Parallel Systems

At the start of her three-nation tour of Africa this January, US Treasury Secretary Janet Yellen spoke to the Associated Press in Senegal, bemoaning the “piling, unsustainable debt” that, she said, “plagued” many African countries. This was a problem, she argued, “related to Chinese investments in Africa.” Two days later Yellen was in Zambia, a country which, having defaulted on its external debt in 2020, was still trying to clinch a final deal with creditors more than two years later. In 2021 the G20 had agreed on the Common Framework, a vague set of guidelines meant to smooth such restructuring talks among low-income debtors and a variety of creditors, each with sometimes contradictory demands. If successful, Yellen stressed, such negotiations would unlock much needed disbursements from a $1.3 billion International Monetary Fund (IMF) loan. The problem, according to Yellen, was that China had become a “barrier to concluding the negotiations.” Back in the US, World Bank President David Malpass told Bloomberg that “China is asking lots of questions in the creditors committees, and that causes delays, that strings out the process.” The following day, the Chinese Embassy in Lusaka released a statement defending China’s role in the Zambian talks, chiding Yellen over US debt ceiling uncertainties and advising that “the biggest contribution that the US can make to the debt issues outside the country is to act on responsible monetary policies, cope with its own debt problem, and stop sabotaging other sovereign countries’ active efforts to solve their debt issues.” In this context, it is hardly surprising that ex-Zambian trade minister Dipak Patel has complained of his country becoming a pawn in a “Common Framework Cold War.”

Global sovereign debt crises are not a new phenomenon. They date as far back as the Panic of 1825, when a wave of defaults by newly independent Latin American states contributed to a financial crisis in London that came close to collapsing the Bank of England. Similar episodes have occurred over the years, with varying responses, even as the framework which exists today for restructuring defaulted debts and restoring debtor governments to solvency has remained relatively unchanged since it emerged in the Latin American debt crisis of the 1980s. Responsibility for coordinating the process has laid principally with the IMF and the Paris Club of major bilateral lenders, most of which are members of the Organization for Cooperation and Development (OECD). Zambia is seen as a test case for these institutions’ ability to resolve a new form of debt crisis, one in which for the first time a significant proportion of the defaulted debt is held by Chinese creditors. The glacial progress in Zambia is therefore far from encouraging, in a context where the governments of Lebanon, Argentina, Sri Lanka, Ghana, Ecuador, and Suriname have also all defaulted on their debts in the past three years, sparking fears of a wider global sovereign debt crisis.¹ Other states—among them Tunisia, Egypt, Bangladesh, Pakistan, Kenya, Uganda, Jordan, and Costa Rica—have sought bailout deals with the IMF over the same period.

Frictions around debt restructuring are certainly exacerbated by the US-China rivalry amid a rising Second Cold War. But a fundamental incompatibility exists between two parallel systems of sovereign lending: on the one hand, a Chinese circuit of development finance which has emerged in the past fifteen years, centered on the country’s state-owned policy banks; and, on the other, the incumbent US-centered system of international financial institutions, bilateral lenders from the global North, and private creditors. Crucially, the current architecture for resolving episodes of debt distress was formed by and for actors from the US-centered lending complex. Today, the gaps in the system are becoming more visible, and it has struggled to accommodate and integrate the distinct modalities of Chinese financing.

Two systems

Until recently, governments unable to repay their international debts faced a predictable, if onerous, set of hurdles. First, they agree to a bailout loan plan with the IMF in exchange for austerity measures and liberalizing economic reforms. They then secure final IMF approval of this loan by negotiating sufficient financing assurances (broad commitments to give debt relief or provide new money) from multilateral organizations and the Paris Club of major bilateral creditors. Governments next hammer out the details of this multilateral and bilateral assistance and, finally, reach a deal with private creditors (banks or bondholders) on reducing or extending commercial debt payments. 

