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China's "Debt Trap" Lending to Africa is a Growing Concern

6th August 2021 - Approximate reading time, 8 minutes.



China's "Debt Trap" Lending to Africa is a Growing Concern



Over the past several years much has been written about the massive level of Chinese state lending to developing economies, particularly in Africa.  However, relatively little reliable information has surfaced with respect to the "onerous and secretive" clauses and "unorthodox parameters" contained in China's loan deals to emerging, pioneer and frontier market countries.  The reality is that we have minimal knowledge when it comes to the specifics (terms, conditions, and legalities) of bilateral public sector Chinese loans. - China simply does not disclose details. Apparently, the same is true for private Chinese lenders.  This lack of transparency should be troubling to anyone holding significant amounts of African bonds or loans, especially when we consider current global economic stresses on less developed nations resulting from Covid -19 pandemic shocks, sociopolitical flash points and prolonged conflicts in some key regions.



China's core investment strategy with respect to Africa has focused primarily on the continent's abundant natural resources.  Under its "Belt and Road Initiative" (BRI), launched in 2013, China has lent billions to developing country governments.  In Africa, a large majority rank as mineral and / or energy rich states, while others are perceived by Beijing to be investment attractive due to geographic and / or political import.  The ambitious program's publicly  communicated aim is to improve global economic links and cooperation.  Some critics see things quite differently and have argued that the BRI's true intention is the creation of a Chinese dominant order in large parts of the developing world - the majority of the countries are sub-Saharan African - potentially leading to high levels of debtor financial dependency over the long-term, while giving China substantial access to an abundance of natural riches, some categorized as strategically vital.



According to the South China Morning Post, China's lending to Africa in the period between 2000 and 2018 totaled at least USD 152 billion (South China Morning Post - China Turns Cautious on Funding in Africa Amid Default Fears - 29th November 2020).  Much of this money has financed a wide assortment of infrastructure projects under the BRI program; which is often referred to as "debt- trap diplomacy", where lending agreements are structured with default provisions containing political or economic compromises.  Under this scheme, inability to service loans could result in the debtor country losing control of major assets.



An example of how consequential loan defaults governed by BRI agreements can be is the 2017 Sri Lanka fiasco, where the government's failure to fully repay harbor modernization debt resulted in a 99-year lease of seaport facilities to Chinese firms.  Western powers now fear that China could, at some point, move to utilize the port as a naval base.  A situation rather similar to what occurred in Sri Lanka may yet develop with one of Djibouti's strategically important ports, as the Horn of Africa nation's Chinese loan responsibilities  - presently, some of the original financing agreement elements concerning concessions may be in dispute - are estimated to be running at over USD two billion and this level of debt appears to be unsustainable, considering current budgetary strains.



The International Assessment and Strategy Center, a think-tank headquartered in Alexandria Virginia, sees China's debt-trap diplomacy as just one component of a far larger undertaking geared to reviving its Middle Kingdom form of global hegemony: to grow influence, accomplish military ingress to strategic locations and generally expand power globally.  In the main, Beijing's developing country calculus seems to be driven by geopolitical ambitions and is designed to accomplish dominant influence in a given nation's security and economic well-being.



Sovereign lending documentation used by Chinese state-owned financial agencies in Africa not only contains political and economic concession clauses, but also prioritize repayment performance ahead of other creditors.  In a study recently completed by AidData, a political and economic research lab at the College of William & Mary, it was revealed that Chinese loan agreements tend to have a number of unusual features that serve to increase repayment chances and stand in conflict with G20 guidelines which require uniform consideration for all creditors, both public and private.  Additionally, the small handful of Chinese / African contracts AidData was able to examine contain language specifically prohibiting a borrower country from equitably restructuring loans, with no allowances made for coordination with non-Chinese creditors.  Moreover, the documentation includes strict confidentiality components forbidding borrowers from revealing loan terms and collateral arrangements (often involving natural resources) that exclusively benefit Chinese entities and allow for wide discretion in loan cancellation and demand for full repayment.  Furthermore, there are no"Paris Club provisions", meaning that Chinese lenders are favored over all other financing institutions and the debt cannot be included in any restructurings. 



Other discovery processes have revealed that much of China's state financing to Africa is founded on the future value of commodities, making it particularly risky for borrowers since any extended drop in commodity prices would require artificial expansion of production in order to satisfy loan obligations.  In a fair percentage of financing arrangements commodities ( in many cases, minerals) are pledged as security and sometimes serve as an alternative form of repayment (Carnegie Endowment for International Peace - What Do We Know About Chinese Lending in Africa? - 2nd June 2021).



The African Exponent. a business and economics news organization, recently listed the African countries with the highest debt loads to China (The African Exponent - The Top Ten African Countries With the Largest Chinese Debt - 31st July 2021).  In order of total amount owed (highest to lowest) the biggest borrowers are as follows:



1) ANGOLA: over USD 25 billion.



