Fortune Magazine writes about the coming debt crisis, and how in “a lot of the world, the clock has hit midnight’: China is calling in loans to dozens of countries from Pakistan to Kenya”:
A dozen poor countries are facing economic instability and even collapse under the weight of hundreds of billions of dollars in foreign loans, much of them from the world’s biggest and most unforgiving government lender, China.
An Associated Press analysis of a dozen countries most indebted to China — including Pakistan, Kenya, Zambia, Laos and Mongolia — found paying back that debt is consuming an ever-greater amount of the tax revenue needed to keep schools open, provide electricity and pay for food and fuel. And it’s draining foreign currency reserves these countries use to pay interest on those loans, leaving some with just months before that money is gone.
Behind the scenes is China’s reluctance to forgive debt and its extreme secrecy about how much money it has loaned and on what terms, which has kept other major lenders from stepping in to help. On top of that is the recent discovery that borrowers have been required to put cash in hidden escrow accounts that push China to the front of the line of creditors to be paid.
If this money were owed to the West, these countries would likely stop paying, because Third World countries have often defaulted on loans to the West when repaying the money would cause enormous suffering. But with China, it’s different: These countries are trying to pay China, at least for the moment, even though they have to cut spending on education, healthcare, and even the salaries of government employees:
Countries in AP’s analysis had as much as 50% of their foreign loans from China and most were devoting more than a third of government revenue to paying off foreign debt. Two of them, Zambia and Sri Lanka, have already gone into default, unable to make even interest payments on loans financing the construction of ports, mines and power plants.
In Pakistan, millions of textile workers have been laid off because the country has too much foreign debt and can’t afford to keep the electricity on and machines running.
In Kenya, the government has held back paychecks to thousands of civil service workers to save cash to pay foreign loans. The president’s chief economic adviser tweeted last month, “Salaries or default? Take your pick.”
Since Sri Lanka defaulted a year ago, a half-million industrial jobs have vanished, inflation has pierced 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 loans to poor countries, there could be a wave of more defaults and political upheavals.
“In a lot of the world, the clock has hit midnight,” said Harvard economist Ken Rogoff. “ China has moved in and left this geopolitical instability that could have long-lasting effects.”
To try to repay China, these countries are, in some cases, taking out new loans on worse terms, which may only delay the inevitable default if their economies don’t improve (if prices rise for a commodity produced by a country, its economy may improve — many African countries are heavily reliant on a single commodity, like copper for Zambia, iron for Guinea, and cashews for Guinea-Bissau):
A case study of how it has played out is in Zambia, a landlocked country of 20 million people in southern Africa that over the past two decades has borrowed billions of dollars from Chinese state-owned banks to build dams, railways and roads.
The loans boosted Zambia’s economy but also raised foreign interest payments so high there was little left for the government, forcing it to cut spending on healthcare, social services and subsidies to farmers for seed and fertilizer.
In the past under such circumstances, big government lenders such as the U.S., Japan and France would work out deals to forgive some debt, with each lender disclosing clearly what they were owed and on what terms so no one would feel cheated.
But China didn’t play by those rules. It refused at first to even join in multinational talks, negotiating separately with Zambia and insisting on confidentiality that barred the country from telling non-Chinese lenders the terms of the loans and whether China had devised a way of muscling to the front of the repayment line.
Amid this confusion in 2020, a group of non-Chinese lenders refused desperate pleas from Zambia to suspend interest payments, even for a few months. That refusal added to the drain on Zambia’s foreign cash reserves, the stash of mostly U.S. dollars that it used to pay interest on loans and to buy major commodities like oil. By November 2020, with little reserves left, Zambia stopped paying the interest and defaulted, locking it out of future borrowing and setting off a vicious cycle of spending cuts and deepening poverty.
Inflation in Zambia has since soared 50%, unemployment has hit a 17-year high and the nation’s currency, the kwacha, has lost 30% of its value in just seven months. A United Nations estimate of Zambians not getting enough food has nearly tripled so far this year, to 3.5 million.
