By Col. (Ret’d.) Siamelie Latu. Secretary General of the Tonga China Friendship Association, a former Tongan Ambassador to China, and Former Acting Secretary for Foreign Affairs.
Introduction
1. China is the world’s largest developing country. In its development, it has endeavored to integrate the interests of the Chinese people with people of other countries, providing assistance to the best of its ability to other developing countries within the framework of South-South cooperation to support and help other developing countries, especially the least developed countries (LDCs), to reduce poverty and improve livelihood. China has proactively promoted international development and cooperation and played a constructive role in this aspect.
2. When providing foreign assistance, China adheres to the principles of not imposing any political conditions, not interfering in the internal affairs of the recipient countries and fully respecting their right to independently choosing their own paths and models of development. The basic principles China upholds in providing foreign assistance are mutual respect, equality, keeping promise, mutual benefits and win-win for both parties.
3. In 2013, China gave its financing of infrastructure around the world a new narrative, billing it as a modern-day Silk Road, a reinvention of historic trading routes between Europe and Asia. Recently in 2018, China’s lending has brought another new name, the rather unflattering “debt-trap diplomacy”. This has become the center stage of discussion by some think tank organizations, strategic commentators and media. A controversial argument is that Chinese aid and lending are a threat to the Pacific nations’ sovereignty and to the influence of the West in the Pacific. Nevertheless, debt can play a useful role in financing development if there is due attention to ensuring debt sustainability as President Xi Jinping emphasized during the Second Belt and Road Forum held in Beijing in April 2019. President Xi stated that: “We also need to ensure the commercial and fiscal sustainability of all projects so that they will achieve the intended goals as planned”. The goal is “Working Together to Deliver a Brighter Future for Belt and Road Cooperation.” (https://eng.yidaiyilu.gov.cn/qwyw/rdxw/88232.htm) .
4. Chinese finance is attractive because it provides a free option for governments that wish to implement national projects of their own choosing. However, this offer creates emotional dimension, in comparison with Western finance, which is perceived to dictate terms and prescribed rigid, pre-approved models of development. The Belt and Road projects have brought effective investment to the relevant countries rather than the so-called debt trap, boosted economy and improved people’s livelihood (Xinhua Published: 28.10.2018).
5. Hence, this paper argues that the evidence to date suggests that China has not been engaged in deliberate ‘debt trap’ diplomacy in the Pacific, rather it emphasizes five key areas of cooperation:
- coordinating development policies;
- forging infrastructure and facilities networks;
- strengthening investment and trade relations;
- enhancing financial cooperation; and
- deepening social and cultural exchanges.
China’s Loan Philosophy and Practice
6. The Chinese people are diligent, wise, innovative and progressive. In traditional Chinese culture, concepts such as “moderate prosperity,” “great harmony,” “having ample food and clothing”, and “living and working on peace and contentment” fully reflect the Chinese people’s aspirations for and pursuit of a better, happier life. In the long course of history, the Chinese people have always striven for better, and shared development opportunities, conditions and benefits.
7. In 2014, during my tenure as Tongan Ambassador to China, I had the opportunity to meet the Chairman and President of China EXIM Bank Mr. Li Ruogu during the visit of the then Tongan Minister of Finance Mr. Sunia Fili to discuss Tonga’s loan and bridge project. The President encouraged Tonga to loan from China in order to build Tonga’s economy without paying much attention to the restriction given by the World Bank and Asia Development Bank. He said if Tonga builds a 2 km bridge and cannot afford to pay back the loan, does Tonga envisage China to destroy the bridge? No, he said, China has always striven for better, and shared development opportunities, conditions and benefits.
Example:
“‘A” borrowed from “B” 50,000.00RMB, the agreement between “A” and “B” is that “A” will pay back 1000RMB every month. “A” commences payment for six consecutive months.
After 6 months of payments “A” requests deferment of payment for two months as he cannot afford to pay school fees of his son. “B” agreed for deferment. After two months “A” continues payment for three months.
After three months, “A” requests that his father has just passed away if the payment of loan could be deferred again for another three months. “B” concurred. “A” continues payment after three months grace period.
