The COVID-19 pandemic has put enormous stress on many of the world’s government budgets. The world’s poorest countries in particular are often not in a position to spend resources fighting the pandemic and repay their debts at the same time. China is the world’s largest bilateral lender, so how it negotiates with borrowers in distress has significant bearing on borrowers’ ability to recover.
So far, Beijing and most other national governments have taken only small steps. The Group of 20 (G-20), a grouping of major economies including China, agreed in April 2020 to suspend many developing countries’ debt payments through the end of the year. The problem is that interest will continue to accrue in the interim, and most borrowers will probably not be in any better financial position come January. China has offered, if necessary, to write off zero-interest loans to “relevant African countries,” but zero-interest loans account for no more than five percent of lending in Africa and no more than two percent globally.
More action will be necessary. What form that takes remains an open question. In some instances, multilateral action will take care of problems with or without major Chinese input. The International Monetary Fund (IMF) has already been active about aiding countries in need, but often focuses on the borrowers with which it has stronger relationships. The G-20’s debt suspension covers a slightly broader footprint, but a suspension of repayments is a somewhat weaker mechanism than an actual loan. Where these options fall short, China will have to act on its own. In these cases, debts can be written off, converted into equity stakes, or restructured.
I look at these options in three steps. First, I introduce China’s most important domestic constraint:a public that has serious doubts about giving too much money away overseas. Second, I look at the multilateral organizations that are likely to get involved. Third, where multilateral help is insufficient, I look at what China can do bilaterally. I find that incremental restructuring is a much more likely outcome than outright forgiveness or debt-equity swaps.
A Rock and a Hard Place
China undoubtedly faces international pressure to do more to relieve lower-income borrower countries’ financial strain, and the raw mathematics of the pandemic do not favor easy repayment. But the Chinese government faces an important countervailing force: its own citizens. The Chinese public is primarily concerned with fighting poverty at home and is not entirely supportive of committing resources overseas. One survey found that on a scale of one (supports using resources at home) to ten (supports foreign assistance), the average Chinese citizen scores a 2.7. This figure falls even farther for those with lower income, less education, or residency in the less-developed, inland western provinces. In other words, the people who have benefited least from China’s coastal-heavy growth boom worry about the government spending money overseas instead of on their regions’ development.
The government is painfully aware of this problem, and many official statements are tailored to address it. One Ministry of Commerce release entitled “Why is China Helping Build Up Africa?” is particularly telling:
Every year, China sends over 60 billion dollars to Africa, but China still has many poor places. Why doesn’t China send the money to these poor areas? […]
First, we want to clarify that China’s so-called “aid” to Africa isn’t non-reimbursed money, but borrowed money. Africa not only pays it back, but repays with interest!
In other words, commitment of money to poorer countries is presented as acceptable because it turns a profit for China. This is the doctrine of “win-win” (共赢)—the partner country and China both gain.
Not all projects, of course, are profitable. China does not publish reliable records of its official projects overseas. Where projects go bad, opacity makes it easier to keep them out of the public eye. Partially for this reason, Chinese officials have to date publicly favored bilateral negotiations. Multilateral negotiations often require the disclosure of bad debts owed to China. This would be embarrassing for any government, but particularly so for China because of heightened domestic sensitivities.
That being said, borrowers will sometimes want to negotiate multilaterally, and China cannot exactly stop them. Say, for example, that a borrower is concerned with what COVID-19 means for its finances and owes most of its debt to the World Bank, China, private bondholders, and several European countries. If the borrower chooses to go to the IMF, and the rest of the creditors are supportive, then negotiations will proceed regardless of China’s preference for bilateralism. In any event, China would financially benefit from an IMF bailout along with the rest of the creditors.
