Global risk of debt crisis with China rising alarmingly

China is the biggest creditor in the world and has invested huge capital for infrastructure projects in many developing countries under the condition that China will have the right to the raw material resources in borrowing countries. Studies done by USA and Germany have found that the risk of a debt crisis is rising alarmingly.

The Colombo Port City project in Sri Lanka, seen here, was funded by $1.4 billion from China.

The Colombo Port City project in Sri Lanka, seen here, was funded by $1.4 billion from China.

Debt trap

After five years of construction activities, the railway project in Laos, which will run through about 400km of jungle terrain, is expected to complete by 2021. This railway track will connect the border of China with the capital of Laos, Vientiane, over the Mekong river. Many bridges, tunnels, and water dams are being constructed to support the railway route.

“It will be complete on time as we are using 4,000 workers. There is a huge investment capital as the Chinese government has set aside USD 6bn for this project”, according to one Chinese contractor.

China, after all, isn't just directly financing 70 percent of the new train lain, it is also building dams, schools, military hospitals and has even launched a communications satellite into space for the country. In April, Beijing loaned Laos another 40 million dollars for road construction -- a credit that was provided through the multilateral Asian Infrastructure Investment Bank based in Beijing, a financial institution that China established as an alternative to Western development banks. 

China is currently the biggest creditor in Laos as well as other parts of the world. Chinese loans have incrementally controlled the global markets, from Kenya to Montenegro, from Ecuador to Djibouti. Many transportation systems, and power plants in developing countries are financed by China. These countries are indebted to paying back both principal and interest in coming years.

Some people believe that the billions of dollar investments of China should be appreciated as it is helping in developing the infrastructure in so many poor areas of Asia and Africa. However, these investments have made the economy and politics of these countries more dependent on China. Some people call this situation “a debt trap”.

Lack of transparency

According to Christine Lagarde, Director of the IMF, it’s very hard to find information on these loans made by the Chinese government. The foreign assets of China are currently estimated at USD 6,000bn. However, besides the Beijing government, no one knows where the huge money amounts are invested or the conditions and risks of these investments. The World Bank and IMF also do not know as China maintains a closed door and does not allow for any transparency.

Recently, a research team under the leading Professor Carmen Reinhart from Harvard University found a clearer picture. After a long time of analyzing all documents and information related to known and unknown loans of China, the study found that many poor countries in the world have accepted to borrow from China at bigger amounts than previously estimated. Most of these loans are linked with strict requirements which support the ambitious strategy of China and has created a high risk of default for many developing countries for future generations to come.

Some people think that Chinese investments have helped prevent a global economic recession after Lehman Brothers went bankrupt. However, this idea is still under a big controversy.
Christoph Trebesch from Kiel Institute said, “western countries do not understand how the strong growth of China has changed the international financial system”.

The statistics office of China only lists small loans while the real numbers are much bigger than actually seen. For example, Djibouti, a small country, borrowed a huge amount from China which is equal to 70% of its GDP. This ratio in Congo and Kenya is 30% and 15% respectively. These ratios are higher than that of the loans from western countries.

Ways to hide loans from China

While the western and multinational governments usually offer a low interest rate for a long period of debt, China loans at higher interest rate and for shorter maturity. To make sure that China will be able to collect the loans, China creates some terms in the contract that allow it to approach all natural and material resources or profits of several companies in the borrowing country.

The Chinese government usually transfers money directly to Chinese companies which sign the construction contracts with borrowing countries. In this way, China does not need to transfer money offshore.

Currently, over 75% of direct aid loans from China are being implemented through two national financial institutions, that of the Export Import Bank of China and China Development Bank. The Chinese government is given full reports and all information related to these funded projects. When a debt crisis happens in the borrowing countries, China is prioritized to get back all collateral assets.

This way may lead to big disputes or conflicts when the projects are not constructed on time or the borrowing countries are not able to pay back the debt. For example, China has control over the seaport in Sri Lanka after this country revealed its difficulties in paying the debt. In Ecuador, China owns 80% of oil revenue of this country, as compensation for a big project in this country which was financed by China. Zambia is at risk to lose Zesco, the national energy supplier because of debt of USD 6bn to China.

South Africa is going to fall into debt trouble with China as well. President Cyril Ramaphosa during his trip to China last autumn negotiated the terms of a contract to borrow EUR 24bn from China. People are afraid that South Africa will soon fall into a debt trap with China and lose Eskon, the national electricity company.

Risk of default

According to the study done by USA and Germany, China has hidden its loans by transferring money directly to Chinese companies which are operating in borrowing country. And most of the balance sheets of these companies are not calculated in government official statistics.

By this way, a huge amount of loans from China are hidden from the eyes of western governments and international institutions. The study of USA and Germany found that the real sovereign loans of China are 50% higher than the official numbers actually shown.

The amount that China loans to developing countries is much higher than the total loans that these developing countries borrow from industrialized western countries. Furthermore, most of these Chinese loans are linked with tight conditions and strict long term contracts.
The difference between official numbers and real numbers is very big in a country which has borrowed huge amounts from China. For example, the debt of Côte d'Ivoire with China is 4bn higher than the official debt. This debt difference in Angola is USD 14bn and in Venezuela is USD 33bn. As China mostly applies a high interest rate and increases it gradually over the years, this causes or leads to risk of default.

In 1970s, some big banks of USA, Europe and Japan also found ways to hide their loans in Latin and African countries. When the debt countries faced financial difficulties as the price of materials tumbled, these countries could not pay back the debt and fell into a debt crisis with their creditors, which later impacted these countries for many years.

Despite all this, the developing countries continue to agree to borrow huge debt amounts from China. This debt is estimated to be equal to the debt amount of 1980. Currently, there are some signs of a debt crisis. Pakistan recently has approached IMF to borrow money from this institution urgently as it is not being able to pay back debt of China. In Sierra Leone, the government of this country has postponed the airport project which is being financed by China.

Expansion of China in Africa

Although the loans from China are always linked with many risks, why do the developing countries still favor taking vast amounts, especially Africa? While Western governments always consider this area as unstable, China sees this as unexplored potential opportunity. About 1.6mn Chinese people are living and working in Africa, including business men, experts, technicians and traders. They have expanded the infrastructure in Africa at a remarkable speed. They have constructed water dams, airports, railways, industrial zones all over Africa. To compensate for these projects, China has full right to exploit their natural resources and markets.

Most countries in Africa need modern infrastructure to replace existing systems. According to Deborah Bräutigam, economist at John Hopkins University in Baltimore, about 17 African countries have already fallen into a serious debt crisis with China.

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