What Will It Take: Defining China’s Role In External Debt Restructuring

By Danny Leipziger

Engaging with one of the world’s largest creditors, China, is central to any effective action to deal with future external debt crises. These events will differ from past restructuring exercises inasmuch as debts are now largely private rather than official and they involve mainly middle-income Emerging Market Economies. Most crucially, China is the major player who needs to be brought inside the creditor tent. This essay explores this issue and makes concrete proposals to remedy the currently untenable situation.

Just before year’s end, the Chair of the Paris Club, Emmanuel Moulin of the French Treasury, lamented the fact that dozens of heavily indebted low-income Emerging Market Economies (EMEs) had declined to participate in the Debt Servicing Suspension Initiative (DSSI) offered by the G-20. He also correctly noted that the Common Framework that was supposed to draw non-official creditors into debt relief exercises led by the IMF was moving slowly. It has been in progress for Ethiopia, Chad and Zambia with only limited success. But are either of these mechanisms actually “fit for purpose,” and what has changed that makes the prospect of future debt crises different from those past?

First, the largest share of external debt is not held by official creditors, if one excludes Chinese-held debt, and second, much of the debt whose repayments may well become unsustainable is owed by middle-income countries. Both realities imply that the Paris Club is not the proper venue for many future cases of external debt distress. Previous systematic debt relief exercises, like HIPC or the MDRI, were focused on the low-income countries and involved largely official debt.¹ Even though the World Bank has recently issued an alert that an additional $11b. will come due for low-income countries in 2022, this is just the tip of the iceberg.²

Here are some additional useful facts: first, the scale of current debt problems facing EMEs is huge as seen by a total external debt-to-gdp figure of 260 percent in pre-pandemic 2019;³ second, much of the rise in EME borrowing has been through capital markets, thus debt repayment concerns are largely a private sector issue; and third, the ill-defined role of China, now the largest lender to EMEs in Africa, makes creditor discussions disjointed as China opts for bilateral solutions when debt problems arise. These realities prompt the call for a different solution, one based on a new framework to deal with debt distress.

Early in the pandemic, a new mechanism that attempted to involve the World Bank as the intermediary for short-term debt relief was proposed.⁴ That proposal didn’t fly, and in fact the proponents later noted that private creditors, as represented by the Institute for International Finance, seemed to get cold feet on the idea of a debt service suspension and hence the notion of their joining the DSSI was left up in the air.⁵ This was regrettable; however, the more pertinent question is how will private creditors react to debt distress among more advanced EMEs, where their exposure is far larger, and how will they treat Chinese debt in any systematic restructuring process?

Given this situation, it is urgent to consider whether the international community has the proper mechanisms in place to deal with future debt distress. Contrary to the last major effort aimed at middle-income debt restructuring, the Brady Plan, the configuration of creditors has markedly changed. Lending is no longer concentrated in banks, but rather involves debt held by many different creditors with very divergent interests. This lack of a common approach was seen in the most recent rescheduling of Argentine debt where different groups of creditors each tried to devise their own reprofiling plans.

The most important complication in the search for a new framework, however, is the very large exposure of China’s Ex-Im Bank and China’s Industrial Development Bank. Their lending as first reported by Horn, Reinhart and Trebesch (2019) was seen to be far in excess of official data;⁶ more recent evidence by the AidData group at William & Mary estimates total Chinese non-concessional lending over the 2000-2017 period at upwards of $700 billion.⁷

Evidence also reveals that many contracts are written in ways to avoid scrutiny, much less openness to rescheduling as part of concerted actions based on equal treatment.⁸ Quite the contrary, many contracts utilize escrow accounts or involve collateralization that creates de-facto preferred creditor status for Chinese loans.⁹ Thus, the status of these quasi-official Chinese lenders, who operate under official auspices but charge commercial rates, is unclear and quite worrisome if the goal is to secure uniform treatment for all creditors.

We have seen issues of Chinese debt raised in the context of the IMF’s recent program for Pakistan, where some shareholders objected to the program’s implicit bailout of Chinese BRI-related lending. The same issue will arise in other default scenarios. In the case of Ecuador, a series of agreements with private creditors (agreeing to a minor haircut) and China agreeing to a short moratorium and fresh funds enabled an IMF agreement to go forward, later bolstered by a US Government initiative to basically replace Chinese debt with a new SPV agreement.¹⁰ However, one-off bilateral arrangements between borrowers and China, even if effective in reducing the debt repayment burden, are not sufficiently transparent to allow for systematic debt relief by the IMF and other private lenders. Hence the conundrum and the question of what it will take to get China inside the creditor tent?

