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HomeGeopolitical CompassEast AsiaChina, International Competition and the Stalemate in Sovereign Debt Restructuring: Beyond Geopolitics

China, International Competition and the Stalemate in Sovereign Debt Restructuring: Beyond Geopolitics

Author: Shahar Hameiri and Lee Jones

Affiliation: University of Queensland, Queen Mary University of London

Organization: International Affairs

Date/Place: March 4, 2024/ UK

Type: Journal Article

Page Number: 20

Link: https://doi.org/10.1093/ia/iiae017

 

Keywords: Chinese Debt-trap Diplomacy, Global South Development Financing, Global South Debt Crisis, Political Economy, Age of Choice

 

Brief:

There has been a shift from an era of supposedly wide range of choices for development financing for sovereign borrowers in the global South to a current state of widespread debt distress. Despite expectations that increased competition among lenders, especially with the emergence of non-traditional providers like China, would benefit developing countries, the reality is starkly different. The recent surge in sovereign defaults, sluggish debt restructuring negotiations, and the lack of attractive bailout offers challenge previous notions of borrower empowerment. Thus, in this article, the authors question why the proliferation of lenders and heightened competition, once seen as advantageous, has now become detrimental. They suggest that geopolitical rivalries, such as China’s Belt and Road Initiative (BRI), may not be leading to expected outcomes like competitive restructuring terms or debt-trap diplomacy. This raises important questions about the evolving dynamics of global development financing and the complexities facing indebted nations today.

 

The authors challenge the prevailing geopolitical narrative of the “age of choice” in development financing, arguing instead for a political economy perspective. They find limited evidence to support the idea that traditional donors increased aid in response to Chinese competition, with commercial bond markets emerging as the primary competitors, suggesting that the lending boom was less about geopolitics and more about favorable conditions in China and global financial markets, including US-led quantitative easing. China’s BRI lending was largely commercially driven, aiming to externalize overcapacity and capital accumulation. Loose monetary policies post-2008 financial crisis encouraged riskier investments, while high commodity prices and debt forgiveness reduced perceived lending risks. As conditions changed, financing flows tightened, leading to increased debt distress for many countries. Both authors emphasize the role of commercial motives and fragmented governance within Chinese lending institutions in shaping China’s stance on debt restructuring. They argue that the primary concern for Chinese lenders is economic competition with other creditors, such as multilateral development banks (MDBs) and commercial bondholders, rather than geopolitical rivalry with Western states. Chinese banks prioritized profitability in their lending practices and lacked mechanisms for accommodating loan “haircuts” or sharing restructuring losses, unlike Western creditors. This situation leads to prolonged negotiations and stalemates in debt restructuring, exacerbated by Western resistance to burden sharing with commercial lenders and MDBs. 

 

The emergence of an “age of choice” for developing countries in the early 2010s was marked by a significant shift in development financing sources. The authors highlight the rapid growth and diversification of funding, with notable increases in non-concessional lending from China and international financial markets. This shift prompted scholarly interest in competition among finance providers and its implications, particularly focusing on the dynamics between traditional aid providers and China amidst rising geopolitical tensions. Scholars explored how this competition empowered recipients vis-à-vis traditional donors and prompted traditional donors to counter China’s influence by increasing generosity.

Western aid historically promoted economic liberalization through conditionalities, often seen as intrusive by recipient countries. In contrast, Chinese financing, primarily non-concessional, focused on large-scale infrastructure projects without stringent governance or economic reform conditions. This approach attracted recipients due to its speed and flexibility, contrasting with the slow-moving Western donors. China’s behavior, seen through a geopolitical lens, sparked debates about its challenge to established practices and accusations of “rogue aid” or “colonialism.” Western policymakers and scholars raised concerns about debt sustainability, governance, and China’s influence on global development architecture, especially with initiatives like the BRI and the Asian Infrastructure Investment Bank seen as challenges to Western-dominated institutions like the World Bank and the Asian Development Bank.

The notion of “debt-trap diplomacy” attributed to China, whereby Chinese loans allegedly lead countries into unsustainable debt to gain strategic advantages or extract concessions, is quite controversial according to the authors. Experts view the claim, which originated from Indian think tanks and is widely echoed in Western policy circles, with skepticism. US President Joe Biden labeled China’s BRI as a “debt and confiscation program,” while European leaders expressed concerns about Chinese hegemony and recipient countries becoming subservient. The authors argue that China’s challenge prompted changes in traditional donors’ approaches, leading to a “Southernization” of development assistance and a shift towards emphasizing economic growth and infrastructure development. Traditional donors, through initiatives like Japan’s Partnership for Quality Infrastructure and the G7’s Build Back Better World, aim to offer alternatives to BRI financing. This geopolitical competition is seen as empowering recipients by providing them with more policy space and reducing conditionality, although it also raises questions about governance and democratic effects associated with different sources of financing. The current sovereign debt restructuring stalemate in the context of the previous “age of choice” in development financing has a paradoxical nature. The authors question why the abundance of creditors, once seen as empowering borrowers due to geopolitical competition, has not translated into better restructuring deals for struggling debtor countries. Despite intensifying US-China geopolitical competition, with some heralding a new Cold War era, China’s behavior in debt negotiations does not align with expectations of geopolitical strategies such as debt-trap diplomacy. For instance, it has not offered substantial debt relief or lenient terms, instead prioritizing full repayment and seizing collateral, resembling a yield-maximizing investment manager rather than a geopolitical power player. This approach has complicated IMF restructuring efforts and prolonged debtors’ distress without evidence of asset seizures or extortion. 

