How does China lend? Insight from a study of 100 loans

The opaque nature of Chinese lending through its Belt and Road Initiative has raised questions among critics about the nature of Chinese loans. New research out Wednesday analyzes 100 Chinese loan contracts to 24 countries, providing insight into how China uses such agreements to gain leverage and calling attention to the need for more transparency in sovereign lending.

The contracts don’t include overt promises of ports or mineral reserves in the case of default. But they do illustrate a country that is aggressive in its terms and seeks to place itself in a position superior to other lenders, authors of the study told Devex.

“There is not any particular smoking gun clause. It’s more the combination of clauses that together add up to impressive bargaining power vis-à-vis the debtor and vis-à-vis the other creditors,” said Anna Gelpern, a professor at Georgetown Law and one of the report’s authors.

The study, “How China Lends: A Rare Look into 100 Debt Contracts with Foreign Governments,” mostly examined contracts from the China Development Bank and China Exim Bank. It’s “the first systematic analysis of the legal terms of China’s foreign lending,” according to its authors.

It took about 100 researchers 36 months to comb through debt information management systems, official registers, and parliamentary websites of 200 borrower countries to compile the dataset of complete and unredacted loan contracts between Chinese state-owned entities and government borrowers. They also collected a comparator dataset of 142 loan agreements from a group of more than 20 non-Chinese creditors.  

“Chinese lenders behave a lot like commercial lenders: muscular, commercially savvy lenders who want to be paid on time and with interest,” and the contracts are designed accordingly, said Brad Parks, executive director of AidData, which led the data gathering process.

How China’s loans work

The Belt and Road Initiative is an ambitious infrastructure initiative launched by China’s government in 2013 that has entailed a dramatic increase in Chinese lending to low- and lower-middle-income countries. The initiative has come under fire, with some questioning its motives and whether it has made unsustainable loans and contributed to rising debt levels.

The loan agreements are written to position China as a “preferred creditor” that could seek repayment first in the event of a problem or default, Parks said.

It does so in two primary ways: by requiring borrowers to create separate escrow or special accounts with cash balance requirements that China can seize in case of default, and by essentially requiring countries to exempt Chinese loans from restructuring efforts with other lenders. The study refers to these as “no Paris Club” clauses, referring to the informal group of official creditors that coordinate solutions for debtor countries with payment difficulties.

Those special accounts Chinese lenders require of borrowers are found in about 30% of contracts. They are often kept secret, making it difficult to “get a clear picture” not only of loan commitments but of revenue streams and resources available to countries, said Scott Morris, a senior fellow at the Center for Global Development and one of the report’s authors.

The special accounts are highly unusual for “full recourse” sovereign loans, in which the government guarantees the loan. But they are not uncommon in commercial project finance, where a lender could agree to be paid back through the revenues of a project — such as a toll road — once it is operational, Gelpern said.

Nearly all of the loans studied also included strict nondisclosure agreements — though there are exceptions if domestic laws require countries to publicize the contracts, which is how the data was collected. One result is that countries struggling with their debt burdens often find themselves trapped between nondisclosure agreements and mounting demands from other creditors to share what they owe China before they will provide debt relief.

These contract provisions give Chinese creditors a leg up in trying to secure their payments, Morris said.

The “no Paris Club” provision, which was found in nearly 75% of the contracts, is particularly relevant because it “clearly runs counter to commitments to the G-20 Common Framework on Debt” and raises questions about whether those provisions will be enforced or China’s commitments at the G-20 will prevail, Morris said.  

Another point of leverage is that China often includes “cross-default” or “cross-cancellation” provisions that in essence tie various loans to one another. These clauses make it harder for a borrower to walk away from a project and give Chinese institutions bargaining power and policy influence, according to the study.

A clear example of this is in Argentina, where a $2 billion China Development Bank loan for a railway project had a cross-cancellation clause tied to a $4.7 billion loan from Chinese banks for a hydroelectric dam project. When a new presidential administration came in and tried to cancel the dam project on environmental grounds, the China Development Bank threatened to cancel the railway project loan. Argentina’s government reversed its decision.

While much of the language in the contracts can be seen as economically or commercially motivated, some of the provisions are more political in nature, Morris said. For example, some contracts state that cutting diplomatic ties with China would result in default. The contracts often include broad language: for example, defaults can be triggered by borrower actions that are adverse to a Chinese entity.

The need for transparency

The sample of Chinese contracts raises questions about how the requirements are implemented — but also suggests potential policy responses, the authors told Devex.

It remains unclear how these contracts are enforced or how the special accounts work in practice. But the various rights China lays out in the contracts gives it leverage whether or not it chooses to enforce them, Gelpern said.

On the policy front, there needs to be a renewed call for improved transparency — not just for China, but for all lenders, most of which often fail to make contracts publicly available, the authors said. The transparency challenge can also be tackled on the borrower side, and countries can be encouraged to pass legislation making contracts public. Countries should incorporate disclosure into their domestic debt authorization frameworks for domestic legitimacy and accountability purposes, Gelpern said.

The study showed that China continues to make loans even in countries where contracts were made public, Parks said.

One worry is that if other creditors see these contracts, they’ll rush to follow China’s example and require additional collateral or other requirements in their lending, Gelpern said. If that happens, low-income countries struggling with unsustainable debt burdens are the ones that will suffer, she said.

“We need to immediately, as a policy matter, defuse this potential arms race,” Gelpern said. “My concern is that the creditors are jockeying for advantage, and the borrowing countries are left holding the bag and they are the ones who can least afford to do it.”

Everyone in the G-20 Common Framework should agree not to take collateral except in the context of revenue-generating projects — preferably with limited recourse and limited to the resources from that investment, she said.

“We’re waking up to the fact that creditors are much more diverse, and every creditor will act opportunistically,” Gelpern said. “A ton of policy work needs to be done to promote creditor coordination.”