This was predicted by financial analysts, who noted that China’s Belt and Road Initiative was funding white-elephant projects that would not pay for themselves in higher economic growth. To the countries that borrowed from China, its loans looked like manna from heaven. China loaned money without demanding that Third World countries respect human rights and avoid corruption, the way the United States often does. But China is much less forgiving about late payments:
China’s unwillingness to take big losses on the hundreds of billions of dollars it is owed, as the International Monetary Fund and World Bank have urged, has left many countries on a treadmill of paying back interest, which stifles the economic growth that would help them pay off the debt.
Foreign cash reserves have dropped in 10 of the dozen countries in AP’s analysis, down an average 25% in just a year. They have plunged more than 50% in Pakistan and the Republic of Congo. Without a bailout, several countries have only months left of foreign cash to pay for food, fuel and other essential imports. Mongolia has eight months left. Pakistan and Ethiopia about two.
“As soon as the financing taps are turned off, the adjustment takes place right away,” said Patrick Curran, senior economist at researcher Tellimer. “The economy contracts, inflation spikes up, food and fuel become unaffordable.”
The Ukraine crisis has aggravated the problems of Third World countries, afflicting them with hard currency shortages, high inflation, jumps in unemployment and rises in malnutrition:
Along with the usual mix of government mismanagement and corruption are two unexpected and devastating events: the war in Ukraine, which has sent prices of grain and oil soaring, and the U.S. Federal Reserve’s decision to raise interest rates 10 times in a row, the latest this month. That has made variable rate loans to countries suddenly much more expensive.
All of it is roiling domestic politics and upending strategic alliances.
In March, heavily indebted Honduras cited “financial pressures” in its decision to establish formal diplomatic ties to China and sever those with Taiwan.
Last month, Pakistan was so desperate to prevent more blackouts that it struck a deal to buy discounted oil from Russia, breaking ranks with the U.S.-led effort to shut off Vladimir Putin’s funds.
China says it is being very understanding and patient with African countries that are struggling to pay their debts:
The Chinese Ministry of Foreign Affairs, in a statement to the AP, disputed the notion that China is an unforgiving lender and echoed previous statements putting the blame on the Federal Reserve. It said that if it is to accede to IMF and World Bank demands to forgive a portion of its loans, so should those multilateral lenders, which it views as U.S. proxies.
“We call on these institutions to actively participate in relevant actions in accordance with the principle of ‘joint action, fair burden’ and make greater contributions to help developing countries tide over the difficulties,” the ministry statement said.
China argues it has offered relief in the form of extended loan maturities and emergency loans, and as the biggest contributor to a program to temporarily suspend interest payments during the coronavirus pandemic. It also says it has forgiven 23 no-interest loans to African countries, though AidData’s Parks said such loans are mostly from two decades ago and amount to less than 5% of the total it has lent.
The IMF and World Bank can’t possibly bail out all these debtors. But the West’s past indulgent policies of forgiving African countries’ past debts probably encouraged these countries to think the IMF and World Bank would bail them out:
The IMF and World Bank say taking losses on their loans would rip up the traditional playbook of dealing with sovereign crises that accords them special treatment because, unlike Chinese banks, they already finance at low rates to help distressed countries get back on their feet. The Chinese foreign ministry noted, however, that the two multilateral lenders have made an exception 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, a former debt official at Pakistan’s Ministry of Finance, said his country’s debt burden is too heavy and time too short for the IMF and World Bank to hold out. He also called for concessions from private investment funds that lent to his country by purchasing bonds.
“Every stakeholder will have to take a haircut,” Hassan said.
Western bondholders are getting a shock as they learn that African nations had hidden debts to China that didn’t even show up in their official books:
China at the time was ramping up lending that would soon become part of its $1 trillion “Belt and Road Initiative” to secure supplies of key minerals, win allies abroad and make more money off its U.S. dollar holdings. Many developing countries were eager for U.S. dollars to build power plants, roads and ports and expand mining operations.
But after a few years of straightforward Chinese government loans, those countries found themselves heavily indebted, and the optics were awful. They feared that piling more loans atop old ones would make them seem reckless to credit rating agencies and make it more expensive to borrow in the future.