8. In 2010 to 2012, during my tenure in Beijing, I recall China appropriated in total RMB 89.34 billion for foreign assistance in three types: grant (aid gratis), interest-free loan and concessional loan. (Information Office of the State Council July 2014, Beijing). The three types of foreign assistance are as follows:
- Grant is mainly offered to help recipient countries build small or medium-sized social welfare projects, and to fund human resource development cooperation, technical cooperation, material assistance and emergency humanitarian aid. In the three years, China provided RMB32.32 billion of grants, accounting for 36.2 percent of the total assistance volume;
- Interest-free loan is mainly used to help recipient countries construct public facilities and launch projects to improve people’s livelihood. In the three years, China offered RMB7.26 billion of interest-free loans, taking up 8.1 percent of its foreign assistance volume; and
- Concessional loan is mainly used to help recipient countries undertake manufacturing projects and large and medium-sized infrastructure projects with economic and social benefits, or for the supply of complete plants, machinery and electronic products. In the three years, the concessional loans China provided to other countries amounted to RMB 49.76 billion, or 55.7 percent of its total assistance volume in the same period.
9. Foreign assistance budget is put under the unified management of the Chinese Ministry of Finance in line with the budget and final accounts system. Concessional loans are raised by the EXIM Bank of China on the market. As the loan interest is lower than the benchmark interest released by the People’s Bank of China, the difference is made up by the state as financial subsides.
10. Tonga’s concessional loan of TOP$119 million from China to help with the reconstruction of Nuku’alofa Central Business District has been deferred for five years. This deferral had no connection whatsoever to the signing up to the China’s Belt and Road initiative MOU. Tonga cannot continue to ask for deferral. The example as stated above suggests that the Tongan government must at least pay its loan for at least number of years. There is no such thing as you loan from someone and the next day you ask for forgiveness. Tonga can request meetings with Chinese officials to discuss options when they lack repayment capacity. Loan extension is the most practical option. Beijing may extend the repayment period in consideration of bilateral relations and the financial situation in the recipient country, as in the case of Tonga.
11. It is extremely difficult for China to write off concessional loans. First and foremost, concessional loans are borrowed by the China Export-Import Bank (China Exim Bank) from the capital market and need to be repaid. Second, setting a precedent could be risky. Writing off one country’s concessional loans may lead to other countries raising similar requests.
12. Turning concessional loans into interest-free loans or grants involves a complicated bureaucratic process to a great extent, to write off concessional loans ‘is not an issue of affordability for China, but of bureaucratic complexity’ (Zhang, D. 2018. Chinese Concessional Loans Part 1 — Perceptions and Misperceptions. In Brief 2018/23. Canberra: ANU). When Chinese concessional loans become due and the recipient country has difficulties in making repayments, they are required to notify China Exim Bank as early as possible. Bank officials will report this to the Chinese government, especially the ministries of Finance and Commerce.
13. The Chinese side is well aware of the Tongan government debt obligation and its potential adverse implication to the Tonga national development if the debt services become unbearable. Both governments are constantly reviewing the fiscal and debt situation. China is willing to assist Tonga in making sure that its loan commitments would not endanger its macro economic and fiscal stability. China can assist with the extension of the grace period for loan repayment and also other forms of concession.
Pacific Islands’ Debt Along Belt and Road Initiative
14. There are six Pacific Island Countries currently debtors to China: Cook Islands; Fiji; Papua New Guinea; Samoa; Tonga; and Vanuatu, although only Papua New Guinea and Vanuatu have taken on new Chinese loans since 2016. This implies that the issue of China’s impact on debt sustainability in the Pacific will gradually grow in years to come. This can be justified by the very large loan-financed projects are officially in the pipeline in Papua New Guinea and Vanuatu. Moreover, the six Pacific governments currently indebted to China officially signed up to the BRI in late 2018 joining around 130 other countries. It shows that these Pacific governments remain interested in further financing from China. Thus, it is most likely that Chinese lending may also expand to more countries in the region as most Pacific Islands look to maximize the amount of external financing available to them in particular, Solomon Islands and Kiribati both announced a switch in diplomatic relations from Taiwan to China.
15. The Belt and Road projects have brought effective investment to the Pacific Island Countries (PICs) rather than the so-called debt trap, boosted local economy and improved people’s livelihood. The Chinese debt model of financing has wrongly been perceived as a “debt-trap”, rather it focuses on investment projects that result in direct returns for the local population of the country they are investing in. The debt issues of some countries are not necessarily connected with the Belt and Road construction and relevant projects, as those countries have been heavily borrowing from other countries and international financial organizations and thus are highly indebted. China is a late comer to the Pacific Islands. It is not the biggest creditor.
16. When making investment or financing Belt and Road projects, China always sticks to an economic benefit-oriented approach, extending loans based on the real conditions of the relevant countries, supporting projects construction and avoiding creating more debt risks or increasing fiscal burdens of the countries. Before financing a project, Chinese banks always scrutinize the liabilities and debt paying ability of borrowers. After loan extension, they continue to monitor country risks and sovereign risks. (Xinhua Published: 28.08.2018).