This so-called global financial safety net has never functioned satisfactorily. Debt workouts can take many months, and bailout packages hinge on IMF programs which mandate ruinous austerity measures and often fail to bring debt down to manageable levels. Creditors negotiate in groups, across the table from individual, isolated debtor governments. Despite commitments to “comparability of treatment” among creditors, private sector lenders have a track record of getting better deals than their official sector counterparts.

Within this system, multilateral agencies, governments and private lenders were able to coordinate their efforts, primarily because the financing system’s center of gravity lay in the advanced economies of the global North, underpinned by global economic hierarchies and a broadly shared set of modalities. Traditional creditors support the IMF—always headed by a European and over which the US continues to exercise veto power—as the central coordinating institution delegated to stitch together the unwieldy sovereign debt restructuring system. This support reflected confidence in the IMF’s ability to embody common norms via its functions of assessing debt sustainability, setting the parameters for restructuring talks, and negotiating packages of policy reform with debtor governments, which signal credibility to other creditors. Until the rise of Chinese lenders, bilateral and private creditors rarely questioned the status of the IMF, World Bank, and other official multilateral banks as senior creditors who are not expected to restructure their own outstanding loans to distressed debtors. While never unified into a single institution, and often subject to calls for reform, a broad creditor consensus has meant that this system of sovereign debt restructuring has thus constituted as much of an expression of the liberal international order as the World Trade Organization or World Bank. Over the past fifteen years, however, China’s parallel circuit of sovereign lending has emerged to sit uneasily alongside and largely disconnected from this regime.           

Chinese aid and development finance has its own long history, encompassing the Tazara Railway in the 1960s and the Mao era stadium diplomacy often aimed at competition with Taiwan. Chinese lending experienced a step change in the twenty-first century, especially after 2008. Led by policy banks (principally China Development Bank and China Export Import Bank), Chinese institutions since then have made foreign loans amounting to anything from $498 billion to perhaps almost double that, depending on which estimate is cited.² Though the scale and speed of this expansion is remarkable, the relative significance of Chinese development lending is nevertheless often exaggerated. Chinese loans are not the dominant form of development finance in low- and middle-income countries. While China is now the world’s largest bilateral creditor, the proportion of public external debt owed to commercial creditors significantly outweighs the Chinese share across Africa, Asia, and Latin America.   

Chinese-financed projects, particularly in Africa, began to attract western skepticism around the mid-2000s, with complaints that “rogue aid” was propping up dictators and undermining traditional creditors’ efforts to promote good governance in recipient countries. Other concerns revolved around Chinese involvement in natural resource projects, especially in Africa. On visits to Zambia in 2011 and Senegal in 2012, Hillary Clinton, then US Secretary of State, twice accused China in thinly veiled terms of extractive practices and lack of concern for governance and human rights on the continent. 

Confusion abounded for some time over how to classify Chinese financial flows, which were often discussed in English-language publications as “aid,” since they tended to go to low- and middle-income countries and to some extent retraced an earlier era of northern development assistance which emphasized big-ticket infrastructure projects.³ Part of this confusion—and suspicion—over Chinese finance was due to its opacity. Neither CDB nor China Exim Bank make detailed loan data available to the public. Chinese lenders are not alone in this regard among G20 nations. However, Paris Club members do provide country-level loan figures, while OECD states share data on export credits. Since China remains outside both organizations, it is not subject to their reporting requirements, which constitute key elements of global financial surveillance systems. 

This lack of transparency meant that for a number of years, outside knowledge of the size, geographical distribution, repayment terms and intent behind Chinese lending remained patchy. To a large extent, media reports or simply rumors took the place of reliable data. Considerable efforts by researchers have since provided a much fuller picture for all of these issues, though gaps certainly remain. Rumors and inaccuracies have also persisted, to the point of influencing policy debates in borrowing countries and in the global North. Most prominent of these, in recent years, has been the notion of debt-trap diplomacy, first coined by Brahma Chellaney in 2017 and coinciding with rising fears over debt sustainability in the global South. This is the claim that China deliberately lends unsustainable sums, waits for borrowers to enter debt distress, and then uses its leverage to take possession of strategic assets. The idea was most famously—and erroneously—evoked in connection with Sri Lanka’s sale of a majority stake in the Hambantota Port to China Merchants Port Holdings. Despite repeated debunkings, the charge of debt-trap diplomacy continues to be leveled at Chinese creditors, and even found its way into a letter from sixteen US Senators warning of China’s predatory loan practices.

