As President Xi Jinping’s signature foreign policy, the Belt and Road Initiative (BRI) incorporates an ambitious array of projects with diverse political and financial risks. Rhetoric portrays the BRI as a panacea, but its most vital policy lever, loan use, is often left unaddressed. In this article, Hannah Feldshuh from China Policy discusses loan use in BRI expansion and its far-reaching consequences.

At the Boao Forum, in April 2018, President Xi made a bold declaration: China will defend multilateralism and provide win-win solutions that the West is no longer able to offer. He went on to outline how the BRI would be a panacea to global problems and will address a range of issues, such as infrastructure and shipping connectivity and economic development in poverty-stricken countries. Reports indicate that approximately United States dollar (USD) 340 billion has already been spent in BRI investments and construction projects since 2013.[1]

Loans are the central component of Belt and Road implementation and expansion. They dictate the terms of engagement between China and partner countries, including projects’ strategic focus and financial exposure.  To better understand how loans facilitate BRI expansion, their composition, associated risks and scope must be assessed. BRI loan agreements serve several functions: they simultaneously benefit partner countries by offering comparatively more lenient terms than other international lenders, while also serving China’s interests by allowing Beijing to dictate their terms, structure and focus. As Beijing touts the initiative’s strengths, international reports from countries affected by the BRI, such as Sri Lanka or Djibouti, raise fears that these loans are a form of ‘debt diplomacy’ with its purpose being to secure China’s regional interests. It is clear that these type of loan agreements are complex, as they can be perceived to both serve the common good, while also bringing tremendous fiscal and political risk along with it.

Loan format and structure

In practice, there are numerous avenues for debt financing, which include loans from a (commercial or policy) bank, bank partnerships and the issuing of bonds. The most popular avenue are loans from banks. Chinese firms that invest abroad may receive line of credit loans from banks, either directly in foreign currency or in renminbi, which then has to be converted into the local currency. State-owned enterprises (SOEs) tend to be the major recipient of these types of loans.

The China Development Bank (CDB) and the Export-Import Bank of China (EXIM) are central to providing BRI loans. Under the BRI these banks have played a prominent role, having already provided USD 200 billion in loans throughout Asia, the Middle East and Africa. The EXIM’s BRI loan balance increased 37 per cent year-on-year in the first six months of 2018,[2] while the Silk Road Fund has already provided USD 6 billion in capital to 15 projects[3] that span a rage of different sectors, including infrastructure, resource development, and capacity and financial cooperation.

Besides the popular bank-to-SOE option, firms may also choose to raise funds from the bond market. The BRI bond market has had less direct government influence, but recent changes indicate a trend of increased regulation. On 2^nd March 2018, security regulators announced that domestic and international firms would be allowed to issue BRI bonds through the Shanghai and Shenzhen Stock Exchanges, signalling a desire to have greater regulatory control over the BRI financing process.[4]

A final and less conventional option are inter-bank partnerships, referred to as “offshore bonds secured by onshore guarantees”.[5] In this system, corporations in partner nations can find a domestic bank that will partner with a Chinese bank. After forming an inter-bank partnership, the firm can then receive Chinese bank loans that are provided by a domestic institution. While a viable option for projects in developed countries, inter-bank partnerships are risky given their potential use for laundering money.

High risk, high reward

There are several parts of the BRI loan process that could be considered risky, such as the selection of high-risk partner countries, the focus on energy financing and the use of commodity­­-backed bonds. Macroeconomic downturns and the fall of commodity prices put stress on bondholders – especially if the projects they receive financing for are unprofitable.[6] ‘Debt distress’ could result in debt-diplomacy, as countries are forced to make disproportionate concessions to repay long-term loans. Sri Lanka has already struggled to pay off the USD 1.3 billion Hambantota Port,[7] which it must now lease to China for 99 years according to the terms of the loan.[8]

A paper from the Center for Global Development (CGD) paper identifies eight countries, including Pakistan, that could suffer debt distress from future BRI-related financing. Countries have accepted the terms of loans given under the auspices of the BRI, due to them being both cheap and numerous. For example, the CDB offered a 40-year soft loan with a 10-year grace period, and no government debt guarantees, for Indonesia’s USD 5.29 billion Jakarta-Bandung Railway project[9] to help finance up to 75 per cent of the project’s costs.

