Abstract: This year marks the tenth anniversary of the Belt and Road Initiative (BRI). While China has made notable strides in fostering connectivity and collaboration with partner nations under the initiative, the global landscape in which it emerged has changed dramatically, which calls for new solutions to new challenges faced by BRI and other international cooperation frameworks. A recent CICC publication, "Belt and Road Initiative at Ten," explores key issues in BRI cooperation. In the book introduction, Zhou Xiaochuan, Vice Chairman of the Boao Forum for Asia, discusses issues related to the high proportion of infrastructure in BRI projects, the so-called China debt trap, and future financing under the BRI. He emphasizes the need for comprehensive research and consensus on debt-related matters and suggests strategies like increasing equity investment and reducing sovereign debt to address challenges and shape the future of BRI investment and financing.
With 2023 marking the 10th anniversary of President Xi Jinping's Belt and Road Initiative (BRI), and China's recent success in hosting the 3rd Belt and Road Forum for International Cooperation, CICC's "Belt and Road Initiative at Ten" comes at a good time.
The book is comprehensive in coverage, containing three chapters that each focuses on macro, finance, and industry, and broaches several topics that merit further in-depth exploration.
I have participated in several discussions on the BRI and international debt issues. In early June, I gave a lecture at Fudan University titled "Some Economic Analyses of the BRI" which is somewhat related to this topic. I will share with you three aspects of the topic.
I. HIGH PROPORTION OF INFRASTRUCTURE IN BRI COOPERATION
CICC's book analyzes why the proportion of infrastructure is high in the BRI cooperation and puts forward the idea of "comparative advantage". I think this issue can be further discussed. Conceptually, three relationships of comparative advantage can be discussed: 1) natural endowment and comparative advantage, 2) international division of labor and comparative advantage, and 3) efficiency advantage and overcapacity.
Early theories of comparative advantage suggested that comparative advantage was the result of natural endowments. Later, it was slowly realized that it was not necessary to have natural endowments and that comparative advantages could also stem from the needs of international division of labor. From the perspective of labor division, a country will gradually develop a certain area of specialization, and then form a comparative advantage, which will in turn accelerate the international division of labor.
If a country wishes to participate more in the international division of labor, it must have an efficiency advantage in technology, management, market development, transportation, and, above all, production and cost. An efficiency advantage would allow a country to develop production capacity that exceeds its local demand, and it would therefore have to go international. If one looks only at domestic market demand, there will be overcapacity.
So from this point of view, overcapacity is not a bad word; in fact, it is closely linked to comparative advantage and the international division of labor. When a country has excess capacity, it can make good use of its advantages in globalization and the international division of labor. BRI has very clear characteristics in this regard.
Before the Asian financial turmoil, China's infrastructure was weak. At that time, China, as a large country, had large infrastructure needs, implying that it would usher in a phase of major infrastructure development. Especially in response to the Asian financial turmoil in the late 1990s and the current round of international financial crisis, the Chinese government stepped up its fiscal spending and aggregate demand management by vigorously promoting infrastructure construction and investment projects. This also accelerated the cultivation of infrastructure construction capacity. When this capacity increased to a certain extent, domestic demand became slightly saturated, creating the potential as well as the pressure for capacity export.
Having gone through these two phases of crisis, China has demonstrated very clear capabilities and comparative advantages in several areas, including infrastructure construction, urbanization, manufacturing, and industrial parks. Advantageous areas of infrastructure construction include highways, railroads, airports, communications systems (especially wireless communications), thermal power generation, and hydroelectric power generation; advantageous areas of urbanization includes the construction of urban infrastructure and utilities as well as commercial and residential real estate; and those of the manufacturing sector include the construction of industrial parks as well as the manufacturing of a wide range of products and key equipment. These areas of strength will vigorously seek overseas projects after exceeding domestic demand, with participation by both state-owned and joint-stock enterprises and private enterprises.
An important topic that corresponds to this production and output capacity is the savings rate, which is also an issue well worth examining.