Advantages of the Chinese Debt Model
17. There is a perception that China is a new imperial power threatening some of the developing economies in Asia, Africa and Oceania. This is a perception that is being promoted by certain China watchers in universities and think tanks mainly in the West, various politicians and by a segment of the global NGO community.
18. The peddlers of this perception argue that by giving out loans for development to poor countries, China is snaring them in a debt trap. It is a trap to ensure that they are perpetually under China’s control. This view is contradictory to the practical aspects of China’s lending practices in the PICs and elsewhere, such as in Asia and Africa. Pakistan for example, has taken loans from China for projects under China Pakistan Economic Corridor (CPEC). The US$50 billion CPEC is a network of infrastructure projects that are currently under construction throughout Pakistan that will connect China’s Xinjiang province with Gwadar port in Pakistan’s Balochistan province. A number of these projects will strengthen Pakistan’s energy sector that is vital for its economic growth
19. Pakistan’s largest creditors are not China but Western countries and multilateral lenders led by the IMF. Its foreign debt “is expected to surpass US$95 billion in 2018 and debt servicing is projected to reach US$3 billion by 2022 – 2023. There is evidence to show that its creditors have been actively meddling in Pakistan’s fiscal policies and sovereignty through debt rescheduling programs and the conditionalities attached to IMF loans. The media does not highlight this. Neither does it inform the public that CPEC loans are for projects that are of immense and direct value to the Pakistani people (Dr. Chandra Muzaffar Star Online 24.10.2018).
20. There is also false accusation and distortions and half-truths have also colored media accounts of China’s relationship to the Sri Lankan port of Hambantota. The construction of the port was a Sri Lankan idea, not a Chinese initiative. The Sri Lankan government reached out to the World Bank, Asian Development Bank and Japan, among others, to finance its construction but was turned down. It was only then that the government approached China, which agreed to help. Similarly, Tonga reached out to its traditional partners to finance the reconstruction of Capital Business District of Nuku’alofa after the riot in 2006 but it was not successful. It was only then that the government of Tonga approached China which agreed to offer assistance.
21. The Chinese-built port in Sri Lanka was opened for commercial use in 2010. Unfortunately, usage was below par. Consequently, due to poor revenue, the Sri Lanka Ports Authority was forced to sign an agreement whereby a Chinese state-run enterprise “took a 99-year lease of 70% of the port and 85% ownership of the port and industrial area with the obligation to continue investing in upgrading the facilities there. The purpose of this deal was to relieve Sri Lanka of the burden of this debt.
22. In the case of Malaysia, which witnessed a change of government in May 2018, major infrastructure projects funded by Chinese state companies could not be implemented because the nation was in a financial crunch. Besides, there are also some problems with the projects. Prime Minister Tun Dr. Mahathir Mohamad however made it very clear that the problems was due more to the previous Malaysian government than its Chinese counterpart.
23. From the three cases in Asia, it would be patently wrong to label China a new imperial power. A quick look at Africa will reinforce this view. The majority of African debt is not held by China but by Western countries and such Western-backed institutions as IMF and World Bank.
24. Similarly, China is the single largest creditor in Tonga, Samoa, and Vanuatu. However, it is only in Tonga that China accounts more than half of total outstanding debt. Elsewhere, either traditional official lenders or domestic creditors dominate. Meanwhile, China is not an active lender to the rest of the region, which remains dominated by traditional creditors, notably the Multilateral Development Banks (MDBs). With the important exception of Tonga, China is currently not a dominant creditor in the Pacific (Rajah, Dayant, and Pryke Oct 2019)
25. According to the analysis by Lowy Institute, it suggested that China’s lending practices in the Pacific have not been so problematic as to justify accusations of debt trap diplomacy. Again, some analysts are dismissive of the China debt trap narrative, concluding that such concerns are without foundation. Academics at the Australian National University have refuted the China debt trap narrative based largely on the limited share of debt owed to China compared to other creditors across the Pacific and the circumstances, particularly in Tonga, in which large Chinese loans came about.
26. Overall, it is clear that rising debt risks in the region, as assessed by the IMF, have been driven by a multitude of factors, rather than by Chinese lending alone.
Avenue of Approach for the Pacific Islands
27. Pacific governments are clearly in the driver’s seat as to whether their own borrowing policies are sustainable and in using their limited debt space wisely for the best projects on the best terms. The major priority lies in strengthening their own fiscal and infrastructure management institutions, for which development partners can also usefully provide technical support, capacity building, and policy-linked budget support to reinforce reform. PICs nations also have an opportunity to use the current climate of competition among major powers to their advantage, for example by pushing for more concessionality (including more grants), better project management, and more responsiveness to local priorities.
