China’s uncomfortable role as the world’s largest official debt collector

New Delhi, Nov 7 China is navigating an unfamiliar and uncomfortable role -- as the world’s largest official debt collector, AidData said in a report.

Fifty-five per cent of its loans to low- and middle-income countries have already entered their principal repayment periods and this figure will increase to 75 per cent by 2030.

Total outstanding debt -- including principal but excluding interest -- from borrowers in the developing world to China is at least $1.1 trillion and potentially even as high as $1.5 trillion (in nominal USD).

China is finding its footing as an international debt collector at a time when many of its biggest borrowers are illiquid or insolvent.

AidData estimates that 80 per cent of China’s overseas lending portfolio in the developing world is currently supporting countries in financial distress.

Overdue repayments to China are also soaring -- in absolute terms and as a proportion of total overdue loan repayments to official (i.e., bilateral and multilateral) creditors.

Contrary to the conventional wisdom, Beijing’s annual international development finance commitments have not plummeted to nearly zero. It remains the world’s single largest official source of international development finance.

China’s aid and credit commitments to low- and middle-income countries are now hovering around $80 billion a year, AidData said in a report.

However, in the long-run, it is not clear that the US and its allies have the financial firepower to compete dollar-for-dollar with Beijing.

The G7 has a history of over-promising and under-delivering net increases in international development spending.

Beijing, by contrast, has a real source of financial strength that allows it to avoid making promises that it cannot keep: foreign exchange reserves that are vastly larger than the official, foreign currency reserve holdings of its central bank.

Beijing’s public approval rating in the developing world plunged from 56 per cent in 2019 to 40 per cent in 2021.

Washington, on the other hand, has seen its public approval rating rise and opened up a 14 percentage point advantage over Beijing.

Across the developing world, China has also struggled to maintain a razor-thin lead over the US in media coverage favorability. Yet it has proven very capable of winning and retaining the foreign policy support of governing elites

. Across all UN General Assembly votes cast between 2000 and 2021, the governments of low- and middle-income countries aligned their foreign policy positions with China 75 per cent of the time, as compared to 23 per cent with the US.

Those who vote with China are richly rewarded: on average, if a foreign government chooses to increase the alignment of its UN General Assembly voting with China by 10 per cent, it can expect to see a 276 per cent increase in aid and credit from Beijing.

Beijing has launched a far-reaching effort to de-risk the BRI by refocusing its time, money, and attention on distressed borrowers, troubled projects, and sources of public backlash in the Global South. It is learning from its mistakes and becoming an increasingly adept international crisis manager, AdiData said.

Neither the US nor its G7 allies seem to have a good understanding of how China is recalibrating its lending and grant-giving practices in response to changing conditions on the ground.

Consequently, those who make and shape policy in Washington, London, Paris, Berlin, Tokyo, Rome, and Ottawa increasingly run the risk of competing with a version of the BRI that no longer exists—BRI 1.0 rather than BRI 2.0.

In recognition of the fact that BRI 1.0 did not have sufficiently robust risk management guardrails in place, Beijing is fundamentally altering the composition of its overseas lending portfolio. It is ramping down dollar-denominated infrastructure project lending, while ramping up RMB-denominated emergency rescue lending to financially distressed borrowers.

Beijing’s strategic objective is to ensure that its largest borrowers have enough cash on hand to service their outstanding infrastructure project debts , the report said.

Beijing is putting in place increasingly stringent safeguards to shield itself from the risk of not being repaid.

At the turn of the century, only 19 per cent of China’s overseas lending to low- and middle-income countries was collateralized. This figure now stands at 72 per cent.

The ability to access cash collateral without borrower consent has become a particularly important safeguard in China’s bilateral lending portfolio.

When illiquid or insolvent borrowers fall behind on their repayments, the policy banks are “paying themselves” overdue principal and interest by unilaterally sweeping foreign currency out of the escrow accounts of their borrowers, the report said.

These cash seizures are mostly being executed in secret and outside the immediate reach of domestic oversight institutions -- such as the auditor general and the public accounts committee within parliament -- in low and middle-income countries.

After making withdrawals that substantially deplete the balance of a borrower’s escrow account, an increasingly common practice is to require that the borrower replenish the account as a condition for any short-term cash flow relief.

Escrow account replenishment has become a major sticking point in debt rescheduling negotiations with the policy banks, yet it is shrouded in secrecy because of strict confidentiality requirements, the report added.

As the number of borrowers facing liquidity and solvency crises has soared, Chinese state-owned creditors have introduced stronger penalties for late repayments.

The average penalty interest rate doubled between the early BRI period (2014-2017) and the late BRI period (2018-2021). The maximum penalty interest rate also increased from 3 per cent to 8.7 per cent between these two time periods.

These findings contradict those of a previous study, which claimed that there is no evidence of penalty interest rates in China’s overseas lending to developing countries.