belt and Road initiative has drawn criticism from some Western countries. The United States remains concerned that China’s rise will undermine its values ​​and interests. The lack of transparency and high loan terms of the BRI are central issues.

The discourse of “debt trap diplomacy” persists in the media and in some policy circles, despite recent research showing that it is an unsubstantiated myth. There are no winners with debt trap strategies. This is because debtors who fall into unsustainable debt are left out of the pockets of their creditors.

The fundamental issue with sovereign debt in developing countries is not China, but how to fairly handle unsustainable debt owed by various creditors when the composition of creditors differs from country to country. That’s true.

Bangladesh owes 53% of its external public debt to multilateral creditors, and only 7% to China. Sri Lanka owes 35% to international bondholders, while Laos owes 49% to China alone.

Understanding the claims against debtors is important to successfully restructuring debt if it becomes unsustainable. This also applies to some Asian countries, with Sri Lanka declaring a suspension of debt payments in April 2022, and Laos continuing to experience a debt crisis.

Policymakers must avoid repeating the same mistake of procrastinating due to optimism bias. Since the 1970s, a series of debt restructurings for developing countries have resulted in the debt forgiveness of many heavily indebted poor countries.

The history of debt relief under sovereign debt governance mechanisms over the past 50 years may shed light on how to appropriately address current debt challenges.

The Paris Club is an informal but well-established forum of primarily Western industrialized countries that has been coordinating the resolution of debt crises in developing countries since 1956.

The number of debt settlements by the Paris Club began to increase in the 1980s after debt accumulated during the petrodollar recycling boom of the late 1970s.

Since the 1960s, newly independent nation-states, mainly in Africa, have also accumulated debt. Then, a series of debt crises began in Latin America and spread around the world, finally subsided in the late 1990s.

During this period of debt crisis, Paris Club creditors grappled with the lack of improvement in debt repayment prospects for heavily indebted poor countries. Eventually, they realized that the prolonged rescheduling was due to solvency issues rather than liquidity issues.

Since 1988, the Paris Club has introduced various debt treatment conditions, including debt cancellation.

The Heavily Indebted Poor Countries (HIPC) Initiative allows for up to 100% debt forgiveness, while the Multilateral Debt Relief Initiative (MDRI) allows multilateral creditors to be granted de facto preferential credit status even though they have traditionally been given priority creditors. Regardless, it made it possible to completely cancel multilateral debt at the expense of shareholders. situation.

At the onset of the coronavirus pandemic, Paris Club creditors and the G20 agreed to implement a debt suspension initiative. This was followed by the development of his G20 Common Framework on Debt Treatment in November 2020.

As a member of the G20, China is committed to holding joint creditor negotiations “in open and transparent matters” and promoting “comparable treatment” that encourages “fair burden-sharing among all official bilateral creditors”. The two countries agreed on the basic principles of the common framework, including “sexuality”. and private creditors.

However, some critics of the common framework argue that there is not enough fiscal common ground between China and other official creditors for the framework to be effective. .

Although China has been cutting back on lending since 2017 to deal with its debt overhang, some countries still have high levels of debt owed to China and will be required to take debt relief measures from China.

China has provided relief to Belt and Road borrowers mired in a debt crisis while scaling back lending. However, the relief approach typically aims to prevent immediate default through extensions of payment deadlines for low-income countries and new funds for middle-income countries.

This relief approach without debt relief does not solve the solvency problem and is similar to the deferral of Paris Club creditors before adopting debt forgiveness in the 1990s.

In line with the principles of collective action and fair burden sharing, China advocates the participation of multilateral creditors in debt settlement and the mobilization of “new and additional concessional resources.”

China’s current economic and financial crisis, including a major domestic debt crisis, is not only due to multilateral creditors’ insistence on debt relief and injection of new funds, but also due to concerns about causing moral hazard domestically, debt relief is being sought. This may explain why they are reluctant to do so.

However, new multilateral financing, even on concessional terms, can be a double-edged sword, as non-reschedulable multilateral debt can only be forgiven at the expense of the shareholder country.

The past debt crisis has taught China a lesson in considering how to deal with prepaid debts to countries with unsustainable debt burdens, especially those that are overly indebted to China.

It’s worth considering debt reduction from a net present value perspective. Another option, especially if China commits to a green Belt and Road initiative, could be climate-centric approaches such as climate debt swaps.

China should be freed from the risk of falling into a debt trap as soon as possible. Otherwise, you could make the same mistakes that Western creditors made and ultimately lose your financial claim.

Toshiro Nishizawa Professor, Graduate School of Public Policy, University of Tokyo.

This article was originally published by East Asia Forum and is republished under a Creative Commons license.