Avenue of Approach for China
28. According to the research conducted by Lowy Institute, their findings show that a continuation of business as usual for bilateral Chinese lending in the Pacific would quickly give rise to potential debt sustainability problems. China will therefore need to reconfigure its approach significantly if it wants to disprove the debt trap accusations made by its critics.
29. China has begun exercising greater caution over the potential debt sustainability implications of the BRI and taken a number of initial steps to address this. China has supported an IMF training centre to help improve the debt management capacity of countries involved in the BRI, and China’s Ministry of Finance has agreed with major multilateral financing institutions to establish a new cooperation platform.(https://www.aiib.org/en/about-aiib/who-we-are/partnership/_download/collaboration-on-matters.pdf). In 2017, China also committed itself to the G20 Operational Guidelines for Sustainable Financing and in 2019 to the G20 Principles for Quality Infrastructure Investment, both of which contain debt-related provisions including complying with World Bank and IMF policies for countries where debt sustainability is already a concern.(https://www.bundesfinanzministerium.de/Content/EN/Standardartikel/Topics/world/G7-G20/G20-Documents/g20-operational-guidelines-for-sustainable-financing.pdf?__blob=publicationFile&v=1 ).
30. These commitments will require concrete action from China to operationalize it. China’s Ministry of Finance has issued a new BRI debt sustainability framework (BRI-DSF), modelled on that of the IMF and World Bank, to guide BRI-financing activities in less-developed countries. Yet, the BRI-DSF remains a “non-mandatory policy tool” and provides little guidance as to how Chinese financial institutions are expected to alter their behavior in response to identified debt sustainability risks.
31. To resolve this, China should adopt formal lending rules similar to those of the MDBs. These could mandate the use of the BRI-DSF by China’s policy banks, notably EXIM Bank, when undertaking sovereign lending to less-developed countries, and require the provision of more concessional financing to countries at greater risk of debt distress. For example, where countries are deemed to be at low risk, standard concessional EXIM loan terms might be appropriate. For those at moderate risk, more concessional loans could be provided, involving a larger interest subsidy from the Ministry of Finance. China could also employ alternative approaches, such as blending EXIM loans with grants from the Ministry of Commerce (MOFCOM) or replacing EXIM loans with interest-free MOFCOM loans (an existing instrument). For countries at high risk, China would ideally only provide grants via MOFCOM.
32. Implementing such formal lending rules would offer certain advantages for China. By applying only to China’s policy banks and MOFCOM, it would be relatively straightforward to implement and require only modest additional coordination efforts. This approach would cover the majority of what might be considered Chinese development finance, therefore bringing China into a substantially more analogous position to traditional development financiers. It would also encourage much greater cooperation and coordination between China, the IMF, and other official creditors — with greater information sharing also potentially helping to reduce some of the geopolitical tensions surrounding the BRI. Ideally, the results of the BRI-DSF would be made publicly available to enhance overall transparency.
33. Ad hoc debt restructurings (as has been China’s approach globally) are also not a panacea should future debt problems emerge. Uncertainty about future debt restructuring can itself undermine prudent management. The case of Tonga is an example, in which China has twice agreed to defer debt repayments, but in a way that risks creating short-term debt-servicing problems only a few years down the track. To reduce these problems, China should set out a clear policy framework for its approach to debt restructurings, and cooperate closely with other official creditors in its approach. Ideally, China should join the longstanding Paris Club group of official creditors (currently it is an observer) or establish some new arrangement.
Conclusion
34. The Chinese debt model of financing has wrongly been perceived as a “debt-trap”, rather it focuses on investment that result in direct returns for the local population of the country they are investing in.
35. China’s Belt and Road Initiative has raised important questions about the risk of debt problems in less-developed countries. The risks are serious for the small and fragile economies of the Pacific. However, the analysis finds a different picture. The evidence to date suggests China has not been engaged in deliberate ‘debt trap’ diplomacy in the PICs. The Belt and Road projects have brought effective investment to the relevant countries rather than the so-called debt trap, boosted local economy and improved people’s livelihood.
36. Moreover, the debt issues of some countries are not necessarily connected with the Belt and Road construction and relevant projects, as those countries have been heavily borrowing from other countries and international financial organizations and thus are highly indebted.
37. Finally, if China wants to remain a major development financier in the Pacific, it will need to substantially restructure its approach, including by adopting formal lending rules similar to those of the multilateral development banks.
