China and the debt crisis
By Joseph Joyce
Sri Lanka is not the first developing economy to default on its external debt, and it certainly won’t be the last. The Economist identified 53 countries as the most vulnerable to a combination of burdens, slowing global growth and tightening financial conditions. China’s reaction to what will be an ongoing series of restructurings and writedowns will say a lot about its position in the 21st international financial system of the century.
Debt crises are (unfortunately) perennial events. In the 1970s, many developing countries, particularly in Latin America, borrowed from international banks to pay energy bills that had risen after the rise in oil prices decreed by the Organization of the Petroleum Countries (OPEC ). Repaying these loans became more difficult after the Federal Reserve raised interest rates in 1979 to fight US inflation. Mexico announced it could no longer repay its debt in August 1982, and other governments soon followed (see here for details).
The US government supported negotiations that brought together the governments unable to make the payments, the banks that had provided the loans, and the International Monetary Fund. Banks were willing to restructure the debt, while the IMF loaned funds to governments that allowed them to maintain their interest payments while avoiding acknowledgment of their inability to repay the debt. But that only delayed a definitive resolution to the crisis and led to a “lost decade” in Latin America. In 1989, Treasury Secretary Nicholas Brady proposed a plan that led to reductions in loan principal in exchange for debtor governments issuing “Brady bonds”.
The United States allowed the IMF to take the lead in subsequent crises, including the 1997-98 East Asian crisis, Russia in 1998, and Argentina in 2000. He also took a more active role when American interests were directly affected, as was the case with Mexico in 1994-95. While America’s attention was focused on its own crisis in 2008-09, the IMF took on the task of lending to middle- and low-income countries that were caught in the economic shock waves of financial collapse. . The Federal Reserve has, however, established currency swap lines with the central banks of other advanced economies as well as with those of four emerging markets: Brazil, South Korea, Mexico and Singapore. The Fed reactivated swap lines in March 2020 in response to the disruption in international credit markets caused by the pandemic and also set up a new facility to provide dollar funding to foreign official institutions.
China has taken a different stance on the debt of developing countries. Its state-owned banks have provided bilateral loans under the Belt and Road Initiative, with many of those loans going to African governments for infrastructure projects. But loan amounts and terms were not always made transparent. Sebastian Horn from the University of Munich, Carmen Reinhart, currently chief economist at the World Bank while on leave from the Kennedy School at Harvard University, and Christoph Trebesch from the Kiel Institute for global economy, developed a database of Chinese lending over the period 1949 -2017 which they published in a 2021 NBER article, “China’s Overseas Lending”. They found “…a substantial portion of China’s overseas lending goes undeclared, and the volume of ‘hidden’ lending reached over $200 billion in 2016.” Another study by AidData, a William & Mary research lab, also documented Chinese lending to low- and middle-income countries and found that many loans are collateralized by future commodity export earnings.
Some of these loans have already been restructured, with China pushing back repayment dates. If there is a systemic wave of defaults, the Chinese government must decide whether it will continue to negotiate directly with governments that have borrowed, or join governments that belong to the Paris Club – a group of creditors officials who try to devise lasting solutions to debt problems – by devising a mechanism to reduce the volume of debt.
In 2020, the Group of 30 working with the IMF and World Bank instituted the Debt Service Initiative (DSSI), which suspended debt service payments from low-income countries to official creditors, including the China. Forty-eight countries participated in the program, which ended in December 2021. The DSSI was followed by the Common Framework, which brings together official creditors and low-income borrowers to provide some form of assistance to insolvent countries. However, private lenders did not agree to participate and only three countries requested relief through the Common Framework. There are concerns about the process and there will no doubt be calls for large-scale debt cancellation as countries with rising food and energy bills seek relief.
Decisions made by China regarding its participation in new initiatives have implications for its future role in the international financial system. The government has sought to strengthen the role of its currency, the renminbi, and its share in central bank foreign exchange reserves has increased as trade with China has grown. In “The Stealth Erosion of Dollar Dominance and the Rise of Non-Traditional Reserve Currencies” in the Journal of International Economics (working document here). They find, however, that changes in the composition of foreign exchange reserves involve more than the Chinese currency and show increases in the relative shares of the Australian dollar, Canadian dollar, Korean won, Singapore dollar and Swedish krona as well. They attribute these changes in part to more active reserve management by central bankers as well as the existence of more liquid foreign exchange markets that facilitate non-dollar transactions.
The use of the dollar-based international financial system as a financial weapon against Russia, including the seizure of more than $300 billion in assets from its central bank, could be an opportunity for another system to take its place. , and there’s been a lot of speculation about the emergence of a China-based rival. But Adam Tooze of Columbia University pointed out that:
“It (the dollar system) is a sprawling, resilient web of state-backed, trade-driven, profit-driven transactions, lubricated by the easy availability of dollars, intertwined with American geopolitical influence, a game repeated in which clever players constantly weigh their pros and cons and the (very few) alternatives available to them and then, when all is said and done, again and again coming back for more.
A new system would take years to set up. It’s unclear whether the Chinese government wants to allow its financial markets to become entangled in a global system by removing remaining capital controls. The combination of drought, COVID-19 and its real estate crisis are fully occupying the attention of the Chinese government. However, it may face a debt crisis among developing countries, and its response will be monitored for signs of how it perceives its position within the global financial web of rules and institutions. .
Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.