Opinion: How China is turning bad loans into strategic investments

China’s Debtbook Diplomacy: How China is Turning Bad Loans into Strategic Investments

Belt and Road is not the Marshall Plan: it’s comprised of loans, not grants, and China expects a return for its money

By Sam Parker and Gabrielle Chefitz

Through its Belt and Road Initiative, China is extending hundreds of billions of dollars in loans to developing countries that often can’t afford to pay them back. In doing so, Beijing may be looking beyond its bottom line, hoping to convert economic loss into geopolitical gain.

Take the case of Hambantota, until a decade ago a little fishing town in southern Sri Lanka — a place few could ever envision becoming a geopolitical flashpoint. In 2007, a Chinese state-owned company came in to build a major port financed by Chinese loans. When the port flopped commercially, it became a money pit, as Sri Lanka threw good money after bad in a fruitless attempt to turn the project around. Despite President Maithripala Sirisena’s campaign promises to reduce Sri Lanka’s dependence on China, last year its mounting debt burden drove Sirisena’s government to sign over the strategically-located port to a Chinese state-owned company on a 99-year lease. The deal has alarmed some U.S. and Indian experts who fear that Hambantota could one day become a Chinese naval outpost in the Indian Ocean.

As China continues to loan billions to construct often commercially non-viable infrastructure projects in debt-strapped nations, we believe this is a pattern that has the potential to repeat itself. In a report published recently by Harvard University’s Belfer Center for Science and International Affairs, we identify 16 developing countries — from the Horn of Africa to far-flung Pacific Islands — that may become vulnerable to what we’ve termed “debtbook diplomacy.” Many of these countries have taken on massive Chinese loans with little clear prospect for repayment and have strategic assets or diplomatic sway that China could demand. Such deals could undermine U.S. interests and foreign policy in Asia.

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Sri Lanka is hardly the only country taking on eye popping levels of Chinese loans. The China Pakistan Economic Corridor has ballooned to over $62 billion, while Chinese loans bumped Djibouti’s debt-to-GDP ratio up from 50 to 85 percent between 2014 and 2016. Laos and Cambodia are so indebted to China that former Australian Foreign Minister Gareth Evans recently characterized them as “wholly owned subsidiaries of China.” These are just a few of the opaque Chinese loans and “white elephant” development projects scattered across the Asia and Africa.

As Beijing accumulates more economic leverage through lending, recent evidence suggests it won’t be shy about using its distinctive state-and-market model towards advancing the ruling party’s global political goals. China’s practice of geoeconomics has been as creative as it’s been proactive: from shuttering South Korean-owned supermarkets in protest of a missile system deployment, to decimating Norway’s salmon exports as punishment for a Chinese dissident winning the Nobel Prize.

With debtbook diplomacy, the stakes are much higher than salmon and supermarkets. We believe China could apply this debt leverage as a tool to achieve three longstanding strategic goals: acquiring a string of ports to project power across South Asia; undermining U.S. led opposition to its contested South China Sea claims; and challenging U.S. naval dominance in the Pacific. As Chinese loans begin to mature, we see early evidence of this playing out. Aside from Hambantota, China has acquired its first overseas naval base in Djibouti, and controls major, Chinese-built ports in Pakistan and Myanmar — three countries heavily dependent on Chinese loans. In Southeast Asia, China’s “subsidiaries” (Laos and Cambodia) have begun to block ASEAN statements condemning Chinese behavior. And in Oceania, China and Vanuatu were recently forced to walk back rumors of a potential Chinese naval base.

Belt and Road is not the Marshall Plan: it’s comprised of loans, not grants, and China expects a return for its money. But it is also not a Chinese ploy to mire developing countries in debt. This debt leverage is probably more of a useful byproduct than a design feature, China’s wielding of it more opportunism than grand strategy. However, what is clear is that these debts will continue to grow, and debtor countries will remain on the hook for repayment–in one form or another.

The U.S. certainly does not have a spotless record when it comes to lending overseas. Risky lending by U.S. banks led to a debt crisis that spread across 27 Latin American countries in the 1980s – now known as the “lost decade” of growth for those countries. The U.S. offered a “voluntary” reform plan that sparked riots as a choice between “democracy or debt,” but also pushed American banks to forgive loans – and in return they received bonds, not ports. It’s too early to tell how China would respond to widespread defaults, but it would have the added ability–unavailable to the U.S. banks – to squeeze these countries for ports or other non-monetary repayments.

So what should the U.S. do? China is promising more than $1 trillion to developing countries, many with real infrastructure needs. In the big picture, there is very little the U.S. can do to change this dynamic: We cannot outbid them, nor should we try. American companies lack the motivation to match China’s massive Asian infrastructure investments, particularly when many of these projects appear commercially non-viable. And there is no mechanism for the U.S. government to direct its companies to do so.

This friction between China’s state-run economic model and the American free market approach highlights a fundamental tension that has come to define the broader economic relationship between the two superpowers. From recent trade talks and the debate around ZTE, to longstanding frustrations over Chinese intellectual property theft, the Trump Administration continues to grate against a China it sees as playing by its own economic rules at the expense of U.S. industry and interests.

When it comes to debtbook diplomacy, what the U.S. can do is work to blunt the sharpest edges by demonstrating its own commitment to regional partners through a targeted application of American diplomatic, economic, and military power. This includes streamlining our public-private investment overseas; supporting India’s ascendance as a regional leader and strengthening relationships among the U.S.-Australia-India-Japan “Quad” network; and encouraging China to become a more responsible creditor while financing independent debt management and contracting expertise to debtor nations.

In justifying the decision to sign over Hambantota Port, Sri Lanka’s ports and shipping minister said “We had to make a decision to get out of this debt trap.” But handing over Hambantota was a temporary reprieve, and for Sri Lanka and others, it may be too late. Strapped for cash and with its economy slowing, earlier this month Sri Lanka had to take out a new $1-billion-dollar loan to build a highway. From China. The debtbook continues to grow.

(Sam Parker and Gabrielle Chefitz are 2018 Master in Public Policy graduates of Harvard Kennedy School. This op-ed has been adapted from the capstone Policy Analysis Exercise they wrote. The article originally appeared on thediplomat.com)