While Beijing may generally prefer bilateral negotiations away from the public eye, it will not and probably cannot stand in the way when a majority of international stakeholders favor coordinated action. This happens in two forums of note of which China is a member. First, the IMF’s core mission is to provide financial stability via loans to countries in distress. Second, the Debt Service Suspension Initiative (DSSI)—a COVID-era initiative endorsed by the G-20, IMF, and World Bank—has already played a leading role in multinational coordination efforts by suspending some debt payments due to G-20 members through the end of the year. Further action through the IMF or DSSI are both workable options from China’s perspective but come with different strengths and weaknesses.
The IMF has better control of financial resources to put to work toward relief. Its basic business model resembles a shareholder corporation: national governments contribute funds to a central pool according to a quota system which in turn determines their voting power. They then vote to allocate new loans to distressed governments. This provides a leg up over the DSSI, which is more ad hoc in nature and does not actually control any money. The DSSI simply involves suspending existing bilateral payments and does not provide any new credit.
The IMF’s downside for China, though, lies in its allocation of voting power. China is the IMF’s third-largest shareholder. This gives it a degree of clout in IMF decision-making but not an overwhelming one. China’s 6.08 percent of voting power still falls behind Japan’s 6.15 percent and well behind the United States’ 16.51 percent. When taken as a bloc, EU members total another 25.6 percent.
In practice, the IMF has been directing funds more to countries with which it already had strong relationships. Of the countries which have reported data to the World Bank’s COVID-era debt suspension database, twenty-eight have been deemed to be either “in distress” or at “high risk” thereof. Of these, twenty-one owed less money to China than to the combined IMF, World Bank, and three largest multilateral development banks. Every one of these twenty-one has received at least some COVID-related assistance from the IMF.
The remaining seven owe more to China than to the major multilateral organizations. Only three of these seven have received IMF assistance. Those missing out on IMF help are Laos, the Republic of the Congo, Tonga, and Zambia, all of which have staked their bets on heavy borrowing from China instead of the more conservative financial strategy usually advised by the IMF. The Republic of the Congo received an IMF bailout in July 2019, but the other three show gaps in IMF coverage where China has the most at stake.
These countries, though, do participate in the DSSI, meaning that they benefit from the repayment moratorium. Justin Yifu Lin, a former Chief Economist of the World Bank and one of Beijing’s leading voices on international development, has advocated for the moratorium’s extension beyond its initial expiration at the end of 2020:
The Chinese government is realistic and also pragmatic. It understands the need for some kind of new arrangement to postpone some of the repayment, and the Chinese government understands six months is not enough. We need to give the countries with debt some time to come back to a normal situation before they can consider the repayment of the capital or interest.
The economic pain from COVID-19 is not going to be over by the end of the year. If other members of the G-20 are similarly inclined, the moratorium could be extended as appropriate. Still, barring further action, this may not be enough by itself. Suspension does not prevent interest from accruing in the interim. Some borrowers may never be fully able to repay their pre-COVID debts.
What’s more, some borrowers do not participate in IMF programs or the DSSI. The DSSI has understandably focused on countries with the greatest need. Of the 29 countries classified by the World Bank as low-income, all but four participate in the DSSI. 37 out of 50 lower-middle income countries also participate. But only 12 of 56 upper-middle income countries participate, and not all will necessarily be able to pay their debts. Upper-middle income countries such as Colombia and Peru have already received IMF help, but some will not. Countries like Russia and Venezuela are in difficult economic situations and owe substantial amounts of money to China but do not exhibit the patterns of economic governance typically favored by the major multilateral organizations. Neither is a member of the DSSI, nor can either expect much help from the IMF. Others, like Ecuador, have received IMF loans but are not part of the DSSI and have had to negotiate bilaterally with China for further assistance. Even in the lower income brackets, the absence of Sudan and Zimbabwe from the DSSI presents a challenge for Beijing.
Where multilateral action is insufficient, China may have to act bilaterally.
To the degree that China can address its issues bilaterally, it could write off debt, convert it to equity, or restructure it. Of the three, restructuring will be most prevalent. This section explains why.