Beyond the rhetoric and geopolitical rivalry, there are more fundamental features of Chinese development finance which have made it a poor fit with the incumbent system. Many of the standard modalities of bilateral development finance have emerged as a mix of shared norms and voluntary agreements, often coordinated through the OECD’s Development Assistance Committee (DAC). Among these modalities is an acceptance of the role played by the international financial institutions (IFIs), and particularly the IMF, in setting conditions for the receipt of aid and credit, with bilateral as well as multilateral flows contingent on such policy reform. In turn, this reflects a shared overall conception among DAC members as to what constitutes appropriate economic and development policy for recipient governments—broadly characterized by economic liberalization, post-Washington Consensus institutional norms and some form of fiscal discipline.⁴ In key respects, China’s domestic development experience departs from this understanding of best practice, and these differences tend to be reflected in Chinese approaches to development overseas. While Chinese development finance is usually conditioned on diplomatic recognition of Beijing over Taipei, the absence of other policy conditions is often seen as a selling point for governments taking on Chinese loans. This approach is linked to the nature of Chinese finance, which tends to be project- rather than program-based. 

Another area of divergence concerns the use of finance to support exports. One of the key drivers behind the growth of Chinese lending has been an effort to support capital goods export industries (such as high speed rail and nuclear plants) and to find outlets for surplus domestic capital and production, especially after the government’s post-2008 stimulus measures. US estimates suggest that by 2015, the annual total of Chinese export credit finance was greater than that provided by all G7 states combined. OECD countries are party to a voluntary agreement which places strict conditions on the extent to which public subsidies can be used to support exports in this way, with information on each state’s export credit deals shared among members as a means of ensuring compliance. A related agreement exists which limits “tied aid”—conditioning aid flows on the procurement of goods and services from the donor country. China is not party to these agreements and nor does it routinely report on the financing or procurement conditions attached to its loans. However, stipulations to use Chinese contractors and industrial inputs are common in Chinese financed-projects, and since many loan deals involve some element of concessionally, it is likely that Chinese finance packages often may not meet OECD standards.

A third area of incompatibility relates to the assessment of risk. Put simply, the geographical distribution of Chinese policy bank loans does not correspond to standard credit-rating criteria. States conventionally judged as high risk investment destinations, particularly in terms of governance standards, often receive large amounts of credit from China. To some extent, this pattern reflects Chinese ambivalence to post-Washington Consensus indicators of institutional quality. But it also reflects the distinctiveness of Chinese policy banks’ approach to risk. Emphasis is often placed on building political relationships. For example, certain projects may often not appear economically viable, but will nonetheless be considered as part of a broader cluster of projects which may cross-subsidize one another, or which are conceived of as part of a “big push” approach where the combined impact of the suite of projects is expected to catalyze economic development to a greater extent than the sum of its parts, thus helping to guarantee sufficient returns. Other risk mitigation strategies have attracted more controversy, such as the use of proceeds from resource exports or other revenue streams as collateral. 

Despite these incompatibilities, US and Chinese-centered systems of lending had largely maintained an uneasy, separate coexistence until the wave of debt crises that hit the global South during and after the pandemic. Most southern states borrowed from a mix of the policy banks (and other Chinese lenders), global capital markets, traditional bilateral donors (along with a few other emerging lenders such as India and Saudi Arabia), and the usual multilaterals such as the World Bank and regional development banks. In some cases, China and other creditors successfully collaborated, as in a $5.5 billion 2017 bailout package for Mongolia jointly financed by China, Japan, Korea, the World Bank and Asian Development Bank. Occasional problems did occur, as in the Democratic Republic of Congo, where a $9 billion Exim Bank loan in 2007 was deemed to have been contracted under commercial terms by the IMF. As such, this would have stalled the Fund’s efforts to restart a program with DRC, since the country was not permitted to contract further debt on market terms. The impasse was negotiated via a compromise, whereby the Exim Bank loan was substantially reduced in size, while the IMF quietly reclassified the terms as concessional, and therefore permissible. 