2) ETHIOPIA: at least USD 13.5 billion.



3) KENYA: in the range of USD 8 billion.



4) THE REPUBLIC OF CONGO (Congo - Brazzaville): approximately USD 7.3 billion.



5) NORTH SUDAN: around USD 6.4 billion.



6) ZAMBIA: estimated at USD 6 billion.



7) CAMEROON: 5.5 billion.



8) NIGERIA: About USD 5 billion.



9) GHANA: USD 3.5 billion.



10) THE DEMOCRATIC REPUBLIC OF CONGO (DRC): Conservatively estimated at more than USD 3 billion.



NOTE:



It should be mentioned that lending by  Chinese organizations to Africa has declined over the last two years out of fear of default (Bloomberg - Chinese Lending to Africa Down on Loan-Default Fears, Study Says - 29th March 2021).



Other than North Sudan and DRC, each of the above named countries, in addition to large amounts of Chinese debt, have outstanding international bonds with final maturities in the mid-to-long-term range.  One country, Zambia, defaulted on its bond obligations in 2020, and due to a combination of serious economic and political factors, Ethiopia could be next.  What role have Chinese loan agreement structures that are fundamentally antithetical to traditional market norms played in the difficulties currently being experienced by these two countries (and some others in Africa)?  Did prioritization of repayment to Chinese lenders somehow hinder Zambia's ability to honor commitments to its bondholders, causing it to default?  Are similar dynamics now at play in Ethiopia?



Angola has several major bond issues as well as the highest Chinese borrowing numbers in Africa.  About three quarters of the country's debt to China is owed to the China Development Bank (CDB). And what stands as a real concern is that Beijing classes the CBD as a commercial creditor, thus keeping it outside of any potential multilateral rescheduling and debt forgiveness negotiations.  In such a situation, the CDB would be free to unilaterally make payment demands on Angola.  This would present substantial complications for the country, its bondholders and commercial creditors, should comprehensive debt relief be sought.



Country risk analysts are in general agreement that Angola will eventually be forced to reschedule its external debt (perhaps before the end of this year) as oil revenues and hard currency reserves have decreased dramatically, in fair part caused by the impact of Covid-19.  The exigent question, then, is what posture will China assume when Angola requests a general debt restructuring?  How will out-of-the-ordinary, restrictive loan contract clauses - market intelligence indicates they exist in most if not all China / Angola loan documentation - that give preference to Chinese creditors over other lenders affect the debt rescheduling process for Angola - or any economically attenuated bond issuing African country burdened with substantial financial obligations to China?  Will China become a reasonable actor show some flexibility?



Adding to the complexities, a good number of African nations have incurred debt not only to Chinese state-owned banks and companies but also to private firms with operations in the continent.  A research team at Johns Hopkins School of Advanced International Studies (specifically, the SAIS China Africa Initiative) has determined that over thirty non-government banks and corporations hold sovereign loan commitments in Africa.  There is a lack of consensus on total amounts owed as well as loan specifications.  Are the architectures of private Chinese loan agreements as stringent as those of Chinese state financing agencies?  The answer to the question is probably yes.



In sum, China's African lending practices fail to comport with long-accepted market standards and global institutional policies - limited evidence gleaned from reviews of Asian / Balkan / Chinese loan documents suggest that the same holds for many non-African developing economies as well.  As argued, loan contracts place outsized obligations and restrictions on borrowers.  Oftentimes, the collateral particulars in Chinese financing agreements can compromise a debtor country's natural resources.  These are likely part of official lending protocol for both public and private financial entities since, in China, there are usually behavioral consistencies between the two domains - all Chinese enterprises are considered to be representatives of the state apparatus regardless of classification, and they conduct their business in accordance with central government guidelines.  At foundation, China's lending techniques seem designed to cement Chinese creditors as "preferred lenders" with exclusive rights, and exempt from multilateral restructurings.



According to some of the research cited above, Paris Club frameworks are not followed, thus prohibiting borrower countries from restructuring / rescheduling their outstanding loans to China in coordination with other government lending agencies.  In addition to the rigid, less than conventional conditions


imposed on Chinese borrowers, certain contracts may include clauses that give creditors extraordinary discretion in calling for repayment ahead of schedule.  An additional risk consideration for African creditors outside of China since the triggering of early repayment stipulations could result in a weakening of debt servicing capabilities as regards non-Chinese debt.



What has been revealed recently about Chinese creditor tactics in Africa (as well as other less economically advanced regions) should give investors pause.  Holders of African bonds, for instance, may want to consider modifications to their country risk modeling so as to give enhanced weight to the possible pressures of elevated China debt levels (and their putative problematic loan contract structures) on a given country's capacity to adequately perform on non-Chinese debt commitments, adjusting their exposure ranges accordingly.



WesBruin Capital


6th August 2021

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