China’s loans push the world’s poorest countries to the brink of collapse

Xi Jinping
FILE PHOTO: Chinese President Xi Jinping waves after his speech as the new Politburo Standing Committee members meet the media following the 20th National Congress of the Communist Party of China, at the Great Hall of the People in Beijing, China October 23, 2022. REUTERS/Tingshu Wang

A dozen poor countries are facing economic instability and even collapse under the weight of hundreds of billions of dollars in foreign loans, many from the world’s largest and most ruthless government lender, China.

An Associated Press analysis of a dozen of the countries most indebted to China – including Pakistan, Kenya, Zambia, Laos and Mongolia – finds that paying down debt is eating up a growing share of the tax revenue needed to keep schools open, supply electricity and pay for food and fuel. And it’s depleting the foreign exchange reserves these countries use to pay the interest on those loans, leaving some with just months before that money runs out.

Behind the scenes is China‘s reluctance to forgive the debt and its extreme secrecy about how much money it has lent and on what terms, which has prevented other big lenders from stepping in to help. Add to this the recent discovery that borrowers have been forced to deposit cash in hidden escrow accounts which puts China at the front of the queue of creditors to be paid.

The countries in the AP analysis had up to 50% of their foreign borrowing coming from China and most spent more than a third of public revenue paying off foreign debt. Two of them, Zambia and Sri Lanka, have already gone into receivership, unable to even pay the interest on loans that finance the construction of ports, mines and power plants.FILE – President Mahinda Rajapaksa, wearing white, walks with Chinese regime chief Xi Jinping after the official launch of a $1.4 billion port city construction project being built on an artificial island off Colombo, Sri Lanka, on September 17, 2014 (AP Photo/Eranga Jayawardena)

In Pakistan, millions of garment workers have been laid off because the country has too much foreign debt and cannot afford to keep electricity and machines running. In Kenya, the government has delayed payroll for thousands of civil servants to save money to pay foreign loans. The president’s top economic adviser tweeted last month: “ Wages or default? Choose ”.

Since Sri Lanka went into default a year ago, half a million jobs have disappeared in the industry, inflation has exceeded 50% and more than half the population in many parts of the country has fallen into poverty.

Experts predict that unless China begins to soften its stance on its lending to poor countries, a wave of more defaults and political upheaval could ensue. “ In much of the world, the clock has struck midnight,” said Harvard economist Ken Rogoff. “China has entered the scene and has left this geopolitical instability that could have lasting effects.”

How is it developing?

Zambia, a landlocked country of 20 million people in southern Africa, has borrowed billions of dollars over the past two decades from Chinese state banks to build dams, railways and highways. The loans boosted the Zambian economy, but also drove up interest payments abroad so much that there was hardly anything left for the government, forcing it to cut spending on health, social services, and subsidies to farmers for seeds and fertilizers.

In the past, in such circumstances, large government lenders such as the United StatesJapan, and France would reach agreements to forgive part of the debt, with each lender clearly disclosing what was owed and under what terms, so that no one would be surprised. I felt cheated.FILE – A motorcyclist walks past sheep on a newly built highway in Haripur, Pakistan, December 22, 2017. China launched the Belt and Road Initiative in 2013 to expand its trade and influence by building roads, ports and other infrastructure abroad. (AP Photo/Aqeel Ahmed)

But China did not follow those rules. At first, he refused even to participate in multinational talks, negotiating separately with Zambia and insisting on confidentiality that prevented Zambia from informing non-Chinese lenders of loan terms and whether China had devised a way to catch up. front of the refund queue.

Amid this turmoil in 2020, a group of non-Chinese lenders rejected Zambia‘s desperate pleas to suspend interest payments, if only for a few months. That refusal compounded the depletion of Zambia‘s foreign exchange reserves, the reserve of US dollars it used to pay interest on loans and purchase raw materials such as oil. In November 2020, with hardly any reserves, Zambia defaulted on interest and defaulted, preventing it from accessing future loans and triggering a vicious cycle of spending cuts and deepening poverty.

Since then, inflation in Zambia has soared 50%, unemployment has reached its highest level in 17 years and the national currency, the kwacha, has lost 30% of its value in just seven monthsAccording to United Nations estimates, the number of Zambians not getting enough food has nearly tripled so far this year, to 3.5 million.