In 2019, in response to debt trap accusations and concerns around default risk, China’s Ministry of Finance launched the Belt and Road Debt Sustainability Framework, aimed at monitoring debt sustainability in debtor countries and placing upper limits on borrowing. Perhaps surprisingly, it is largely based on the 2017 World Bank-IMF framework, an updated version of the same guidelines which proved a stumbling block in DRC. Notably, however, the Chinese version leaves room for even debt-distressed states to take on further borrowing, with the rationale that, if properly directed, new finance may be used to generate economic growth and thus make debt more sustainable over the long run. This attitude to dealing with debt problems is in sharp contrast to the logic of austerity which continues to underpin the IMF’s approach to debt distress (and which is broadly shared by the US-centered circuit of creditors which defer to IMF judgements on these questions). 

Yellen’s January trip to Lusaka overlapped with a visit by IMF Managing Director Kristalina Georgieva. Unlike Yellen, Georgieva did not criticize China directly. Instead, she praised the Zambian authorities for implementing many of the policy reforms stipulated as part of the country’s IMF loan program, even as the stalled negotiations between creditors threatened to derail the deal and prevent the country from receiving further disbursements. A major element of this program is a series of austerity measures aimed at reducing the budget deficit, including the cancellation of a large number of Chinese loan-financed infrastructure projects. Georgieva in particular commended the Zambian government for its “efforts to improve the use of public resources by reallocating resources from poorly targeted and inefficient spending.” A few days later, Chinese Foreign Ministry Spokesperson Mao Ning would underline the difference in principles by stressing the growth-enhancing effects of Chinese-financed projects in Africa, singling out the Kafue Gorge Lower Hydropower Project (KGL) as having “generated significant economic benefits and contributed notably to Zambia’s fiscal revenue. We believe that loans for projects like the KGL have helped bolster Zambia’s debt sustainability, not otherwise.” 

A Common Framework?

In the context of a rising debt crisis and ratcheting tensions between the US and China, global debt workout mechanisms are becoming ever more dysfunctional. In the midst of the pandemic and anticipating a wave of defaults, the IMF, World Bank, and G20 countries did temporarily suspend repayments from seventy-seven of the world’s poorest countries (private creditors declined to follow suit). This was followed in late 2020 by the G20’s Common Framework, an attempt to agree a joint debt restructuring process that would bring China and other non-traditional bilateral creditors into the fold alongside the established international financial institutions and Paris Club lenders. 

The loose Common Framework agreement has produced little of substance. While governments can request talks under the Framework whether they have defaulted on their debts or not, concerns over how such a request might affect their credit ratings have apparently discouraged many debt-distressed governments from participating. Only Zambia, Ethiopia, Ghana, and Chad have signed up for talks so far. Ethiopia asked to begin negotiations in February 2021, and over two years later with little progress to show for it, the government is now bypassing the G20 and attempting to negotiate with China bilaterally. Only Chad has fully concluded a Common Framework deal—and only because creditors reached a precarious agreement which offers no upfront debt reduction, in the hope that higher oil prices will restore the country’s solvency. Zambia finally reached a restructuring agreement with bilateral creditors in June this year. The deal will see repayments stretched out over twenty years, with an initially much reduced interest rate which, however, may rise if the country’s economic performance improves. Zambian authorities now must negotiate a separate but “comparable” deal with private creditors, including the holders of $3 billion in Eurodollar bonds. Long delays have also been seen in cases not covered by the Common Framework. Most prominently, Sri Lanka’s April 2022 default brought talks which were mired in stasis for almost a year before an IMF loan was finally confirmed, still leaving the hard work of agreeing debt restructuring specifics with the countries’ creditors. 

