The Chinese ‘Debt Trap’ Is it a Myth?

China, we are told, persuades poorer countries into taking out loan after loan to build expensive infrastructure that they can’t afford. The end goal of Beijing is eventually to take control of these assets from its struggling borrowers. As states around the world pile on debt to combat the coronavirus pandemic and bolster flagging economies, fears of such possible seizures have only amplified.

Source: https://asiapowerwatch.com

China’s internationalization—as laid out in programs such as the Belt and Road Initiative—is not simply a pursuit of geopolitical influence but also, a weapon according to some. Once a country is weighed down by Chinese loans, like a hapless gambler who borrows from the Mafia, it is Beijing’s puppet and in danger of losing a limb.

The prime example of this is the Sri Lankan port of Hambantota. As the story goes, Beijing pushed Sri Lanka into borrowing money from Chinese banks to pay for the project, which had no prospect of commercial success. Onerous terms and feeble revenues eventually pushed Sri Lanka into default, at which point Beijing demanded the port as collateral, forcing the Sri Lankan government to surrender control to a Chinese firm.

The Trump administration pointed to Hambantota to warn of China’s strategic use of debt. Former Vice President Mike Pence called it “debt-trap diplomacy”—a phrase he used through the last days of the administration.

But many Chinese banks are willing to restructure the terms of existing loans and have never actually seized an asset from any country. That includes the port of Hambantota.  The city of Hambantota lies at the southern tip of Sri Lanka, a few nautical miles from the busy Indian Ocean shipping lane that accounts for nearly all of the ocean-borne trade between Asia and Europe, and more than 80 percent of ocean-borne global trade. When a Chinese firm secured the contract to build the city’s port, it was stepping into an ongoing Western competition.

It was the Canadian International Development Agency that financed SNC-Lavalin, to carry out a feasibility study for the port. The study, concluded in 2003, confirmed that building the port at Hambantota was feasible. SNC-Lavalin recommended that it be undertaken through a joint-venture agreement between the Sri Lanka Ports Authority (SLPA) and a “private consortium” on a build-own-operate-transfer basis.

The Canadian project failed to move forward, mostly because of Sri Lankan politics. But the plan to build a port in Hambantota gained traction during the rule of the Rajapaksas—Mahinda Rajapaksa, who served as president from 2005 through 2015, and his brother Gotabaya, the current president and former minister of defence—who grew up in Hambantota. They promised to bring big ships to the region, a call that gained urgency after the devastating 2004 tsunami pulverized Sri Lanka’s coast and the local economy.

A second feasibility report, produced in 2006 by the Danish engineering firm Ramboll, also made similar recommendations to the plans put forward by SNC-Lavalin. 

Armed with the Ramboll report, Sri Lanka’s government approached the United States and India; both countries declined. But a Chinese construction firm, China Harbor Group, had learned about Colombo’s hopes, and lobbied hard for the project. China Eximbank agreed to fund it, and China Harbor won the contract.

This was in 2007, six years before Xi Jinping introduced the Belt and Road Initiative. Sri Lanka was still in the last, and bloodiest, phase of its long civil war, and the world was on the verge of a financial crisis. China Eximbank offered a $307 million, 15-year commercial loan with a four-year grace period, offering Sri Lanka a choice between a 6.3 percent fixed interest rate or one that would rise or fall depending on LIBOR. Colombo chose the former, conscious that global interest rates were trending higher during the negotiations and hoping to lock in what it thought would be favourable terms. Phase I of the port project was completed on schedule within three years.

In Hambantota, instead of waiting for phase 1 of the port to generate revenue as the Ramboll team had recommended, Mahinda Rajapaksa pushed ahead with phase 2, transforming Hambantota into a container port. In 2012, Sri Lanka borrowed another $757 million from China Eximbank, this time at a reduced, post-financial-crisis interest rate of 2 percent. Rajapaksa took the liberty of naming the port after himself.

By 2014, Hambantota was losing money. Realizing that they needed more experienced operators, the SLPA signed an agreement with China Harbor and China Merchants Group to have them jointly develop and operate the new port for 35 years. China Merchants was already operating a new terminal in the port in Colombo, and China Harbor had invested $1.4 billion in Colombo Port City, a lucrative real-estate project involving land reclamation. But while the lawyers drew up the contracts, a political upheaval was taking shape.

Steep payments on international sovereign bonds, which comprised nearly 40 percent of the country’s external debt, put Sri Lanka’s government in dire fiscal straits almost immediately. Sri Lanka owed more to Japan, the World Bank, and the Asian Development Bank than to China. Of the $4.5 billion in debt service Sri Lanka would pay in 2017, only 5 percent was because of Hambantota. The Chinese finance in general, was not the source of the country’s financial distress.

The notion of “debt-trap diplomacy” casts China as a conniving creditor and countries such as Sri Lanka as its credulous victims. On a closer look, however, the situation is far more complex. China’s march outward, like its domestic development, is probing and experimental, a learning process marked by frequent adjustment.

Over the past 20 years, Chinese firms have learned a lot about how to play in an international construction business that remains dominated by Europe: Whereas China has 27 firms among the top 100 global contractors, up from nine in 2000, Europe has 37, down from 41. The U.S. has seven, compared to 19 two decades ago.

Chinese firms are not the only companies to benefit from Chinese-financed projects. Perhaps no country was more alarmed by Hambantota than India, the regional giant that several times rebuffed Sri Lanka’s appeals for investment, aid, and equity partnerships. Yet an Indian-led business, Meghraj, joined the U.K.-based engineering firm Atkins Limited in an international consortium to write the long-term plan for Hambantota Port and for the development of a new business zone. The French firms Bolloré and CMA-CGM have partnered with China Merchants and China Harbor in port developments in Nigeria, Cameroon, and elsewhere.

The other side of the debt-trap myth involves debtor countries. Sri Lanka—or, for that matter, Kenya, Zambia, or Malaysia—are no stranger to geopolitical games. And the Americans are irritated by Chinese initiatives. 

The events that led to a Chinese company’s acquisition of a majority stake in a Sri Lankan port reveal a great deal about how the world is changing. China and other countries are becoming more sophisticated in bargaining with one another. And it is a pity if the U.S. fails to learn to work better to secure deals.

So, is it a myth? Yes, if we understand geopolitics and international competition. But that does not remove the need to be circumspect in negotiating “fair” deals with China or any other party.

Reference:

The Chinese “Debt Trap” Is a Myth? Deborah Brautigam and Meg Rithmire, Feb 6, 2021 

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