China's unusual loan practices in the spotlight

Clauses in its overseas loans can complicate debt relief efforts in distressed nations: Study

When a new Argentinian government came to power in 2016, it tried to cancel two dam projects for environmental reasons.

The China Development Bank (CDB), one of three Chinese banks financing the projects, threatened to cancel a railway project that would carry Argentina's agricultural goods to Chile's Pacific ports if the dam projects were abandoned.

In the end, Argentina went ahead with building the dams.

The CDB had invoked a loan clause that allowed it to stop loans in one project if the borrower should default on or cancel another.

This cross-cancellation clause is one of several unconventional ways Chinese lenders use to manage the risks of their loans overseas, said a new study on China's international lending programme.

The practice of suspending or cancelling multiple projects with a debtor is used by multilateral institutions to protect lenders' finances and ensure public funds do not continue to support failed projects or poor policy outcomes.

However, the CDB has used a similar practice as a security device for its loans and as a way to protect China's other interests in the borrowing country, the study noted.

This and other practices, such as Chinese lenders prohibiting borrowing countries from restructuring Chinese loans on equal terms and in coordination with other creditors, complicate debt relief efforts in financially distressed countries, say the researchers.

In addition, the restrictions that Chinese lenders place on debt transparency through broad confidentiality clauses make it difficult for citizens and other creditors to hold the borrowing governments accountable.

The study, How China Lends, released last Wednesday, looks at 100 Chinese loan contracts with foreign governments in 24 countries and benchmarks them against 142 contracts countries have with other major lenders.

It involves researchers from AidData, a research lab at the College of William and Mary; the Peterson Institute for International Economics; the Centre for Global Development; and the Kiel Institute for the World Economy. The first three are in the United States and the fourth in Germany.

The study comes at a time when China has become the world's largest official creditor, with direct loans and trade credits to more than 150 countries amounting to US$1.5 trillion (S$2 trillion), according to some estimates.

Chinese foreign lending burgeoned from 2010 and particularly from 2014, as China's Belt and Road Initiative to build infrastructure in developing countries, launched in 2013, took off.

Dr Bradley Parks, executive director of AidData, explained that as China suffered from domestic overproduction of industrial inputs such as cement and steel, it needed to find buyers for the excess. It therefore offered relatively cheap credit for overseas infrastructure projects that relied heavily on these products.

One unusual feature of Chinese contracts is that they contain provisions that position Chinese state-owned banks as senior creditors whose loans should be repaid on a priority basis.

Nearly a third of the contracts require borrowing countries to maintain significant cash balances in bank or escrow accounts. These informal collateral arrangements put Chinese lenders at the forefront of the repayment line as the lenders can dip into these accounts to collect unpaid debts.

China's contracts also give it broad latitude to cancel loans or accelerate repayment if it disagrees with a borrower's policies. For example, CDB treats termination of diplomatic relations with China as "an event of default".

Expansive cross-default and cross-cancellation provisions give Chinese lenders more leverage over borrowers and other creditors than previously understood, the study said.

Although some of the contractual conditions are challenging to borrowers, there are states that are willing to borrow from China, because the development projects that these loans support can generate significant economic benefits, noted Dr Parks.

An evaluation by Dr Parks and his colleagues of 4,300 Chinese government-financed development projects in 138 countries showed that these projects generate substantial economic growth dividends for host countries.

He said that for an average country, the receipt of an additional such project increased economic growth by 0.41 percentage point two years after the financial commitment.

In some cases, countries with bad credit ratings borrow from China because they cannot access large loans elsewhere, he said.

With the Covid-19 pandemic causing financial strain to many developing countries, the Group of 20 (G-20) economies last year came up with a common framework for debt restructuring.

China, a G-20 member, had repeatedly objected to portions of the debt relief plans, but its Ministry of Finance officials recently signalled a willingness to cooperate through the framework.

However, the How China Lends report suggests there is a disconnect between the recent announcements and the actual debt contracts being issued by Chinese banks, said Dr Parks. "Only time will tell if Beijing's rhetoric will eventually come into alignment with its lending behaviour."

A version of this article appeared in the print edition of The Sunday Times on April 04, 2021, with the headline 'China's unusual loan practices in the spotlight'. Subscribe