China’s Secret Lending to Developing Countries Poses Problems, Study Finds | Company | German economic and financial news | DW
China, the world’s largest public lender to developing countries, imposes unique conditions on borrowing countries that could give Beijing undue influence over their economic and foreign policies, according to a study by the German Kiel Institute for world economy (IfW) released Wednesday.
Study analyzes 100 Chinese loan agreements with 24 countries, the first systematic analysis of the legal conditions of China’s foreign loans, write the authors of the report. Produced with the support of several American research institutes, it compares the agreements concluded with Chinese public banks to 142 publicly accessible contracts from other major creditor countries.
The contracts in question “use a creative design to manage credit risk and overcome obstacles to enforcement,” the report’s authors conclude, revealing that China is “a strong and commercially savvy lender to developing countries.” .
Much of the loans were made under the China Belt and Road Initiative, an ambitious global infrastructure investment strategy involving more than 60 countries.
Sworn to secrecy
In these agreements, China’s state-owned finance banks set new lending terms or adapt standard terms to “go beyond maximizing trade advantage,” the researchers found.
“Such conditions can amplify the influence of the lender on the economic and foreign policies of the debtor,” the report said. He goes on to list several examples.
Over 90% of Chinese contracts reviewed include a clause that allows the creditor to terminate the contract and demand repayment in the event of a significant change in law or policy in the borrowing country. While policy change clauses are standard in commercial contracts, researchers argue that it takes on a different dimension when the lender is a state entity and not a private company subject to standard financial regulation.
The contracts also contain “confidentiality clauses of unusual scope,” the researchers found.
“Many contracts contain or refer to promises by borrowers not to disclose their terms – or, in some cases, even the fact of the existence of the contract,” write the authors, who have not been granted access to these. documents only through multi-year data. collection initiative led by AidData, a research laboratory at the College of William and Mary in Virginia, United States.
This secrecy prevents other lenders from reliably assessing a country’s creditworthiness. “More importantly,” the authors write, “citizens of lending and borrowing countries cannot hold their governments accountable for debts secret”.
A privileged position for China
The contracts also give China’s state-owned banks priority over other creditors. At the same time, many agreements give China “a lot of leeway to cancel loans or speed up repayment if it does not agree with a borrower’s policy.”
The severing of diplomatic relations with China is also classified as default and breach of contract. Policy changes in the recipient country can also trigger a breach of contract, forcing the debtor government to immediately repay the full loan amount.
In a normal case, the lender would choose to expedite principal and interest repayments, rather than requiring that the loan be repaid in full.
“Default triggers of the type we have identified in Chinese debt contracts potentially amplify China’s economic and political influence over a sovereign borrower,” the report said.
The researchers also found that 30% of contracts require countries receiving loans to deposit collateral in special escrow accounts, often held by a Chinese state-owned bank. Borrowing countries may also be required to deposit income from projects financed by these banks into these accounts. In the event of bankruptcy, the Chinese bank could then seize these assets. Only 7% of OECD bilateral creditors and 1% of benchmark multilateral creditors had similar stipulations, the report says.
We will always have Paris – where are we going?
The majority of contracts also prevent borrowers from accessing standard debt restructuring mechanisms. Almost three quarters of contracts contain an explicit “no Paris Club” clause. The Paris Club is an informal body of donor countries that meets if a country is struggling to pay its debts in order to find a way to cancel or restructure it. In such contracts, however, China explicitly requires borrowers to exclude Chinese lenders from collective restructuring initiatives.
Such a provision contradicts an agreement reached in November 2020 by China and other non-Paris Club G20 countries, which provided for roughly the same conditions for restructuring the debt of the most common sovereign borrowers. poor.
These opaque lending practices have taken on greater significance now that the global health crisis caused by COVID-19 has increased the risk of financial distress in countries heavily indebted to Chinese lenders. “In light of the high stakes, the terms and conditions of China’s debt contracts have become a matter of global public concern,” the report said.
However, not everyone agrees with this characterization of China as an aggressive lending shark.
“The notion of ‘debt trap diplomacy’ makes China an accomplice creditor and countries like Sri Lanka its gullible victims,” wrote Deborah Bräutigam, professor of international political economy at the School of Advanced International Studies. from Johns Hopkins University Meg Rithmire, Associate Professor at Harvard Business School, in an article for The Atlantic. The professors explain their argument by citing an example in which Sri Lanka borrowed money from Chinese banks to finance investments in an ill-fated port. China’s questionable lending practices can be attributed to growing difficulties, they say.
“China’s outward march, like its internal development, is exploratory and experimental, a learning process marked by frequent adjustments,” they wrote.
The authors of the latest study also point out that, in many ways, the loan terms of Chinese public lenders are a difference in degree, rather than nature, from those of commercial lenders and other official bilateral lenders. All creditors, whether commercial banks, hedge funds or others, will use “all legal, economic and political means at their disposal” to increase the likelihood of their being repaid, say the authors.
However, China’s contracts differ in the use of unique provisions which, while perhaps standard in the context of commercial debt, take on greater significance when it comes to government-to-government loans.