China's savings rate has always remained high. Preliminary estimates suggest that China's savings to GDP ratio stayed around 45% in 2022, and this high savings rate seems unlikely to be changed in the short term. A high savings rate has advantages and disadvantages, but from the perspective of foreign investment and financing, it is an advantage, implying a strong ability to finance overseas projects.
This is an equally important advantage alongside the comparative advantages of construction projects and equipment manufacturing. Looking around the world, some countries have a strong capacity to export, but with their domestic savings rate low, they lack investment and financing capacity. Some can invest and finance but do not necessarily have a strong construction capacity. China can do both. Among the BRI countries, the proportion of financing contributed by China is high, and the two main financial institutions are the China Development Bank (CDB) and the Export-Import Bank of China (Exim Bank), which support the BRI projects mainly by issuing bonds domestically (of course, there are other ad hoc financing methods as well). This is very much related to the high domestic savings rate.
In addition, if we break down the types of projects under the BRI, government aid projects only take up a very small share, and the share of typical government loan projects is not high either. The vast majority of the projects are market-driven corporate behaviors with commercial attributes and financed as such. These projects are associated with the comparative advantage, excess capacity, and high savings rate mentioned earlier, and are sought after actively under the influence of these forces. There is often less governmental involvement in them. While corporate behavior can be active or passive, for many domestic companies with expertise in infrastructure, most of them choose to look for and develop projects overseas out of their own volition. Of course, there are also a few that are openly tendered or requested by Party A.
As we seek projects in BRI countries, many low-income countries will then put forward financing needs. To meet this financing need, infrastructure companies often look domestically for money from financial institutions, in particular, from the CDB and the Exim Bank. Of course, there are also a few that would go to the Industrial and Commercial Bank of China (ICBC) or other financial institutions for financing.
Because these financial institutions may not have a full understanding of the specifics of the projects and the situation of the host countries at the outset, and some of the projects do have risks, they usually charge a high risk premium. To reduce the cost of financing, they often propose two solutions: one is to require the other party to provide sovereign or quasi-sovereign guarantees, which include repayment with future resource output; the other is to ask China Export & Credit Insurance Corporation to provide insurance.
In general, the predominant approach for most projects is “market-driven business behavior with commercial features.”
Due to the extensive diplomatic interactions between China and BRI countries, on occasions of high-level visits and other related events, there is often a signing ceremony for BRI projects, financing agreements, and relevant contracts, which highlights the willingness of cooperation between the parties involved. However, it is important to clarify that agreements or contracts signed in these ceremonies under a company's name primarily signify mutual friendship, cooperation, and support, and do not necessarily indicate that the project is government-backed, nor do they imply government decision-making.
If we further categorize these projects, it could be found that some projects labeled as sovereign financing involve the debtor providing sovereign guarantees, and are not necessarily actions by the creditor's government. The projects do not fall strictly into two opposite camps, either being purely commercial or purely governmental. Instead, there’s a whole spectrum between the two extremes, with some projects driven more by commercial interests and some backed by a level of government support. There is significant divergence in the international understanding of this, leading to substantial misconceptions. Some even assume that projects China is involved in, especially those financed by state-owned financial institutions, are all government behavior. However, based on our understanding of specific projects and how they are distributed, this is not the case.
We have consistently made it clear that China’s Big Four banks are joint-stock commercial banks, and they provide commercial loans. China Development Bank (CDB) is a development financial institution, not a government credit institution, whose behavior does not count as government action and whose debt does not represent sovereign debt on behalf of the government, and therefore should not participate in bilateral sovereign debt restructuring. Only the Exim Bank is defined by China as a policy bank, described in its official statement as a “government export credit institution,” and consequently treated as a sovereign lending institution. However, even for the Exim Bank, a considerable portion of the debt related to restructuring issues involves commercial loans, not typical government export credit.
