(Bloomberg) — China to be more cautious about extending loans to Latin American countries after difficulties in securing repayment suggest it has at times fallen into a ‘creditor’s trap’, says author of new book on Beijing’s loans to the region.
Yet China will not abandon state-to-state lending because it still sees lending as a tool to boost exports, Stephen Kaplan, a former economist at the Federal Reserve Bank of New York, said in an interview about his recent article titled “Globalizing Patient Capital: The Political Economy of Chinese Finance in the Americas.
Kaplan, who is now an associate professor at George Washington University, estimates that China’s two main state banks had nearly $67 billion in outstanding loans to Latin American governments in 2017, compared to just $5 billion ten years earlier.
Washington sees China’s loans as part of strategic competition in the region, calling them a “debt trap”. Kaplan argues that, to expand its influence, Beijing has been reluctant to impose political conditions – such as demanding fiscal austerity – on its lenders, sometimes making it more vulnerable to defaults, as in Venezuela.
President Xi Jinping faced two difficult cases on the sidelines of the Winter Olympics in Beijing this month when the leaders of Ecuador and Argentina visited. Ecuador’s Guillermo Lasso secured Xi’s backing for a nearly $4.6 billion debt renegotiation, while Argentina’s Alberto Fernandez secured $23.7 billion in Chinese funding, mostly for development projects. infrastructure, in discussions with the International Monetary Fund to avoid a default.
Here are excerpts from the interview with Kaplan, which has been lightly edited for clarity.
What is your opinion on Beijing’s motivation to lend to Latin America?
I see them as strategically trying to maximize their market internationally. Chinese development banks tend to look at how to expand China’s commercial presence in an entire sector, often a key sector like nuclear power or renewable energy. When you look at the contents of these agreements, you have a lot of capital inputs — machinery and turbines — from China. In order to develop trade, they are willing to take more risk compared to a loan from the World Bank.
What I argue is that China is on a learning curve as a creditor, which is why I sometimes call it a “creditor trap.” Indeed, they try to find ways to interact as a financier internationally and also adhere to long-standing foreign policy principles like non-interference in internal affairs. They want to avoid political conditionality on their loans. So they need to have other ways to cover their risk and my argument is that they cover more risk with trade conditionality. They hedge risk with natural resources, either as collateral for loans or as a means of repayment in the event of default.
Your data analysis revealed that China’s state loans to Latin America are a form of “patient capital” – less likely to leave the region in times of economic turmoil than Western finance. Why is this important?
As countries become more dependent on Chinese financing, the results show that countries have more fiscal space, as evidenced by higher budget deficits.
There are many examples. In the five years since the global financial crisis, Bolivia has been slow to tap into Chinese funding, so we still ran budget surpluses to begin with. But then, with the commodity downturn, Bolivia got about $2 trillion from China, or a fifth of its overall external debt, and we started to see more deficit financing. In Costa Rica, when Western financing withdraws, China agrees to buy Costa Rican bonds, allowing them to have an influx of financing that covers countercyclical spending.
You argue that loans from China could reinforce dependence on natural resources and slow industrial development in developing countries. How have Latin American governments tried to avoid this?
In Argentina, we saw them making requests for more local content. Brazil didn’t want to do Chinese deals because of local content requirements. A country that is more dependent on China for funding has found this more difficult to do. Ecuador saw a two-fifths spike in external financing from China. So they had less flexibility in terms of local content requirement compared to Brazil.
China’s loans to Latin America were suspended in the first year of the pandemic, but deals continue, such as $8.3 billion for a Chinese-designed nuclear power plant in Argentina. What are the prospects?
This agreement is part of the patient capital and market maximization approach. Argentina will get financing below market rate and China is trying to gain market share in one sector. State-to-state financing is always very good for penetrating new markets, which is why I think this type of financing is still likely to be part of China’s toolbox. There is probably more risk aversion with large state-to-state loans than there has been historically due to Covid and the previous commodity downturn, rising US rates and the trade war uncertainty. This could make Chinese bankers more hesitant to commit.
Following the pandemic shock to their economies, the prospect of restructuring and default is looming for several countries in the region. How will Beijing engage in this process?
The big question is how ready China is for bilateral restructuring and how much it will work within multilateral frameworks. In some cases, it might make more sense to allow the IMF to intervene as it did in Ecuador. The China Development Bank (CDB) is one of Latin America’s main creditors and tends to renegotiate bilaterally. When we saw the Moreno administration arrive in Ecuador, the CDB was quite willing to restructure this debt.
CDB and China’s Export-Import Bank committed $1 billion in new loans to Ecuador, about 1% of GDP, and said it was one of the lowest rates . Why such a low rate? In Ecuador, we were seeing less favorable public views of China. As a result of the issues surrounding Venezuela’s debt moratorium, if you start to see multiple countries having debt issues, that’s not good for soft power, so there was a real incentive for China to restructure. Domestically, Chinese banks tend to renew their loans and wait for better times.