I sit at home thinking about what to eat because I don’t have money to buy food,” says Marvis Kunda, a 70-year-old blind widow from Zambia‘s Luapula province, whose welfare benefits have recently been cut. “Sometimes I eat once a day and if no one remembers to help me with food from the neighborhood, then I starve.”FILE – Workers use a crane to unload a Chinese-made high-speed passenger train car from a cargo ship at the Tanjung Priok port in Jakarta, Indonesia, on Sept. 2, 2022, for the Jakarta High-Speed ​​Railway. -Bandung. A $4 billion Chinese loan to help build the railway never appeared on public accounts. Everything changed years later when, with an overbudget of 1.5 billion dollars, the Indonesian government was forced to bail out the railway twice (AP Photo/Dita Alangkara)

A few months after the default, investigators found that Zambia owed $6.6 billion to Chinese state-owned banks, double what many thought at the time and about a third of the country’s total debt.

We are flying blind,” said Brad Parks, executive director of AidData, a College of William & Mary research lab that has uncovered thousands of secret Chinese loanwords and assisted the AP in its analysis. “ When you look under the sofa cushions, you suddenly realize: ‘Oh, there are a lot of things we missed. And actually things are much worse .’”

Debt and turmoil

China‘s unwillingness to take huge losses on hundreds of billions of dollars owed to it, as the International Monetary Fund and World Bank have urged, has left many countries in a rut of repaying interest, which it stifles the economic growth that would help them pay down the debt.

Foreign reserves have fallen in 10 of the dozen countries surveyed by the AP, an average of 25% in just one year. They have fallen more than 50% in Pakistan and the Republic of the Congo. Without a bailout, many countries have only months of cash left abroad to pay for food, fuel and other essential imports. Mongolia has eight months left. To Pakistan and Ethiopia, about two.

As soon as the funding taps are turned off, the adjustment happens immediately,” says Patrick Curran, principal economist at researcher Tellimer.“ The economy shrinks, inflation soars, food and fuel become unaffordable.”FILE – An SGR freight train travels from the port’s container depot on a Chinese-backed railway costing nearly $3.3 billion, launched by Kenya’s president as one of the country’s biggest infrastructure projects since independence, in Mombasa, Kenya, on May 30, 2017, as part of a plan to link much of East Africa to a major Indian Ocean port, as China seeks to increase trade and influence. (AP Photo/Khalil Senosi)

Mohammad Tahir, laid off six months ago from his job at a textile factory in the Pakistani city of Multan, says he has contemplated suicide because he can no longer bear to see his family of four go to bed night after night without dinner.

I have faced the worst of poverty,” says Tahir, who was recently told that Pakistan‘s foreign exchange reserves had been so depleted that he could now import raw materials for his factory. “ I have no idea when we will get our jobs back .”

Poor countries have been hit before by currency shortages, high inflation, unemployment spikes and widespread hunger, but rarely as in the past year.

Adding to the usual mix of government mismanagement and corruption are two unexpected and devastating events: the war in Ukraine, which has sent grain and oil prices soaring, and the US Federal Reserve‘s decision to raise interest rates. interest 10 times in a row, the last one this month. This has suddenly made variable-rate loans to countries more expensive.

All of this is stirring up national politics and disrupting strategic alliances.

In March, heavily indebted Honduras cited “ financial pressures ” in its decision to establish formal diplomatic ties with China and break those with Taiwan. Brad Parks, executive director of the AidData research lab, poses for a portrait at the College of William and Mary in Williamsburg, Virginia, Tuesday, May 16, 2023. Much of the credit for exposing China’s hidden debt goes to Parks, who for the last decade has had to deal with all kinds of obstacles, obfuscations and falsehoods of authoritarian rule. (AP Photo/John C. Clark)

Last month, Pakistan was so desperate to avoid more blackouts that it struck a deal to buy oil at a discount from Russia, breaking ranks with the US-led effort to turn off the spigot on Vladimir Putin‘s funds.

In Sri Lanka, rioters took to the streets last July, torching the homes of government ministers and storming the presidential palace, sending the leader linked to onerous deals with China fleeing the country.

The Chinese answer

The Chinese Foreign Ministry, in a statement to the AP, disputed the idea that China is a ruthless lender, echoing earlier statements blaming the Federal Reserve. He said that if he must agree to the demands of the IMF and the World Bank to forgive a part of his loans, so must those multilateral lenders, whom he considers proxies of the United States.