In Sri Lanka as much as in Zambia, Chinese banks have been accused of foot-dragging in restructuring talks, and failing to offer sufficient relief on debt, leading to the long delays in agreeing a bailout. Chinese officials, by contrast, have begun to question the fundamental rules of the game. Where institutions such as the IMF and Paris Club are often treated as representatives of a global, universal interest, the stance adopted by Chinese negotiators in recent talks suggests they see such institutions as western particularists, arrayed alongside western-dominated bondholders in a more or less united front. As such, Chinese officials have adopted a two track approach. On the one hand, Beijing pushes for reform of the international debt restructuring architecture. Simultaneously, Chinese actors work outside these structures to the extent possible, conducting negotiations on a bilateral, often loan-by-loan basis, with a preference for ad hoc solutions over binding multilateral standards. The result is a curious mixture. Chinese policy banks have proven more flexible than other creditors in their willingness to provide restructurings, often well before debtors enter default. But this flexibility exists within rigid boundaries. While agreements to extend repayment periods are common and sometimes accompanied by interest rate reductions, Chinese lenders have almost always proved unwilling to offer a “haircut” in the sense of reducing the principal owed.⁵ Since the beginning of the pandemic, for example, Angola has agreed a three year deferral of principal repayments, with payments then stretched out over a longer period than in the original terms. Prior to default, Sri Lanka was provided with new credit lines, a limited delay on repayments, and a reduced interest rate on some debt. Others, such as Kenya and Tajikistan, seem to have encountered more difficulty in gaining relief beyond a temporary suspension in line with the G20 agreement. Reluctance to offer a reduction on loan principal appears to stem from the practicalities of China’s institutional decision-making structures, whereby individual bankers may be held responsible for losses, and debt forgiveness requires approval from the State Council. It also reflects some of the distinctive features of policy bank lending, whereby loans are usually tied to specific projects that should, in principle, generate future returns with which debt can be repaid—roads, power plants, or ports, for example. On this basis, when a debtor struggles to make repayments, Chinese officials tend to view this as a temporary problem of liquidity, rather than a more fundamental crisis of solvency requiring debt forgiveness.⁶

When Chinese policy banks have engaged in negotiations with other creditors, like under the Common Framework, they appear reluctant to accept IMF judgements on the debt treatments required. Chinese negotiators have suggested that private creditors should be expected to make greater commitments earlier in the process. Most significantly, they have argued that multilaterals, including the IMF and World Bank, should not be excused from offering relief and thus taking losses on their loans. Such a shift is seemingly unthinkable for IFIs themselves. IFIs have argued that the ability to offer highly concessional finance is predicated on their AAA credit ratings,⁷ and the top level rating requires that they have first claim to be paid in full during sovereign debt restructurings. Chinese officials have responded by pointing out that IFIs have at times provided new loans to debt distressed countries as means of kicking the can down the road, avoiding restructuring at the cost of adding to the debt burden. To some degree, China itself has engaged in similar practices, issuing emergency loans to the likes of Sri Lanka and Pakistan in an attempt to prevent default and help friendly borrowing governments avoid calling on the IMF. 

Bypassing China

With negotiations stalling earlier this year, talks in Sri Lanka threatened to become a proxy struggle over the future of the international debt architecture. By last September, the Sri Lankan government had agreed the basic terms of a $3 billion IMF bailout—which some argue may cause more problems than it solves. But final approval was delayed as Chinese creditors’ restructuring offer fell well short of that judged necessary by the IMF to put Sri Lanka’s debt on a sustainable footing. In February, Yellen, the Paris Club, and the Indian government all called for stronger Chinese commitments on debt relief. 