So China started setting up shell companies for some infrastructure projects and lent to them instead, which allowed heavily indebted countries to avoid putting that new debt on their books. Even if the loans were backed by the government, no one would be the wiser.
In Zambia, for example, a $1.5 billion loan from two Chinese banks to a shell company to build a giant hydroelectric dam didn’t appear on the country’s books for years.
In Indonesia, Chinese loans of $4 billion to help build a railway also never appeared on public government accounts. That all changed years later when, overbudget by $1.5 billion, the Indonesian government was forced to bail out the railroad twice.
“When these projects go bad, what was advertised as a private debt becomes a public debt,” Parks said. “There are projects all over the globe like this.”
In 2021, a decade after Parks and his team began their hunt, they had gathered enough information for a blockbuster finding: At least $385 billion of hidden and underreported Chinese debt in 88 countries, and many of those countries were in far worse shape than anyone knew.
Among the disclosures was that China issued a $3.5 billion loan to build a railway system in Laos, which would take nearly a quarter of the country’s annual output to pay off.
Another AidData report around the same time suggested that many Chinese loans go to projects in areas of countries favored by powerful politicians and frequently right 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 away from most of the country’s population is so barely used that elephants have been spotted wandering on its tarmac.
Cracks are appearing in hydroelectric plants in Uganda and Ecuador, where in March the government got judicial approval for corruption charges tied to the project against a former president now in exile.
In Pakistan, a power plant had to be shut down for fear it could collapse. In Kenya, the last key miles of a railway were never built due to poor planning and a lack of funds.
Chinese lenders required African and Asian countries to enter into collusive deals that ripped off Western lenders:
As Parks dug into the details of the loans, he found something alarming: Clauses mandating that borrowing countries deposit U.S. dollars or other foreign currency in secret escrow accounts that Beijing could raid if those countries stopped paying interest on their loans.
In effect, China had jumped to the front of the line to get paid without other lenders knowing.
In Uganda, Parks revealed a loan to expand the main airport included an escrow account that could hold more than $15 million. A legislative probe blasted the finance minister for agreeing to such terms, with the lead investigator saying he should be prosecuted and jailed.
Parks is not sure how many such accounts have been set up, but governments insisting on any kind of collateral, much less collateral in the form of hard cash, is rare in sovereign lending. And their very existence has rattled non-Chinese banks, bond investors and other lenders and made them unwilling to accept less than they’re owed.
“The other creditors are saying, ‘We’re not going to offer anything if China is, in effect, at the head of the repayment line,’” Parks said. “It leads to paralysis. Everyone is sizing each other up and saying, ‘Am I going to be a chump here?’”
Yes. Yes, you are.
Meanwhile, Beijing has taken on a new kind of hidden lending that has added to the confusion and distrust. Parks and others found that China’s central bank has effectively been lending tens of billions of dollars through what appear as ordinary foreign currency exchanges.
Foreign currency exchanges, called swaps, allow countries to essentially borrow more widely used currencies like the U.S. dollar to plug temporary shortages in foreign reserves. They are intended for liquidity purposes, not to build things, and last for only a few months.
But China’s swaps mimic loans by lasting years and charging higher-than-normal interest rates. And importantly, they don’t show up on the books as loans that would add to a country’s debt total.
Mongolia has taken out $1.8 billion annually in such swaps for years, an amount equivalent to 14% of its annual economic output. Pakistan has taken out nearly $3.6 billion annually for years and Laos $300 million .
The swaps can help stave off default by replenishing currency reserves, but they pile more loans on top of old ones and can make a collapse much worse, akin to what happened in the runup to 2009 financial crisis when U.S. banks kept offering ever-bigger mortgages to homeowners who couldn’t afford the first one.
Some poor countries struggling to repay China now find themselves stuck in a kind of loan limbo: China won’t budge in taking losses, and the IMF won’t offer low-interest loans if the money is just going to pay interest on Chinese debt.
If Western countries — or the IMF or World Bank — bail out these African and Asian countries, that will effectively reward China for its unethical schemes putting western lenders at a disadvantage.