“We call on these institutions to actively participate in relevant actions in accordance with the principle of ‘joint action, fair burden’ and to make greater contributions to help developing countries overcome difficulties,” the ministry statement said.FILE – People jostle to buy subsidized bags of wheat flour in Quetta, Pakistan, Thursday, January 12, 2023, following a recent rise in the price of flour in the country. An Associated Press analysis of a dozen of the countries most indebted to China found that debt is eating up an increasing amount of the tax revenue needed to keep schools open, provide electricity and pay for food and fuel. (AP Photo/Arshad Butt)

China argues that it has offered help in the form of extended loan maturities and emergency loans and as a major contributor to a program to temporarily suspend interest payments during the coronavirus pandemic. It also claims it has forgiven 23 interest-free loans to African countries, though AidData ‘s Parks say these loans are mostly two decades old and represent less than 5% of the total it has lent.

At high-level talks in Washington last month, China considered withdrawing its request that the IMF and World Bank forgive loans if the two leaders agreed to offer grants and other aid to troubled countries. according to various news. But in the weeks since then there has been no announcement and both lenders have expressed their frustration with Beijing.

My opinion is that we have to drag them along – perhaps it is an impolite word – we have to walk together”, declared the Managing Director of the IMF, Kristalina Georgieva, at the beginning of the month. “Because if we don’t, there will be a catastrophe for many countries .”

The IMF and World Bank say taking losses on their loans would break the traditional sovereign crisis management manual that gives them special treatment because, unlike Chinese banks, they already finance at low rates to help struggling countries recuperate. The Chinese Foreign Ministry noted, however, that the two multilateral lenders have made exceptions to the rules in the past, forgiving loans to many countries in the mid-1990s to save them from collapse.

As time runs out, some officials are urging concessions.

Ashfaq Hassan, formerly head of debt at Pakistan‘s Ministry of Finance, said his country’s debt burden is too heavy and time is too short for the IMF and World Bank to bear. He also asked for concessions from private investment funds that lent to his country through the purchase of bonds. “All concerned will have to accept a cut,” Hassan said .FILE – Former Pakistani Prime Minister Imran Khan is broadcast live speaking of “substantial progress” in the China-Pakistan Economic Corridor, during the Second Belt and Road Forum in Beijing on Friday, April 26, 2019. (AP Photo/Ng Han Guan)

China has also disputed the idea, popularized in the Trump administration, that it has engaged in “debt-trap diplomacy,” leaving countries saddled with loans they cannot repay so they can seize ports, mines and other strategic assets.

On this point, experts who have studied the issue in detail have sided with Beijing. Chinese loans come from dozens of mainland Chinese banks and are too haphazard and sloppy to be coordinated from above. In any case, they say, Chinese banks are not taking losses because the timing is bad, as they face big hits from reckless real estate lending at home and a sharply slowing economy.

But experts are quick to point out that less sinister Chinese paper is no less terrifying. “ There’s no one person responsible,” says Teal Emery, a former sovereign loan analyst who now runs consulting group Teal InsightsAidData‘s Parks add of Beijing: “ They’re making it up as they go along. There is no master plan ”.

Rigor in loans

Much of the credit for exposing China‘s hidden debt goes to Parks, who for the past decade has had to deal with all kinds of obstacles, obfuscations and falsehoods from authoritarian rule.

The hunt began in 2011, when a top World Bank economist asked Parks to take charge of investigating Chinese loans. Within a few months, using online data mining techniques, Parks and some researchers began uncovering hundreds of loans that the World Bank was unaware of.

At the time, China was ramping up loans that would soon become part of its $1 trillion ” Belt and Road Initiative ” to secure supplies of key minerals, win allies abroad and get more money from its countries. US dollar holdings. Many developing countries were eager for US dollars to build power plants, roads and ports, and expand their mining operations.FILE – Sri Lankan port workers hold up a Chinese national flag to welcome the Chinese research vessel Yuan Wang 5, packed with surveillance equipment, upon its arrival at Hambantota International Port in Hambantota, Sri Lanka, on August 16. 2022. In 2022, the country entered into receivership, unable to even meet the interest on loans that financed the construction of ports, roads and railways. (AP Photo/Eranga Jayawardena)

But after a few years of direct loans from the Chinese government, those countries found themselves heavily in debt, and the optics were horrible. They feared that piling on more loans on top of their old ones would make them appear reckless to credit rating agencies and make it more expensive for them to borrow in the future.

So China started creating shell companies for some infrastructure projects and giving them loans instead, allowing heavily indebted countries to avoid putting that new debt on their books. Even if the loans were backed by the government, no one would know.

In Zambia, for example, a $1.5 billion loan from two Chinese banks to a shell company to build a gigantic hydroelectric dam did not appear on the country’s books for years.