Chinese analysts react to BRI

Given the BRI’s already large impact and rapid expansion, it is important to understand how Chinese academics, businesses and policymakers understand these loans and why they choose to respond in a particular way to international criticism. The response of the Chinese policy community has had a direct impact on how the BRI is promoted, expanded and adjusted. How they respond to BRI criticisms reflects the degree to which China can be flexible and responsive in setting the terms of BRI loans. Chinese perspectives on the BRI roughly fall into two camps: the first is unapologetically positive about the current loan environment, while the second seeks to adjust loan structures and mitigate risk. The perspective that wins out will determine if these loans will be adjusted.

SOEs and policy banks are unsurprisingly sanguine about the BRI. The CDB has placed strict limits[10] on sovereign borrowers’ credit lines and put controls on the concentration of loans. Several academics have also been resistant to negative feedback. Criticisms of this initiative in Malaysia and Colombia are unreasonable,[11] argues Zhao Lei, professor of the Central Party School at the CPC Institute for International Strategic Studies. All projects have associated risks and the BRI is no different. Western nations have criticised Chinese investment abroad out of a fear of growing Chinese influence,[12] writes Peng Nian, a researcher at the National Institute for South China Sea Studies. In November 2017, Pakistan’s parliament began posing questions about the development of the Gwadar Port, as it directs 91 per cent of Gwardar’s profits to China and only nine per cent to the city over the next 40 years. In response, the Global Times painted these concerns as simple fearmongering. The Global Times went on to argue that this project was modelled after a Singaporean negotiated deal, which both the port authorities and Chinese partners claim is an internationally legitimate practice.[13]

To push back against accusations that Chinese investment terms are exploitative, China must refuse to accept the West’s assumptions, while simultaneously increasing investment transparency and partner country coordination. China’s experience in planning and constructing large infrastructure projects gives it a comparative advantage,[14] a strength that is appropriately leveraged in the BRI’s emphasis on infrastructure development, defends Zheng Yongnian, chairman of the South China University of Technology Institute of Public Policy. Dr Zheng argues it is a unique partnership offering what no other nation is able or willing to provide.

Despite the call to defend the BRI, others are sceptical of its true aims and are wary of inviting financial risk. For instance, the China National Petroleum Corporation states that while progress has been made in cooperating with countries on BRI projects, it is very much aware of the serious risks[15] that come with some of these endeavours, as they take place in a complicated investment environment fraught with geopolitical, social, political and financial risk. To ensure the BRI is successful, Zhou Xiaochuan, governor of the People’s Bank of China, suggests that investment and financing must become more multilateral.[16] This entails the leveraging of development finance, the strengthening of financial services networks and the collaboration of those in financial services across multiple countries. Mr Zhou outlined various steps that could be undertaken, which included the creation of cross-border fund transfers, the use of syndicated loans and the allowance of sharing risk. Dr Zheng echoes some of these sentiments by urging caution, warning that overplaying the BRI could be a “fatal error”[17] that could engender resistance from partner countries and the international community at large.

Outlook

Loan expansion in the BRI is a double-edged sword, with some of its most promising projects containing the most risk. The BRI will benefit some nations that would normally not qualify for traditional loans, and it will help funnel cheaply-obtained money into infrastructure, something that is greatly needed by many of these developing countries to increase trade and economically develop. On the other hand, partnering with these high-risk countries, while using unfavourable loan terms, risks debt distress.

Whether these projects succeed or fail, China will be the one dictating the terms of BRI agreements and will ultimately maximise its gains wherever possible. Accusations of the BRI being used for debt diplomacy is partially dependent on the ability of Chinese policy banks and foreign policy institutions being able to incorporate feedback and country concerns swiftly and effectively. The further Chinese investment travels, the less direct control Chinese leaders will have over projects’ outcome.

China Policy is a research and strategic advisory group based in Beijing, China. Working with clients at the leadership, executive and research levels, they deliver clear insight into China’s policy world as it affects strategic and operational decision-making not only in China but around the world.

