China’s Latest ‘Debt Trap’ Scandal And US AidData Research

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By Chris Devonshire-Ellis 

Capitalism vs Cashflow as Beijing and Washington deploy very different standards to their overseas investment policies

The media has been covering the story of a report issued by US AidData, a research unit at the William & Mary University in Virginia. In it, they state that China has lent an additional ‘secret’ USS$385 billion to 165 countries that has not appeared on Government balance sheets as the loans have been made to private companies. The report, four years in preparation, implies that this was done to keep the loans out of government and World Bank regulatory mechanisms, and that 42 of the countries concerned, including Brunei, Cambodia, Laos, the Maldives, Myanmar, and Papua New Guinea, now owe China debt at percentages exceeding 10% of their national GDP. The report raised the spectre of China ‘seizing’ assets should there be loan defaults. However, there are numerous problematic side issues to the report.

Timeframe

The AidData research covers the period 2000-2017, meaning the data collected is between a minimum of four, and up to twenty years old. It only includes four years of investments made under the life of China’s Belt and Road Initiative as this didn’t start life as Chinese policy until 2013.

Contradictions

The AidData report directly contradicts the findings of two earlier researched reports, by the John Hopkins University and Chatham House, stating that the concept of a China ‘debt trap’ was a myth.

‘Hidden’ Debt

The report refers to the loans as ‘secret’ and ‘hidden’ and suggests they were structured in this manner to avoid scrutiny. If so, US AidData has effectively pointed the finger at 165 countries worldwide and suggested their national audit offices are not compliant – a staggering accusation to make that leaves virtually no country in the world in line with US AidData’s vision of ‘transparency’.

Debt to GDP ratios

Is having as much as 10% of your national GDP owed to China actually a problem? AidData suggest it is, as it raises the possibility that China could ‘seize’ assets should any default occur. This effectively divides the issue into two parts, Debt/GDP Ratio, and Asset Securitization. I deal with these as follows:

Debt/GDP Ratio

According to World Population Review, the most indebted countries in the world are Japan, at 234.2% of its GDP, followed by Greece (182%). US national debt to GDP is 107%, China at 54.5% and Russia among the lowest at 19.5%.

Of the low-income countries mentioned by AidData, with alarm bells sounded about 10% of GDP being owed to China, Brunei, an oil-rich nation, actually has the lowest debt to GDP ratio at 2.63%. The other countries singled out by AidData as having a ‘problematic’ debt ratio with China have debt to GDP ratios as follows:

Cambodia 29.57
Laos 64.13
Maldives 61.43
Myanmar 39.19
Papua New Guinea 37.72

It is true that these are relatively low-income countries – however all are well below the average global debt to GDP ratio of 82.99%. Does it really matter if 10% of this – some 5.2 weeks of 52 weeks in the year – is money that is owed to China?

Asset Securitization

AidData then go on to state that should defaults occur, China could ‘seize’ assets in repayment. This again is problematic, as national assets such as Ports are protected by international treaties and may not be removed from sovereign integrity. The only way for China to seize assets overseas would be to declare war and invade. That leads us to other issues such as the disputes in the South China Sea and the recent Aukus security deal. However, China is very unlikely to invade a country due to an unpaid debt.

There is also the issue of intent. AidData suggests China would repossess assets in other countries, despite the obvious logistical difficulties in doing so and the issue that this has never happened. AidData implies “But it could!”

China became the world’s largest provider of Outbound Direct Investment (ODI) last year, increasing its lending by 12.3% to US$153.7 billion in 2020. China’s ODI lending is about 20.2% of the global total of ODI remitted each year. All lenders realize that in doing so, there will be risks and unforeseen problems; China is not exempt from this, and certain loans have been problematic, with Covid interfering with some countries ability to generate income from assets built with Chinese loans.

There are several examples in Africa, not least the Kenyan Nairobi-Naivasha Central Rift Valley railway line with loan capital expected to be returned via ticket revenues that have not yet materialized.  Under the China rescheduling deal, Kenya will have the next six years to make payments on the suspended debt service costs including a one-year grace period from June this year. That compares with the West’s Paris club creditors, who also offered debt-service suspension for the same project. However, the Paris Club offer was just six months of debt-service suspension, a far less generous set of arrangements.

China has therefore extended the term of the loan to match new cash flow revenue forecasts. It’s not rocket science, but AidData seem to view such incidents as a debt trap mechanism – whereas it is in fact a debt solution.

There are other areas where AidData’s understanding of debt differs from that of China’s. As evidenced above, China is prepared – and its SOEs want – to be retained in cashflow generating infrastructure builds. These businesses are changing their income structuring models to develop sustainable cashflow rather than concentrate on pure infrastructure build. The US capital lending model tends to be less adventurous and amounts to fast exit strategies, in order for shareholders to maximize their financial returns as quickly as possible.

This is one of the reasons one reads a great deal about ‘sustainability’ in Chinese political rhetoric but rarely the US term ‘exit’. Here then arises different opinions as concerns fiscal policy – and one that Washington is almost certain to lose.

Infrastructure Capital vs Infrastructure Cashflow

Any sound businessman understands the differences between capital and cashflow. Yet at present it seems debatable whether US politicians do.

The US AidData research was politically primed to come out on the same day that President Joe Biden talked up his competing ‘Build Back Better World’ plan, which promises to offer infrastructure loans competitive to China. It is arguable that the AidData research was released at that same time to create questions about China’s ODI just at the same time the US was talking up its own.

But the United States has rather larger problems than competing with China over ODI. By the skin of their teeth, the US Congress passed a bill yesterday to extend Government funding until December. However, a larger problem awaits: a decision needs to be made by October 18 to raise the US national debt ceiling from an already all-time high of US$28.4 trillion. If it does not, the country will default.

Then there is the actual issue of the ‘Build Back Better World’ – Washington’s version of China’s Belt and Road Initiative. The capital for that – an estimated US$1 trillion – is tied up in what is being called a “Partisan Infrastructure Bill” which is currently stalled. US Republicans would like to see the idea defeated and give Biden a bloody nose. It is also likely to happen, collateral damage in return for agreeing both a new US debt ceiling and more Government funding in December. What then for B3W?

The US AidData research and its accusatory tone towards China needs to be taken in context – it is politically motivated. That is a shame as it means the research it provides is not impartial. It is distorted and passed off as academically researched and subject to tested integrity reviews. But is it?

As a businessman and investor, I can appreciate the logic of China applying cashflow sensibilities to its loans. In contrast, the United States in-fighting over capital, short-term fixes, exit strategies and ever-increasing debt do not, on the face of it, auger well. Readers may of course make up their own minds, but China’s ODI structures, policy and attention to cash-flow seem to position it as a rather more sustainable lender than Washington is currently able to guarantee.

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About Us

Silk Road Briefing is written by Dezan Shira & Associates. The firm has 28 offices throughout Asia, and assists foreign investors into the region. For strategic advisory and business intelligence issues please contact the firm at silkroad@dezshira.com or visit www.dezshira.com

 

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