In Indonesia, $4 billion worth of Chinese loans to help build a railway also failed to appear in the public accounts. Everything changed years later, when, with a budget of more than 1.5 billion dollars, the Indonesian government was forced to bail out the railway twice.

“ When these projects go wrong, what was billed as private debt becomes public debt,” says Parks. “ There are projects like this all over the world .”

In 2021, a decade after Parks and his team began their search, they had amassed enough information for a blockbuster find: at least $385 billion of hidden and unreported Chinese debt in 88 countries, many of those countries in a much worse situation than anyone knew.

Among the revelations was that China had provided a $3.5 billion loan to build a railway system in Laos, which would require almost a quarter of the country’s annual production to pay off.A view of the main dam of the Neelum-Jhelum hydroelectric project in Nauseri, Pakistan, near Muzaffarabad, the capital of Pakistani-administered Kashmir, Thursday, May 4, 2023. The dam, built by a Chinese consortium, had to be closed due to fears for it to collapse. (AP Photo/Shahzaib Afzal)

Another AidData report from the same time suggested that many Chinese loans go to projects in parts of countries favored by powerful politicians, often just before key elections. Some of the things built made little economic sense and were riddled with problems.

In Sri Lanka, a Chinese -funded airport built in the president’s hometown, far from most of the country’s population, is used so little that elephants have been seen roaming its runway.

Cracks are appearing in hydroelectric plants in Uganda and Ecuador, where the government in March won court approval of corruption charges linked to the project against a former president now in exile.

In Pakistan, a power station had to be shut down for fear it might collapse. In Kenya, the last key kilometers of a railway was never built due to poor planning and a lack of funds.

jump to front

When Parks dug into the details of the loans, he discovered something alarming: clauses that forced borrowing countries to deposit US dollars or other currencies into secret escrow accounts that Beijing could raid if those countries defaulted on their loan interest.

In effect, China had moved to the head of the line to collect without the other lenders knowing.

In UgandaParks revealed that a loan to expand the main airport included a blocked account that could contain more than $15 million. A legislative inquiry criticized the Finance Minister for agreeing to those conditions, and the lead investigator said he should be prosecuted and jailed.

Parks aren’t sure how many such accounts have been opened, but government insistence on any kind of collateral, let alone cash, is rare for sovereign loans. And its mere existence has made non-Chinese banks, bond investors and other lenders nervous, unwilling to accept less than what they are owed.

The other creditors are saying, ‘We’re not going to offer anything if China is actually at the top of the repayment line,’” Parks said. “This leads to paralysis. Everybody is measuring themselves and saying: ‘Am I going to be a fool here?

Loans as “currency exchange”

Meanwhile, Beijing has embraced a new type of hidden loan that has added to confusion and mistrust. Parks and others discovered that the Central Bank of China has been lending out tens of billions of dollars through what appear to be ordinary currency exchanges.

Currency exchanges, called swaps, allow countries to borrow more widely used currencies, such as the US dollar, to cover temporary shortfalls in foreign exchange reserves. They are meant to get liquidity, not to build things, and they only last a few months.

But China swaps mimic loans in that they last for years and charge higher than normal interest rates. More importantly, they do not appear on the books as loans that would add to a country’s total debt.

Mongolia has subscribed 5,400 million dollars in this type of swaps, an amount equivalent to 14% of its total debt. Pakistan has subscribed almost 11,000 million dollars in three years and Laos has borrowed 600 million.

Swaps can help avoid default by replenishing foreign exchange reserves, but they pile more loans on top of old ones and can make a collapse much worse, much like what happened in the run-up to the 2009 financial crisis, when banks Americans continued to offer larger and larger mortgages to homeowners who couldn’t afford their first one.

Some poor countries struggling to pay China are now stuck in a kind of lending limbo: China won’t budge when it comes to taking losses, and the IMF won’t offer low-interest loans if the money only goes to pay the interest. of Chinese debt.

In the case of Chad and Ethiopia, it has been more than a year since IMF bailout packages were approved in so-called staff-level agreements, but most of the money has been withheld as negotiations drag on between its members. creditors.

More and more countries are in dire financial straits,” says Parks, attributing much of it to the astonishing rise of China, which in just one generation has gone from being a net recipient of foreign aid to become the largest creditor in the world.

Somehow, they have managed to do all this out of public view,” he said. “So unless people understand how China lends, how their lending practices work, we’re never going to solve these crises.”