The solution lies inside the G20 and with the IMF itself. China has shown a willingness to use the G20 for more concrete discussions, and since there are other creditors who also are prone to go their own way with quasi-official lending, this forum may be a productive one to deal with the impasse. Moreover, China’s own interests may well change as it scales down its infrastructure-based lending to Africa in particular, and as it runs into more debt repayment issues among its Sub-Saharan debtors. Its loans to Angola and Zambia have already needed reprofiling and, when combined with outstanding loans to Djibouti, Uganda, Kenya, and Ethiopia, China’s exposure to those countries alone exceeds $80 billion.

Recent World Bank warnings concerning a “ two-speed “ recovery in which EME rebounds lag and their debt situation worsens should prompt more energetic solutions, in particular ones that of necessity include China.¹¹ A new approach requires some revisions in past thinking, however.

First, China must be urged to acknowledge that lending by its state banks, largely for infrastructure projects, does not confer preferred creditor status to them. To achieve this, the African Union will need a unified front to initiate political discussions with Beijing to reclassify loans and add addendums to existing contracts that make Chinese lending more comparable to other private creditors. It is in China’s long-term interest to do this unless it wants to be seen as an imperialist power taking unfair advantage of poorer nations.

Second, the International Financial Institutions need be present a unified position that no programs will proceed without debt data transparency and without agreement on comparable treatment. To this can be added larger amounts of concessional financing through the Bank and Fund that will make it more likely that EMEs can repay their private debt, including Chinese debt, if common rules for debt relief are followed.¹² Work on this idea can proceed leading up to the Annual Meetings of these institutions in Marrakech in 2022.

Third, the international community will need to coalesce, as they did around the HIPC and MDRI initiatives, to deal with the lack of a systematic approach to unsustainable debt levels in all developing countries, including those classified as middle-income. This shift can begin with non-governmental organizations (NGOs) speaking out loudly and clearly about predatory lending practices by some large creditors. Focusing more light on the situation of middle-income countries (MICs) would be desirable since there are more people living below the poverty in MICs than elsewhere.¹³

Each of these actions requires political capital, but each is do-able since there are enough tangible gains to make it worthwhile for all participants. What is needed is multilateral leadership. The relatively less politicized nature of the G20 and the common appreciation for the roles of the IFIs might provide an effective forum for such deliberations. The cost of not moving forward constructively promises to be high for many heavily indebted countries. Many of them either mistakenly borrowed from China at commercial rates for large public projects that require repayment in foreign exchange or borrowed excessively in capital markets that seemed flush and now face worsening post-pandemic growth prospects, or both. In either case, when debt becomes unsustainable, a comprehensive, fair, and transparent solution will be needed. Moving forward on a new mechanism is therefore urgent business.

About the Author

Danny Leipziger is Professor of International Business at George Washington University and Managing Director of the Growth Dialogue. A former Vice President at the World Bank and Vice Chair of the Spence Commission on Growth and Development, he has written extensively on international development and finance, is the author of numerous books and over 50 refereed journal articles. Dr Leipziger is a frequent contributor to various media outlets.

References

• We refer here to the Heavily Indebted Poor Country debt relief program and the Multilateral Debt Relief Initiatives organized by the World Bank and the International Monetary Fund for Low-Income Countries.
• World Bank Press Release, Jan 17, 2021, and World Bank, Global Economic Prospects, Jan 11, 2022
• World Bank, New Waves of Debt, 2019.
• See Bolton, Buchheit et. al. “Born Out of Necessity: A Debt Standstill for Covid-19,” CEPR Policy Insight No. 103 (April, 28, 2020)
• See Bolton, Buchheit et. al. “Sovereign Debt Standstill: An Update,” VoxEU (May 28, 2020)
• Horn, Reinhart, and Trebesch, “China’s Overseas Lending,” KIEL Institute Working Paper No. 2132 (June, 22019)
• Concessional lending as defined by the Development Assistance Committee of the OECD involves a grant element   in excess of 25 percent. See Leipziger, “Lending Versus Giving: The Economics of Foreign Assistance, World Development, vol. 11, no. 4 (1983) on grant element calculations, and see AidData, “Global China’s Development Finance Dataset,” for the latest stock-taking on Chinese lending to EMEs as well as AidData, “ Banking on the Belt and Road,” (Sept, 29, 2021).
• See Gelpern, Horn, et. al., “How China Lends: A Rare Look Into 100 Debt Contracts with Foreign Governments,” Center for Global Development (March, 2010).
• Ibid.
• See Landers, Lee and Morris, “Why does the DFC Want to Pay Off Ecuador’s Chinese Creditors? Center for Global Development (Jan. 19, 2021).
• World Bank, Global Economic Prospects (January 2022)
• See Dooley and Kharas, “Status Check: Managing Debt Sustainability and Development Priorities Through a Big Push,” Brookings Institution (October, 2021) for some concrete suggestions on how to increase the flow of concessional resources to EMEs.
• See World Bank, Poverty and Shared Prosperity: Piecing Together the Poverty Puzzle (2018)