Due to significant differences in understanding, there has been substantial controversy over the characterization of debt and the arrangements for debt restructuring. In particular, when debt restructuring is necessary, it raises the question of who bears the cost of the restructuring: is it borne by the government, or is it the responsibility of the specific companies and financial institutions involved?
Some people abroad, upon seeing that the Chinese company undertaking the project is a state-owned enterprise and the financing institution is a state-owned financial institution, assume that the debt should be included in bilateral sovereign debt restructuring. In fact, whether the debt is to be restructured and who bears the cost of restructuring does not necessarily depend on whether the project company and financial institution are state-owned or private. Instead, it comes down to the actual motivations behind the formation of the debt, its nature, and the sources of funding.
In summary, from the perspectives of comparative advantage, infrastructure capabilities, and production capacity, the multitude of projects and their financing under the BRI, spanning from infrastructure to industry, are primarily driven by economic considerations. This involves market-driven action, company behavior, and commercial financing.
II. CHINA’S SO-CALLED “DEBT TRAP”
The book also mentioned the debt issue.
Internationally, the narrative of China's “debt trap” has been abuzz for some time, and it is essential for us to address this issue directly. Regarding the “debt trap,” one perspective suggests that developing countries borrowing to develop under the BRI face debt repayment issues for various reasons and fall into a debt quagmire. Another perspective takes on a more nefarious tone, speculating that China actively set traps with the aim to control the victim countries. This view is more fueled by conspiracy theories and geopolitical tensions than anything substantial.
From our own perspective, China has not been a major creditor country until recent and lacked the associated experience. We have yet to thoroughly examine these claims ourselves, much less coming up with and reaching consensus on a strategic framework to counter such narratives. Hence, it is crucial to enhance research efforts in this regard.
In general, we should not sweep aside such rhetoric as merely an attack from individual Western countries. Nor should we believe that the vast number of developing countries participating in the BRI will not be influenced by them. It is insufficient to solely assess the underlying political agenda or strongly condemn them; specific measures must also be taken to address the various negative impacts.
In fact, the “debt trap” narrative has had a notable impact on several BRI countries, leading to a shift in their attitudes toward engaging with China. Moreover, individuals with ulterior motives have disseminated numerous negative views about the BRI, influencing public opinion in some countries and hindering the progress of specific projects. Certain developing countries in Africa, influenced by such narratives, have started to harbor doubts about Chinese projects and financing.
From the perspective of China, there has been a noticeable fall in new project financing from CDB and the Exim Bank. For instance, the Exim Bank has seen a reduction of over half in the number of newly financed projects each year, accompanied by a significant decrease in the volume of financing. Indeed, the decrease in the number of new projects is also related to the COVID-19 pandemic, which has disrupted personnel movements, resulting in halted face-to-face communications and delays in on-site inspections.
In fact, this is a reasonable response, as certain countries are facing challenges with debt repayment, raising the possibility of default. For creditor financial institutions, this would lead to a downgrade in the internal credit rating of these country and an increase in the risk assessment coefficient. If default occurs, the international credit rating of these country would also be downgraded. Consequently, financial institutions are likely to reduce future loans and debt financing to these country, and ongoing projects may even be postponed or subject to reevaluation.
This involves many issues, and the book discussed some of them. I attempt to summarize the core issues as follows: Is there a need for a tiered approach to the debt issue? If tiers are necessary, who should be placed in each tier? How should relationships between tiers and rules within each tier be established?
Creditors are generally classified into three tiers.
The first tier consists of multilateral creditors, primarily including the World Bank and a number of regional and sub-regional development institutions such as the Inter-American Development Bank, the European Bank for Reconstruction and Development, the African Development Bank, the Asian Development Bank, the Asian Infrastructure Investment Bank, and their smaller counterparts like the West African Development Bank, the East and Southern African Trade and Development Bank, and the Caribbean Development Bank. The second tier involves bilateral official creditors, primarily government loans. The third tier comprises of commercial creditors, with holdings dispersed among private entities and institutions.
