What advantages does China have with CPEC

Chinese loan agreements hold debt traps

For years, China has made the expansion of the New Silk Road a priority. To this end, the country is granting loans amounting to billions for infrastructure projects to neighboring countries. A current report shows, however, that the terms of the contract should be treated with caution.

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In the past two decades, China has developed into the largest international lender, financing infrastructure projects in other countries with billions in loans. In the context of the so-called New Silk Road in particular, capital flows into regions that are strategically important for the Chinese state. With the multi-trillion dollar initiative "One Belt, One Road" (OBOR initiative), the country wants to reduce overcapacities in its own economy and create jobs for its own population, write Elena Gatti and Christina Richter in the book chapter "Die New Silk Road - One Belt, One Road ". "China suffers from considerable overcapacities in important raw material and building material sectors such as steel and cement, and the Silk Road is helping the Chinese government to relieve the troubled industries," the Springer authors explain on page 107.

08/08/2020 | Issue 4/2020 Open Access

Beyond Donation: China’s Policy Banks and the Reshaping of Development Finance

This paper seeks to demystify and characterize China’s official development finance by examining lending mechanisms of China’s two policy banks — China Development Bank and Export-Import Bank of China. Using quantitative and qualitative data, the paper shows how and why policy banks implement a peculiar means of development finance, ie, funding projects in developing countries with relatively high-interest rate loans, differing from low-interest rate development-finance credits from industrial countries .

Lots of borrowers along the New Silk Road

According to the current report "How China Lends - A Rare Look into 100 Debt Contracts with Foreign Governments", which deals with Chinese loans and possible risks for the borrowing countries, the Chinese government and its state-owned banks have already had enormous sums of money since the beginning of the noughties bestowed on governments in low and middle income countries. The vast majority of OBOR funding comes from the government's excess foreign exchange reserves, which amounted to over $ 3 trillion in 2015 when the initiative was announced, according to Gatti and Richter.

"However, because government bonds have low returns and strategic value, this source of capital will be used to fund the new OBOR initiative and the new organizations under its umbrella, including the multilateral Asian Infrastructure Investment Bank, Silk Road Fund and existing development finance banks such as the China Development Bank, the Export-Import Bank of China and the Agricultural Development Bank of China, which each received tens of billions of dollars, "the Springer authors say.

A total of 65 countries are "influenced in some way" by the initiative, write the two retail business experts in China. The capital flows to Pakistan serve as an example:

China is investing over $ 62 billion in infrastructure projects in Pakistan, and the China Pakistan Economic Corridor (CPEC), which connects China's western provinces of Tibet and Xinjiang to the Arabian Sea, is expected to facilitate significant trade flows between the two countries. Even more important for China is creating an overland route through which China can import oil from the Middle East, "the authors say on page 113.

China's loans are flowing into infrastructure projects

With this strategy, the Chinese state is helping many financially weak countries to get more infrastructure. What the associated loan agreements and terms look like, however, usually remains under strict lock and key. "Neither Chinese creditors nor their sovereign debtors normally disclose the text of their loan agreements. But the legal and financial details in these agreements have come in the wake of the Covid-19 shock and the growing risk of financial distress in countries that are heavily indebted to Chinese lenders have gained in importance, "says the comprehensive report.

This was created in cooperation with Aiddata at William & Mary, the Center for Global Development, the Kiel Institute for the World Economy (IfW Kiel) and the Peterson Institute for International Economics. The authors examine 100 Chinese loan agreements with 24 countries totaling 36.6 billion US dollars - many of which are part of the OBOR initiative.

"Given the high level of risk, the terms of China's loan agreements have become a matter of global public concern," the study authors said, referring to the political debate. For example, critics in Beijing accuse the government of deliberately pursuing a diplomacy of the debt trap. This allows the Chinese state to seize strategic assets if debtor countries get into financial problems. Other experts, on the other hand, highlight the benefits of Chinese lending. According to them, "concerns about harsh conditions and a loss of sovereignty are greatly exaggerated".

First systematic analysis of Chinese loan agreements

According to the authors of the study, the evaluation of original contracts for Chinese loans is unique in this form and the first systematic analysis of the legal conditions of China's lending abroad to date. The contracts were found on the government websites of the debtor countries and were apparently not intended for the public. The contract data set compiled by Aiddata is the largest source to date for debt contracts between state-owned Chinese lenders and developing countries and is publicly available via an online database.

The research group compared the Chinese loan agreements with 142 publicly available agreements from other major creditor countries. The key results are shown in the table below:

Unusual features of Chinese loan agreements

China's treaties contain unusual extensive confidentiality clausesthat prevent borrowers from disclosing the terms or sometimes even the existence of the loans. In the course of time, China's treaties were subject to increasingly strict confidentiality clauses. Since 2014, every contract examined has contained a confidentiality clause. This makes them non-transparent for taxpayers, who ultimately have to pay for the repayment, and also for other lenders who cannot reliably assess the creditworthiness of a country.

The treaties also contain provisions that Chinese state banks take precedence over other creditors give. Almost a third of the contracts required borrowing countries to hold significant cash balances in bank or escrow accounts that Chinese banks can seize in the event of default. These informal security arrangements put Chinese lenders at the top of the repayment line as banks can access their borrowers' accounts to collect unpaid debts. Most of the contracts also explicitly forbade borrowers to restructure their debts in consultation with other creditors, leaving China at sole discretion as to whether, when, and how to grant debt relief to countries in need.

The treaties give China one too great leeway to cancel loans or accelerate repaymentwhen it disagrees with a borrower's policy. For example, the China Development Bank (CDB) treats the severance of diplomatic relations with China as a "default event". Far-reaching cross-default and cross-cancellation regulations also give Chinese lenders more leverage over borrowers and other creditors than previously assumed.

China is an accomplished lender

"China's practices make it difficult for countries that are in financial distress due to the corona pandemic, for example, to get their debt situation under control," says Christoph Trebesch, co-author of the study and research director at IfW Kiel. "Most Chinese loan agreements contain clauses that prohibit the debtor governments from rescheduling Chinese loans in coordination with other creditors," adds IfW researcher Sebastian Horn.

Overall, the contracts in the sample indicated that China is acting as an accomplished lender to developing countries. The contracts contain more sophisticated loan terms than are customary on the official loan market. They gave Chinese lenders an advantage over other creditors.

However, the study authors emphasize, the analysis does not systematically address contract implementation and enforcement, for which there is little anecdotal evidence. The authors of the study expressly do not want to give an assessment of Chinese law or the Chinese system for settling trade disputes with regard to worrying clauses in debt contracts between state borrowers and Chinese state-owned companies.

OBOR initiative increases China's political influence

From the point of view of economist Britta Kuhn, the New Silk Road remains "an ambitious project with major economic, political and social effects". In an article in the journal "Wirtschaftsdienst" (issue 12 | 2019), the professor of economics at the Wiesbaden Business School of the Rhein Main University of Applied Sciences writes:

Ideally, it will promote international trade and contribute peacefully to a multipolar world order. In purely economic terms, however, the initiative could often turn out to be unprofitable for China and its partners. In any case, the People's Republic is likely to expand its political and cultural influence more than Western democracies would like. The success of the Belt and Road Initiative therefore also depends on the economic and political response of the US and its allies. "