 

The authors propose a shift from geopolitical analyses to political economy perspectives to explain the lack of an “age of choice” in debt restructuring amid ongoing great-power competition. They argue that earlier Chinese lending stemmed primarily from economic and commercial motives, aiming to address domestic issues like overcapacity, falling profitability, and capital accumulation by externalizing demand for Chinese goods and services through loans. This lending was mostly commercial, facilitated by fragmented governance arrangements favoring approvals. The post-global financial crisis environment, along with high commodity prices, also fueled borrowing from China and international bond markets. Today, Chinese lenders remain commercially driven, prioritizing debt recovery and avoiding write-downs that would benefit rival creditors like MDBs and bondholders, rather than geopolitical rivals. The lack of systematic mechanisms to compensate or compel Chinese lenders regarding losses prolongs negotiations, leading to ad hoc restructuring processes.

 

China’s lending practices are primarily driven by commercial motives rather than geopolitical ambitions. While China does have a smaller aid program driven by political and diplomatic goals, its larger non-concessional lending is mainly commercially oriented. This lending surge is a product of China’s post-2000 “going out” policy, encouraging Chinese firms, especially state-owned enterprises (SOEs), to seek resources and markets abroad due to domestic saturation and dwindling supplies. The BRI was a strategic expansion of this pre-existing activity, with geopolitical considerations  secondary drivers. China’s economic challenges, such as overcapacity from years of investment-led growth and declining profitability, were key factors prompting these lending practices. The global financial crisis further exacerbated these challenges, leading China to prioritize infrastructure investments and overseas expansions. Thus, China’s lending behavior is rooted in economic imperatives rather than solely geopolitical ambitions, shaping its approach to debt restructuring and global economic engagement.

Contrary to a purely geopolitical agenda, the BRI’s development and oversight was led by China’s National Development and Reform Commission, which emphasizes economic planning and industrial upgrading. Provincial governments also played a role in shaping BRI projects to align with their economic interests. The surge in Chinese development financing was facilitated by a permissive regulatory environment and fragmented governance, with multiple agencies focused on supporting Chinese businesses’ global expansion. Key entities like Eximbank and CDB operated as profit-oriented, quasi-autonomous actors, making lending decisions autonomously based on market principles rather than government directives. China’s political economic context, coupled with limited oversight of outbound financing and moral hazard assumptions regarding loan repayments, contributed to extensive commercial-rate lending with recipient-state guarantees, often misinterpreted as purely government-driven projects.

Lax oversight and favorable global conditions initially fueled Chinese lending, driven more by economic imperatives than geopolitical strategies like “debt-trap diplomacy.” As such, the BRI projects were influenced by industrial overcapacity and provincial economic interests rather than official policy corridors. However, concerns over environmental issues, corruption, and debt traps led to regulatory tightening and reduced enthusiasm for overseas lending by Chinese policy banks. Simultaneously, developing countries benefited from favorable global conditions such as commodity price booms and post-financial crisis liquidity, which boosted their borrowing capacity and confidence in contracting Chinese loans. Yet, changes such as US quantitative tightening and currency fluctuations led to debt distress for borrowers, contributing to the decline in Chinese lending. Ultimately, the authors argue that the “age of choice” in lending stemmed more from China’s economic challenges and global financial conditions than from geopolitical competition. 

Chinese lenders prioritize repayment over geopolitical advantages, viewing rival creditors like MDBs and commercial bondholders as their main competitors rather than geopolitical adversaries. This stance, influenced by governance fragmentation, contributes to the deadlock in debt restructuring negotiations. The authors emphasize that debt restructuring hinges on burden sharing among creditors, determining who will take haircuts to make debt repayments sustainable. This process traditionally involves assessments by the IMF, negotiations with creditors based on specified reductions, and eventual financial assurances to resume payments. The Paris Club norms aim for comparable treatment among creditors to address collective action problems, highlighting the complexities and challenges in debt restructuring processes involving diverse lender groups.