At present, the first-tier creditors do not agree to participate in restructuring and debt reduction. In recent years, there has been a significant change in the third-tier model, with a noticeable decrease in the proportion of commercial bank loans and a shift towards bond issuance. The transparency of bond issuance has improved, involving a broader range of creditors, predominantly private institutions. Since it is more difficult to coordinate commercial creditors, they naturally take a more backseat role in debt restructuring arrangements. This has shifted the pressure and attention on reduction primarily to the second tier.
Since the G20 (Group of Twenty) introduced the “Debt Service Suspension Initiative” in 2020 and proposed the “G20 Common Framework for Debt Treatments” in 2021, many controversies have revolved around the issue of tier classification. Central to the debates include questions such as whether the tier classification is appropriate and which entities should be placed in the same tier.
Different tier classification means different relief obligations and the order of payout. This somewhat resembles the hierarchical arrangements in domestic debt restructuring, such as the ranking of senior, ordinary, and subordinate debts. In the first tier, there is considerable controversy regarding the participation of multilateral development institutions like the World Bank in debt restructuring and reduction. In the second tier, after numerous efforts, there has been a general acceptance internationally that the CDB belongs to development financing, not sovereign government debt, and should not be included in bilateral government-level debt restructuring arrangements. Concerning the private debt tier, opinions differ on whether they should participate in debt restructuring and reduction on an equal reduction basis, and how feasible it is. In summary, all these questions clearly involve the classification of creditors, leading to different viewpoints and conflicting interests.
If a debtor country indeed faces significant challenges, debt reduction becomes practically inevitable, and there are several ways to achieve this reduction. Direct haircut, extension of maturity, longer grace periods, and reduction of future interest rates are all viable options. However, these methods can be regarded as concessions on the net present value of the debt, and the magnitude of reduction for creditors at the same tier should be roughly similar. Meanwhile, this raises questions about who should be in the same tier, and to which tier should their concessions be compared.
Indeed, debt restructuring is not the only solution. The necessity for debt restructuring must be assessed by first examining the sustainability of the debt, which involves analyzing the extent of a debtor country's debt severity and the likelihood of default. Sometimes, there are differing views on debt sustainability. For some countries, debt sustainability is influenced by price fluctuations in international mineral and resource markets, while for others, it may be impacted by various non-economic factors.
Meanwhile, the nature of debt is a frequently discussed issue in the debt restructuring process. It's not always the case that the “hat” determines the head; sometimes, the nature of an institution may not necessarily correspond to the nature of the debt claim. Therefore, it is also necessary to analyze the comparability of debt claims.
Furthermore, it is necessary to establish a set of principles and mechanisms for debt restructuring. Creditors should have the right to be informed, and to assess the repayment capacity of the debtor. Additionally, China advocates for the exclusion of certain good projects from debt restructuring and their treatment as profits. Moreover, when dealing with the relationship between external and domestic debt, as seen in recent cases like Sri Lanka, which has both high external and domestic debt, there needs to be a proper understanding of how to treat domestic and external debt respectively.
In summary, debt restructuring requires a thorough analysis of the costs associated with different restructuring plans. This necessitates a strong foundation in economic and financial expertise for effective analysis.
In terms of certain issues related specifically to China, there may not have been sufficient attention paid to them. For example, which tier should the National Development Bank's debt claims be placed in? Furthermore, when dealing with specific debt restructuring arrangements, to what extent should we rely on multilateral mechanisms or bilateral mechanisms? Under what circumstances should we choose multilateral and bilateral mechanisms? What is the relationship between the two? Additionally, if debt issues arise, there will be costs associated with debt restructuring, giving rise to questions about the cost-sharing mechanism—who should ultimately bear the cost of the restructuring?
Not all these issues have been resolved; some require more thorough discussions to achieve a high degree of consensus. Discussions like today's are rare, and there is insufficient exchange on specific issues. Only by thorough research, discussion, and consensus-building on these issues can we proactively, efficiently, and convincingly address the “debt trap” problem, which will significantly facilitate the development of the BRI.