[1] China’s Debt-Trap Diplomacy, National Review, 3^rd July 2018, viewed16^th August 2018,

<https://www.nationalreview.com/2018/07/china-belt-and-road-initiative-debt-trap-diplomacy/>

[2] China’s EximBank’s Belt and Road loans up 37 pct in H1 – Xinhua, Reuters, 4^th August 2018, viewed 16^th August 2018, <https://www.reuters.com/article/china-cexim-beltandroad/chinas-eximbanks-belt-and-road-loans-up-37-pct-in-h1-xinhua-idUSL4N1UV053>

[3] An Interview with Visiting Jin Qi, Chairman of Silk Road Fund–Creating new investment and financing cooperation for the Belt and Road, China Finance, 9^th May 2017, viewed 17^th August 2018, <http://www.cnfinance.cn/articles/2017-05/09-25567.html>

[4] China to allow the issuance of “Belt & Road” bonds via exchanges, Reuters, 2^nd March 2018, viewed 16^th August 2018, <https://www.reuters.com/article/china-bonds-belt/china-to-allow-the-issuance-of-belt-road-bonds-via-exchanges-idUSB9N1N201T>

[5] Desai, Umesh, Chinese companies seek cheaper offshore debt after rule change, Reuters, 27^th February 2017, viewed 28^th August 2018, <https://www.reuters.com/article/us-china-debt-offshore/chinese-companies-seek-cheaper-offshore-debt-after-rule-change-idUSKBN1660MV>

[6] Varma, Sonal, and Paracuelles, Euben, The Future of Belt and Road: Debt and Delays, or Huge Growth?, Brink Asia, 16^th May 2018, viewed 17^th August 2018, <https://www.brinknews.com/asia/the-future-of-belt-and-road-debt-and-delays-or-huge-growth/>

[7] Stacey, Kiran, China signs 99-year lease on Sri Lanka’s Hambantota port, Financial Times, 11^th December 2017, viewed 17^th August 2018, <https://www.ft.com/content/e150ef0c-de37-11e7-a8a4-0a1e63a52f9c>

[8] Inside China’s $1 billion port in Lanka where ships don’t want to stop, The Times of India, 18^th April 2018, viewed 17^th August 2018, <https://timesofindia.indiatimes.com/business/international-business/inside-chinas-1-billion-port-where-ships-dont-want-to-stop/articleshow/63811395.cms>

[9] Zhang, Shu and Miller, Matthew, Behind China’s Silk Road vision: cheap funds, heavy debt, growing risk, Reuters, 15^th May 2017, viewed 18^th August 2018, <https://www.reuters.com/article/us-china-silkroad-finance/behind-chinas-silk-road-vision-cheap-funds-heavy-debt-growing-risk-idUSKCN18B0YS>

[10] Zhang, Shu, and Miller, Matthew, Behind China’s Silk Road vision: cheap funds, heavy debt, growing risk, Reuters, 15^th May 2017, viewed 18^th August 2018, <https://www.reuters.com/article/us-china-silkroad-finance/behind-chinas-silk-road-vision-cheap-funds-heavy-debt-growing-risk-idUSKCN18B0YS>

[11] Zhao, Lei, Belt and Road Initiative: How to address negative evaluations?, Cfisnet, 23^rd July 2018, 19^th August 2018, <http://comment.cfisnet.com/2018/0723/1313192.html>

[12] Peng, Nian, Breaking through the West’s Debt Trap Lies, Global Times, 13^th August 2018, viewed 19^th August 2018, <http://opinion.huanqiu.com/hqpl/2018-08/12703351.html>

[13] China Enterprises responds to Gwadar’s revenue distribution: We have already abundantly considered Pakistan’s Interests, Global Times, 28^th November 2017, viewed 19^th August 2018, <http://world.huanqiu.com/exclusive/2017-11/11405122.html>

[14] Xue, Li, and Zheng, Yongnian, An Assessment of the Belt and Road Initiative Five Years on, DWNews, 25^th July 2018, viewed 18^th August 2018 <http://blog.dwnews.com/post-1042851.html>

[15] Active Promotion of Belt and Road Initiative Oil Cooperation, China Oil News Center, 24^th July 2018, viewed 19^th August 2018,

<http://news.cnpc.com.cn/system/2018/07/24/001698896.shtml>

[16] Zhou, Xiaochun, Joint Consultation and Joint Construction: the Belt and Road Initiative’s Investment and Financing Cooperation System, China Finance, 5^th May 2017, viewed 18^th August 2018, <http://www.cnfinance.cn/articles/2017-05/05-25526.html>

[17] Zheng, Yongnian, The New International Order: Trade War and Trump, Cfisnet, 6^th July 2018, viewed 18^th August 2018, <http://comment.cfisnet.com/2018/0706/1313027.html>