IMF officials then raised the possibility of using the Fund’s Lending Into Official Arrears (LIOA) policy as a means to break the impasse. Under certain circumstances, this mechanism allows for restructuring and IMF program approval even in the absence of sufficient financial assurances on the part of all official creditors. Debts to recalcitrant creditors like China can be separated from the restructuring and left to accumulate unpaid arrears. The Fund has had a similar policy for private creditors since the 1980s to prevent individual banks from exercising veto power over debt deals. But an equivalent for official lenders was long thought unnecessary, so long as most bilateral loans came from Paris Club members. In 2013, discussion around a policy change explicitly responded to the rise of new official creditors like China not bound by Paris Club rules on restructuring.  

In principle, LIOA is meant as a temporary measure to expedite a much-needed relief deal for the debtor and place pressure on a holdout creditor to sign up rather than allow claims to remain unpaid. One stipulation is that the debtor must continue good faith efforts to reach agreement with any holdouts. However, when the IMF adopted the LIOA policy in 2015, it was immediately used to push through a debt relief package for Ukraine in the wake of Russia’s Donbass and Crimea takeovers. $3 billion in Russian debt contracted under the Yanukovych government was excluded from the restructuring and remains in default to this day.⁸ This set a precedent where LIOA policy may be used as a de facto repudiation of debts to a bilateral lender for political reasons.     

In the Sri Lanka negotiations, China blinked—on March 7 the IMF reported that it had received sufficient financing assurances to allow for the approval of a loan program two weeks later. Even if the LIOA were applied in Sri Lanka or elsewhere, it would aim to pressure China to join a restructuring deal, rather than to exclude it indefinitely, as with Russian claims in Ukraine.⁹ The Ukrainian government has had little desire to settle its debts to Russia, a stance which the IMF has tacitly supported by excluding Russian claims from its assessments of Ukraine’s debt sustainability. For states in default to the Chinese policy banks, the calculus is very different, given the importance of maintaining economic relationships. Most governments would therefore hope to avoid choosing between China and the US-led creditor complex. 

Integration or bifurcation?

Recent events, however, have demonstrated a mounting pressure to choose. In addition to Zambia’s IMF deal and the cancellation of most Chinese projects, Pakistan has been squeezed between competing Chinese and IMF demands. In 2021 the US Senate passed a bill directing US officials to use their influence at the Inter-American Development Bank (IADB) to prevent members from accumulating further debts to China, an expanded version of an agreement made by the outgoing Trump administration with Ecuador. Although the IABD provisions were dropped from the final version of the bill, lawmakers have expressed a desire to revisit the original proposals.  

There is some optimism that Zambia’s recent deal on bilateral debt may serve as a precedent for other restructuring workouts.¹⁰This makes it more likely that multilateral efforts at debt restructuring will continue muddling through the existing, increasingly dysfunctional frameworks, continuing to generate long delays and considerable suffering for those debtor countries. But this may soon become unsustainable. With deteriorating US-China relations, the IMF is reaching the limits of its own quiet rule-bending.¹¹ The “Common Framework Cold War” bemoaned by Dipak Patel could reach a fever pitch if a strategically important state like Pakistan were to default in the near future. One possible path forward is reconciliation. Rather than simply forcing China to adopt OECD and Paris Club norms on debt treatment, the development finance architecture could rather integrate—or at least make compatible—US-centered and Chinese systems. Individual, ad hoc deals such as that agreed with Zambia do not necessarily point the way to the kind of systemic reform which would be required, given how far apart the two systems remain in their understanding of several crucial issues, including appropriate policies for debt distressed states and the role that austerity or further borrowing might play in resolving debt crises. The poor state of US-China relations also means that there is little chance of China and OECD countries agreeing to the much higher level of information sharing required to integrate the two systems. The alternative path may be a kind of financial friendshoring, whereby global North and Chinese development finance are separated into discrete geographic spheres of operation, with debtor states assigned to one or another of the two systems. That kind of bifurcation could only be accomplished via a fundamental rewiring of global financial circuits, a process much more likely to deepen the current crisis.