China typically only forgives interest-free loans, which are often financed through past fiscal allocations, according to the authors. For commercial loans, Chinese lenders prioritize full repayment of principals, occasionally offering payment pauses or extended maturities but rarely reducing interest rates. This stance reflects their profit-seeking nature and aversion to losses, evident in loan agreements that prioritize repayment safeguards and exclude loans from Paris Club provisions for comparable treatment in restructuring. Despite narratives of “debt-trap diplomacy,” Chinese lenders are generally uninterested in taking over failing debt-financed projects, as this would burden them with unprofitable ventures. The fragmented financial governance in China allows lender motives to dominate, with no compensation system for loan write-offs and no clear decision-making process for negotiating terms with creditors, leading to prolonged negotiations and inter-agency conflicts. While some Chinese agencies recognize potential negative consequences for China’s global reputation, they have limited influence in practical implementation, where lenders’ self-interest prevails. Chinese lenders are concerned about unfair burden sharing in debt restructuring efforts, especially regarding private creditors.

 

While Chinese officials resist demands for extensive debt relief, citing the significant debts owed to MDBs and private lenders, they argue that private creditors often act in predatory ways, contributing to widespread debt distress. Evidence shows that official creditors have accepted larger debt reductions than private ones historically, with Paris Club agreements averaging 60% versus 40% for private creditors. Despite participating in the Debt Service Suspension Initiative (DSSI) with repayment pauses, China emphasized rescheduling over debt write-offs, aligning with its commercial lending priorities. Chinese commercial banks, including Eximbank and CDB, claimed exemptions based on their lending classifications, providing less official relief than Paris Club lenders but more than private creditors, ultimately shaping debt restructuring dynamics and borrower-creditor relationships. Thus, the authors argue that there are challenges in implementing the Common Framework for debt restructuring due to the resistance of China’s commercially-oriented lenders to significant haircuts. Chinese officials called for fair burden sharing among all creditors but faced obstacles as Western states expanded MDB lending without ensuring comparable treatment for private creditors. Private lenders often secured favorable terms, prompting Chinese lenders like Eximbank to hinder debt relief efforts. For instance, in mid-2021, Eximbank opposed a third round of commercial debt repayments, highlighting competitive dynamics. Similar tensions delayed Zambia’s debt restructuring, with Chinese lenders pushing for prioritizing commercial debts. Bondholders resisted, fearing that their relief might benefit Chinese loans, eventually leading to Zambia defaulting. Although agreements were reached, Chinese debts remained commercially classified, underscoring the ongoing challenges in achieving fair burden sharing and comparable treatment among creditors.

 

The role of private creditor obstruction is significant in Chad’s debt relief process under the Common Framework, initiated in January 2021. Chad faced challenges servicing a substantial loan from Glencore, a Swiss multinational, amounting to a third of its external debt and which was tied to oil export revenues that plummeted during the COVID-19 pandemic. Despite the IMF’s proposed measures and agreement from official creditors, including China, Glencore resisted comparable treatment, extracting $600 million in repayments until November 2022 when a compromise was finally reached due to rising oil revenues and ongoing debt repayments. This case raised concerns about the accuracy of IMF Debt Sustainability Analyses (DSAs) and highlighted the unequal burden-sharing with private creditors, as seen in Suriname’s restructuring in 2023 outside the Common Framework. Bondholders negotiated significantly lower haircuts and gained unprecedented rights to future oil sales, echoing criticisms of China’s debt deals.

 

When it comes to Sri Lanka’s debt dynamics, the authors challenge the ‘debt-trap diplomacy’ narrative regarding China’s lending practices. They note that while Chinese loans did contribute to Sri Lanka’s debt distress, the country’s commercial borrowing and high interest costs were equally significant factors. Contrary to the narrative of asset seizure, China facilitated a lease agreement for Hambantota Port, directing proceeds toward debt servicing without a debt-for-equity swap. Despite Sri Lanka’s subsequent debt distress and significant commercial creditor burdens, China did not provide substantial rescue funding, unlike India’s proactive assistance. In debt restructuring talks, Chinese lenders prioritized loan recovery and resisted burden-sharing, leading to delays in IMF disbursements and exacerbating Sri Lanka’s economic crisis. This commercial stance contrasts with geopolitical narratives, emphasizing Chinese lenders’ self-interest over strategic leverage or client support, while other actors like India gained geopolitical influence through more generous aid.

 

The authors in this article challenge the realist perspectives on lending and debt politics, arguing that the assumption of coherent, geopolitically driven state actions is flawed. They assert that economic and commercial logics play a stronger role, given that state logics are more fragmented. The rise of commercial lenders, both Chinese and Western, in the global South is attributed to economic conditions and fragmented financial governance in China. The authors highlight Chinese lenders’ primarily commercial motives as they navigate competition with MDBs and bondholders, impacting China’s standing in the global South. Despite alleged geopolitical ambitions, China’s fragmented governance often leads to outcomes that are inconsistent with national interests, hindering multilateral cooperation and eroding public support. Western states’ refusal to address reckless commercial lenders further perpetuates the standoff, limiting progress on multilateral debt relief. This dynamic suggests that developing countries remain vulnerable to international capital movements, with the potential for the poorest societies to suffer the most in a more ‘realist’ world, reminiscent of Cold War dynamics.

 

By: Sara El Souhagy, CIGA Research Assistent

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