New Silk Road: with 60% of foreign loans at risk of default, China increasingly has to bail out its debtors

An increasing number of emerging and developing countries borrowed from China to build infrastructure under the New Silk Road cannot service them on schedule.

As a result, Beijing has dramatically expanded its bailout lending in recent years.

An analysis by researchers at AidData, the Harvard Kennedy School, the Kiel Institute for the World Economy (IfW Kiel), and the World Bank now makes the dimension public for the first time.

According to the study, 60% of all Chinese foreign loans are now at risk of default (as of 2022).

In 2010, this proportion was just 5%.

To prevent defaults, Beijing is granting rescue loans on a grand scale.

By the end of 2021, the authors count 128 rescue loans to 22 debtor countries totaling US$240 billion.

Much of this – US$170 billion – is being provided through central bank loans, which are particularly difficult for international organizations and rating agencies to track.

Most of these are refinancing loans, i.e., extending maturities or payment terms or granting new loans to finance maturing debt.

Debt forgiveness takes place only extremely rarely.

According to the analysis, Chinese banks have drastically reduced regular lending for new infrastructure and energy projects due to the extensive bailout loans, which raises questions about the future of the New Silk Road.

The study, “China as an International Lender of Last Resort,” was authored by:

• Sebastian Horn (World Bank),
• Brad Parks (AidData, William & Mary University),
• Carmen Reinhart (Harvard Kennedy School, former chief economist at the World Bank),
• and Christoph Trebesch (Kiel Institute for the World Economy).

The authors systematically analyzed central bank balance sheets, among other data, for the underlying dataset on bailout loans, which is freely available.

According to the authors, Beijing treats debtor countries with payment difficulties differently.

Middle-income countries pose large balance sheet risks to Chinese banks because they account for 80% of China’s total foreign loans or more than US$500 billion.

China’s leadership, therefore, has strong incentives to prevent these countries from defaulting at all costs.

It usually offers them new loans in the event of payment difficulties, using them to pay off old debts.

Since many of these countries have weak credit ratings and low foreign exchange reserves, the risk of defaulting on the new loans is high.

Low-income countries account for only 20% of Chinese foreign loans.

These loans are, therefore, less important for the stability of China’s banking sector.

Low-income countries rarely receive new funds.

In the event of payment difficulties, their only options are usually sovereign default or debt restructuring, for example, by stretching out maturities.

BEIJING IS TRYING TO BAIL OUT ITS BANKS

“Chinese banks are interested in ensuring that their largest foreign borrowers have sufficient liquidity to continue servicing outstanding debt for New Silk Road infrastructure projects.”

“Beijing is ultimately trying to save its banks. That’s why it got involved in the risky business of international bailout loans,” says Carmen Reinhart.

“But when you’re trying to rescue a debtor that’s in default or about to default, you have to be clear about whether you’re trying to solve a short-term liquidity problem or a long-term solvency problem.”

The study’s authors see parallels to the European bailout loans to Greece and other southern European countries during the eurozone crisis.

Then, the bailout of domestic banks also played a significant role in providing rescue loans.

China has extended rescue loans to 22 countries, including Argentina, Ecuador, Laos, Mongolia, Egypt, Pakistan, Suriname, Sri Lanka, Turkey, Ukraine, Venezuela, and Belarus.

In this context, the average loan interest rate is 5%.

A typical rescue loan from the International Monetary Fund (IMF) carries an interest rate of only 2%.

“Thanks to our data, we can understand China’s growing influence on the international financial order.”

“Until now, it was unknown that China had set up a system to bail out crisis states, let alone the large scale and recipients of the bailout loans,” Trebesch said.

“China’s decisive action in financial crises in the global South could be a harbinger of a new, fragmented global financial system in which bailouts are no longer handed out from Washington DC alone.”

“Former emerging economies such as China and India that once depended on the West for emergency loans are increasingly becoming active creditors themselves.”

“Beijing has created a new global system for cross-border bailout loans, but in an opaque and uncoordinated way,” Parks said.

“Its strictly bilateral approach has made it difficult to coordinate the activities of all major lenders, which is concerning because resolving sovereign debt crises usually requires some degree of coordination among creditors.”

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