III. FINANCING BRI PROJECTS: WHAT’S NEXT?
There are numerous questions regarding the future of investment and financing under the BRI. This book, in its financial chapter, mentioned the role of capital markets and the internationalization of the RMB. Here, I would like to add a few perspectives.
First, how to address the excessively high debt leverage of debtor countries? Combining the analysis mentioned earlier regarding comparative advantages, production capacity advantages, and the “debt trap” issue, the prominent issue in the current BRI investment and financing is essentially the problem of high debt leverage. This problem is similar to the financial restructuring issues we encounter domestically.
To address the issue of high leverage, the proportion of equity should be increased. Equity investment can help reduce high leverage. Meanwhile, the alignment of interests through equity investment also helps improve project efficiency and avoid various unnecessary administrative interventions.
If the debt is too high, converting a portion of the debt to equity is also a reasonable choice. A higher proportion of equity investment and debt-equity swaps in the event of debt issues ultimately yield similar results.
A concept close to equity financing is the BOT (Build-Operate-Transfer) model, where control is relinquished before the final transfer. In some cases, equity arrangements for countries participating in the BRI are temporary, not permanent, and are ultimately intended for transfer.
Highway and railway projects often adopt the BOT model. For example: one highway project has an operating period of 50 years; another transportation project has an initial operating period of 50 years, which is later extended to 75 years. Sri Lanka's Hambantota Port project involved a debt-to-equity conversion with a specified operating period of 99 years. Although there are variations in operation durations, they all fall within the range of 50 to 100 years, making them, in essence, phased equity arrangements.
In Western attempts to portray China negatively, this practice has been sensationalized as China seeking to gain control and pursuing its interests through control. However, if one cares to look deeper into how the model actually operates and why it is chosen in the first place, it is clear that the primary goal is to ensure the smooth construction and operation of the project, while allowing the investing party to obtain a reasonable return, which fall under a company’s market-driven commercial behavior.
Of course, there are also cases where, despite implementing BOT or rearranging debt and equity, projects that were originally viable end up continuously generating losses.
There are a number of reasons. In some cases, the host country sets the price too low to cater to populism and electoral needs. For example, if the ticket for a well-constructed railway project is priced too low to garner the support of some voters, it becomes challenging for the project to generate returns. In other cases, local government corruption throughout project construction increases project costs to a level far beyond expectation, adding substantial loan service burden down the road and turning a project that could have been profitable into a loss-making one.
An appropriate debt-equity arrangement can reduce such illicit interest-seeking behaviors, or correct financial burdens that have already occurred. This helps to minimize moral hazard and can be a good option for financing arrangements or debt restructuring, providing that we could solve the ethical problems associated with the so-called “debt trap” issue.
Second, sovereign debt should be reduced moderately. Given that some countries participating in the BRI are facing high levels of domestic and external debt, China should follow the new trends in global financing. For future development projects in these countries, China should reduce the use of sovereign debt, moderately decrease reliance on loans from banking institutions, increase bond financing, and rely more on regional and sub-regional development banks for joint investment and financing.
Third, the reform and establishment of multilateral mechanisms should be promoted. Due to the complexity of financing and debt restructuring, there are numerous controversies and no effective mechanisms for addressing these problems. There are many challenges related to the reform of multilateral mechanisms and issues related to the establishment of multilateral institutions, including the economic principles, historical background, and the analytical and restructuring frameworks underlying the decisions of existing multilateral institutions.
China explicitly supports multilateralism, but on the issue of debt, the rules of the current multilateral mechanisms are under constant debate and change and have not yet been fully established. Therefore, there is still much work to be done in this regard. This aspect is also addressed to some extent in the book.
These are the three aspects I’d like to share with you, hoping to draw attention, encourage further discussion, and advance research in these areas so that we can improve BRI-related efforts.
