China has not engaged in deliberate “debt-trap diplomacy” in the Pacific, but the burgeoning scale of its lending, and institutional weakness within Pacific states, pose clear risks for small states being overwhelmed by debt, a new report argues.
An infrastructure arms race between China and other countries with interests in the region — including Australia — might only exacerbate the problem.
China’s Belt and Road Initiative has exposed the issue of unsustainable debt risk for less-developed countries, in particular for the small and fragile economies of the Pacific, said the Lowy Institute report, Ocean of Debt?
Illustration: Mountain People
However, the report’s authors, Roland Rajah, Alexandre Dayant and Jonathan Pryke, argue that China’s global infrastructure plan presents a more “nuanced picture” than the accusation of “debt-trap diplomacy” and sovereign risk to small nations unable to service their debts.
“The evidence suggests China has not been engaged in problematic debt practices in the Pacific as to justify accusations of debt trap diplomacy, at least not to date. Still, the sheer scale of Chinese lending and the lack of strong institutional mechanisms to protect the debt sustainability of borrowing countries mean a continuation of business as usual would pose clear risks,” the report said.
“China will need to substantially restructure its approach if it wants to remain a major player in the Pacific without fulfilling the debt trap accusations of its critics,” the report added.
“Debt-trap diplomacy,” broadly defined, is when a creditor country intentionally lends excessive credit to a smaller debtor country, with the intention of extracting economic or political concessions when the smaller country cannot service the loan.
Due to small populations, fragile economies prone to external shocks (like oil price hikes) or uncontrollable events such as natural disasters, and weak institutions of government, Pacific states are acutely vulnerable to debts becoming unsustainable.
Economic growth in Pacific states is “more volatile than it is fast,” and that unpredictably could make repaying large loans unsustainable, the Lowy report said.
China’s massively increased aid and development presence in the Pacific is made starkly apparent by its contrasting style to traditional aid donors in the region, such as Australia.
China has backed infrastructure development — usually large, landmark constructions such as bridges or significant public buildings — and usually through loans rather than through grants.
“Chinese assistance is perceived to be faster, more responsive to the needs of local political elites and have fewer conditions attached. As one senior Pacific bureaucrat put it: ‘We like China because they bring the red flags, not the red tape,’” the Lowy report said.
China’s development presence was acutely apparent when Australian Prime Minister Scott Morrison visited Fiji last week. In order to meet with the Fijian Prime Minister Frank Bainimarama, Morrison’s motorcade had to drive over the Fiji-China friendship bridge, and past the construction site of a Chinese-financed 30-story tower, soon to be the tallest building in the Pacific islands.
However, the nature and quality of Chinese infrastructure projects have been criticized.
Former Australian minister for international development and the Pacific Concetta Fierravanti-Wells accused Beijing of “duchessing” the Pacific, building “white elephant” infrastructure, “roads to nowhere” and “useless buildings.”
“Tied financing, little due diligence, outsized projects, weak project oversight and fraudulent and corrupt practices are among the many criticisms that have been directed at Chinese projects,” the Lowy report said.
However, a 2014 study analyzing the impact and quality of Chinese projects in the Pacific found some performed far better than others.
“The evidence suggests that, if left alone, Chinese state firms will cut corners and inflate prices. If managed properly, they can deliver good quality infrastructure,” the Lowy report said.
The case of Hambantota port in Sri Lanka is held up as an exemplar of “debt-trap” diplomacy.
After the Export-Import Bank of China financed, and Chinese companies built, a new inland port in Hambantota — the home district of former Sri Lankan president Mahinda Rajapaksa, who greenlit the port, and after whom it is named — the Sri Lankan government ran into debt-related problems and a debt-for-equity swap was proposed, giving a state-owned Chinese firm a majority equity stake in the strategically located port starting from 2017.
Similarly, Tonga, a country of 100,000 people, still owes the Chinese bank A$108 million (US$ 74 million at the current exchange rate) — about 25 percent of Tonga’s GDP — for loans taken out in 2008 and 2010, and since deferred twice.
Last year, then-Australian minister for foreign affairs Julie Bishop said that Australia wanted to ensure Pacific states were not “trapped into unsustainable debt outcomes” by Chinese loans.
“The trap can then be a debt-for-equity swap and they have lost their sovereignty,” Bishop said.
In August, US Secretary of Defense Mark Esper accused China of destabilizing the region through “predatory economics and debt-for-sovereignty deals.”
China has fiercely rejected the accusations.
Chinese Ambassador to Samoa Chao Xiaoliang (巢小良) wrote in the Samoa Observer: “Rather than pointing fingers at China’s good deeds, those who keep on making groundless accusations and speculations might as well do more themselves to provide help to the Pacific island countries. Some people questioned the purpose of China’s aid, even disregarded the facts and fabricated the so-called ‘China debt trap’ — this is either out of prejudice or ignorance of China’s foreign aid policy.”
The Lowy paper argues that to avoid its Pacific infrastructure projects becoming debt traps for small nations, China should reform its lending practices to be closer to those of the World Bank and the Asian Development Bank, “the standard-bearers for international good practice.”
“If China wants to remain a major development financier in the Pacific without fulfilling the debt trap accusations of its critics, it will need to substantially restructure its approach, including adopting formal lending rules similar to those of the multilateral development banks,” the report said.
Despite a significantly decreased aid budget — currently a historic low 0.21 percent of gross national income — Australia remains the dominant aid provider to the region. However, as part of the “Pacific Step-Up” it announced in November last year, Australia is seeking to move more into providing loans, alongside aid grants, with the A$2 billion Australian Infrastructure Financing Facility for the Pacific — A$1.5 billion in loans, A$0.5 billion in grants — as well as another A$1 billion in callable capital for Export Finance Australia.
The Lowy paper warns against an infrastructure ‘arms race’ with China in the Pacific, arguing it could worsen the risk of debt traps for island nations.
“There are concerns that in seeking to compete directly with loans from China, Australia might simply exacerbate existing debt sustainability problems in the Pacific,” it said.
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