Major write-offs are probably a non-starter. Xi’s aforementioned announced forgiveness of zero-interest loans was limited to a small category of lending which has been disproportionately written off in the past. Zero-interest loans are handled by the government proper via the Ministry of Commerce and were never really meant to be profitable: with inflation, they usually lose money. Most Chinese lending, though, bears interest and is handled by state-owned banks which raise much of their own money on the bond markets and are in less of a position to forgive debt. These loans are also much larger: one source puts the grand total of Chinese lending to developing countries at 40 percent of China’s GDP. A small portion of this could be written off, but too much would hobble China’s financial establishment and anger its citizens.
A more palatable option to the Chinese financial establishment would be debt-equity swaps. Here, debt would be written off in exchange for title to a relevant asset. This is essentially the same as banks foreclosing on houses. The usual problem with this arrangement in taking over businesses (as opposed to houses) is that the concerned businesses are typically loss-makers. For example, if China helped to build a power plant in a small African country, but the power plant could not cover its debts, then why would the bank expect to do any better as its owner? COVID-19 presents an exception to this rule: many assets are underperforming not because they are weak investments but because of events beyond anyone’s control. Many of these will bounce back to profitability as the overall economy rebounds, so banks might actually want to own them.
The optics of these arrangements, though, would be horrendous. The specter of Chinese loan sharks taking advantage of a pandemic to take control of poor countries’ assets feeds into the worst stereotypes of Chinese lending as inherently predatory. The memory of China’s purchase of the underperforming Hambantota Port in Sri Lanka would not be far in the background. For this reason, the central government is likely to nix discussion of debt-equity swaps, even if banks might find them attractive.
This leaves some form of debt restructuring as a stronger option. Formally renegotiating loan terms to cut interest rates or extend repayment periods does carry some domestic political costs: such a move would impair the narrative that loans are earning a return for China and do not come at the expense of domestic rural development. Still, restructuring is less damaging to this narrative than would be debt forgiveness.
One workaround to avoid domestic backlash would be to simply ignore the overdue debts without making any kind of formal announcement. In many countries, a legal debt contract saying a certain amount is due at a certain date means that a certain amount is due at a certain date. In China, where the letter of the law carries less weight, contracts’ meaning can be somewhat fuzzier. Many domestic Chinese debts are simply ignored if overdue, especially if the borrower is state-owned or somehow important to local development. Doing this overseas allows both governments to avoid publicly mentioning to citizens that deals have gone bad. Where the financial pain is manageable for banks, this is thus a preferred option over formal restructuring. One scholar finds that Ethiopia intentionally repays its European railway debts before its Chinese ones because of China’s more “flexible” approach.
Of course, China’s decision to keep quiet is contingent on borrowers’ preferring to do the same. For those with more transparent government finances, it might be necessary to announce that repayments are being postponed and formally renegotiated, as has already been done in Ecuador. Countries which participate in the DSSI report their projected monthly payments by creditor, meaning that information on payments due to China is publicly available in an unprecedentedly reliable way. For the sixty-eight countries disclosing information to the DSSI, staying quiet is not a viable option.
China has a hierarchy of options. Working through 1) the IMF to provide new funding is clearly ideal in that it shares the burden with other creditors, but this option is limited to borrowers with good relationships with the Fund. Where IMF assistance is not forthcoming or not enough, some borrowers might receive more help from 2) the DSSI suspension. Where the DSSI suspension is not enough, China will probably have to 3) formally restructure some debts. Then, there are the countries outside both the IMF and the DSSI. For the more transparent among these, formal restructuring might be necessary. But in some cases, China’s preferred method of 4) keeping renegotiations informal and quiet may become an option.
Scott Wingo focuses on China’s economic engagement in the developing world and why its modes of doing business are different from those used by Western governments, international organizations, and multinational corporations. He has previously worked with the Woodrow Wilson Center, the World Bank, and in the private sector, and has served as a teaching assistant for five semesters at the University of Pennsylvania. Scott is proficient in Mandarin Chinese and Spanish and reads Portuguese. He holds a doctorate in political science from the University of Pennsylvania. You can follow him on Twitter @ScottCWingo.