by Ichiro Suzuki
The Economist article below reveals how China has been lending practices to the less developed world, as the country has grown to be the largest lender to them. China obviously has been lending in a different way that are common among multi-lateral institutions such as the World Bank and the IMF. To begin with, China stands out in its aggressiveness in extending loans. Since they began to lend fiercely to less developed countries in early years of the 21st century, outstanding has grown to be $700 billion today, which is Larger than any multi-lateral lenders and is approximately 5% of China’s economy. To put this in perspective, the Marshall Plan in the post WWII era translated to $100 billion in the 2018 dollars, and this was only 0.5% of the U.S. economy. The Chinese financial exposure to less developed countries in Asia, Africa and Latin America has grown simply extraordinarily. These countries in general lack credible track record of managing their own economies with a history of living beyond their means at a time of easy credit. According to the article, 50 biggest borrowers have debt outstanding at a stunning 17% of GDP, up from 1% in 2005. These countries obviously owe money to multi-lateral lenders and developed country governments and banks, too. These aggressive borrowers were forgiven debt by developed countries’ lenders at the beginning of the century. As soon as they received debt reliefs, they started borrowing fiercely from China. This is essentially how the great emerging market boom was created. Now the borrowers would have to face consequences, and so would the lender, as is always with the cases with aggressive lending practices. In the long run, China would have to face risks of not getting paid back as planned, if not outright default. Bad debts would put pressure on China’s domestic finances as the Chinese economy already has to deal with a substantial amount of debt outstanding amid slowing of its economic growth rate. Credit quality of China’s aid recipients are starkly weaker than Western Europe under the Marshall Plan. In fact, large borrowers include some least creditworthy countries such as Zimbabwe, Venezuela, Pakistan or Iran. Aggressive lending to these countries creates leverage to China but it comes with some costs. The Chinese economy would have to operate with a significant amount of non-performing loans that would work detrimental to the country’s economic growth potential. As the growth rate of the Chinese economy slows, capital outflows in the form of lending also decrease. While less capital flows out of China, these borrowers are likely to be stuck with the heavy debt burden with China. In the face of their inability to pay back, China would have to writing down non-performing loans, since Beijing would increasingly lack resources to support the borrowers. It was once feared that what China would do to the borrowers with difficulties to pay the money back, since Beijing does not belong to the Paris Club that reschedules loans to heavily indebted countries. It wad feared that China would seize the assets of the borrowers as a compensation and eventually ending up with owning the bulk of the borrowers’ strategic assets. This was the case with Sri Lanka that had to agreed to a 99-year lease of a port when they found it unable to pay back. As it turned out, this appears to be more like an isolated case than a norm. China has been renegotiating debt repayment with highly indebted borrowers to the tune of the Paris Club. The article also reversals that Chinese government has been lending directly to Chinese contractors in some countries so that funds are not misused. This is a very sensible practice as a lender. On the other hand, Such practice contributes little to developing aid-recipient countries’ industries. These countries are handed competed railways and roads and bridges. While this is efficient, skills and know-hows of running such projects do not stay in the aid recipients. Eventually, this could negatively affect sentiment against China in these countries.
About the author: Ichiro Suzuki, CFA, is an Advisory Group member at Richard A. Mayo Center for Asset Management of Darden School of Business, University of Virginia. He has retired as Senior Portfolio Manager/ Global Equity Strategist at Nomura Asset Management. Suzuki graduated with B.A. from Waseda University and MBA from UVA's Darden School of Business.