‘Entrapment’ or ‘ineptitude’? Sri Lanka debt crisis reignites debate on Chinese lending

While Chinese lending may have worsened debt problems in some countries, debt owed to China was in most cases dwarfed by what was owed to other lenders.

May 07, 2022 05:44 pm | Updated May 08, 2022 01:20 am IST - Hong Kong

Chinese Foreign Minister Wang Yi speaks with Sri Lanka’s Prime Minister Malinda Rajapakse during an official meeting  in Colombo on January 9, 2022.

Chinese Foreign Minister Wang Yi speaks with Sri Lanka’s Prime Minister Malinda Rajapakse during an official meeting in Colombo on January 9, 2022. | Photo Credit: AFP

Watch | Does China Debt-Trap Countries?

With the on-going debt crisis in Sri Lanka turning the spotlight on China’s lending practices, Beijing has been pushing back against allegations of what has been called “debt trap diplomacy”.

Many economies are reeling from the impact of the COVID-19 pandemic, which has worsened financial stress. Some of those countries, such as Sri Lanka and Zambia, were also the recipients of large Chinese loans.

China’s former central bank governor Zhou Xiaochuan acknowledged at a conference last month there were debt problems in partner countries, but rebutted suggestions that China had a motive in fomenting such crises.

“Most of [the lending] is for projects that companies in debtor countries have demanded, and at the same time they have economic benefits and are beneficial to the country in the long run,” he was quoted as saying by the Hong Kong-based South China Morning Post. “There is a certain degree of difficulty in this process and it must be carefully considered and designed to find a way to alleviate the debt problems of the countries along the belt and road, while avoiding suggestions that there are bad motives,” he said.

Experts have noted that while Chinese lending may have worsened debt problems in some countries, debt owed to China was in most cases dwarfed by what was owed to other lenders, including the World Bank and International Monetary Fund.

In 2020, Zambia became the first prominent default during the pandemic. As of the end of last year, the Post reported, its debt had reached $32 billion, or 120% of GDP. Chinese lending, however, accounted for 18% of that figure.

For Sri Lanka, that figure is even less. According to the Sri Lankan government, China accounted for 10% of the $35 billion outstanding external debt as of April 2021.

In both cases, Chinese debt appeared to be more the symptom than cause of the crisis, due to economic policies that led governments to seek short-term fixes or pursue projects they could not afford. Some governments turned to China because they could not find loans at similar terms elsewhere. In those cases, Chinese lending worsened, rather than caused, already concerning exposure. And the countries themselves sought out Chinese financing.

With the rise in Chinese lending particularly since the Belt and Road Initiative launched in 2013, a growing number of countries have exposure to Chinese debt. A 2021 study by AidData, a development research lab at the College of William & Mary in the U.S., found under-reported debts to the tune of $385 billion in projects carried out in dozens of countries under the BRI, and 42 countries now have levels of public debt exposure to China in excess of 10% of GDP.

From 2000 to 2017, Iraq ($8.5 billion), North Korea ($7.17 billion) and Ethiopia ($6.57) were the biggest recipients of Chinese assistance, while Russia ($151.8 billion), Venezuela ($ 81.96 billion) and Angola ($50.47 billion) were the biggest recipients of Chinese loans. India ranked 23rd in the list of top recipients of Chinese loans from 2000 to 2017, receiving $8.86 billion, according to the study.

If debt is rising and fuelling problems in partner countries, the gains for China are not, however, clearly apparent, as the “debt trap” theory suggests. In most of these cases, Chinese firms have had little to gain from loans that haven’t been repaid, and have ended up restructuring loans rather than take over assets.

Research by China scholars Deborah Brautigam and Meg Rithmire showed “Chinese banks are willing to restructure the terms of existing loans and have never actually seized an asset from any country, much less the port of Hambantota” in Sri Lanka, which is the most widely cited example of the “debt trap” theory.

This does not, however, suggest that Chinese lending is without problems. A study that analysed 100 contracts between Chinese state-owned entities and government borrowers in 24 developing countries in Africa, Asia, Eastern Europe, Latin America, and Oceania, conducted by Anna Gelpern at the Peterson Institute for International Economics, Sebastian Horn at the Kiel Institute for the World Economy, and others, found that one problem with Chinese contracts was “unusual confidentiality clauses that bar borrowers from revealing the terms or even the existence of the debt.”

Other research on Chinese lending suggests financing from China, rather than a coordinated plan by Beijing, has been haphazard and very poorly thought out, leading to losses for Chinese companies. As a study by Lee Jones of Queen Mary University of London and Shahar Hameiri at the University of Queensland for Chatham House noted, China’s overseas lending was “fragmented and poorly coordinated international development financing system”.

This is not unlike lending within China itself, where domestic debt has risen to alarming levels and regulators have been looking to tighten debt-fuelled growth and curb wasteful spending on projects that aren’t needed.

As the noted Beijing-based economist Michael Pettis observed recently, the debt problems faced by countries that received Chinese loans were more likely the result of “ineptitude”, rather than a consequence of “nefarious plotting”.  

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