Chinese people keep money in the bank

Since China has been granting loans to poorer countries as part of its "New Silk Road" investment program, critics have suspected that the deals were gagged contracts that are supposed to increase political dependencies. While Beijing asserts that it is a question of development aid on the usual terms, what has so far been the lack of reliable evidence to substantiate the allegations against the Chinese government.

For the first time, an international team of researchers has now succeeded in systematically evaluating original contracts from Chinese creditors, which are representative of contracts that the Chinese government and its state banks conclude with other countries on behalf of Beijing. In their study "How China Lends", scientists from the US research center for development finance AidData, the think tank Center for Global Development in Washington, the Kiel Institute for the World Economy and the Peterson Institute for International Economics, also in Washington, examined 100 Chinese loan agreements with 24 countries .

Many of them are part of the New Silk Road, the Chinese government's global investment program. The researchers compared the Chinese loan agreements with 142 publicly available agreements from other major creditor countries at the same time.

The data collection compiled by the AidData research center is the largest source of debt contracts between Chinese government lenders and developing countries to date and is publicly available via an online database. The contracts were found on the government websites of the debtor countries, but were apparently not intended for the public.

Explicit confidentiality clauses

In principle, many debt contracts are not publicly available. In almost all of the Chinese contracts examined by the scientists, however, there were unusual explicit nondisclosure clauses that forbade the debtor countries from disclosing information about the terms of the loans and projects or, in some cases, even from disclosing the existence of the loans. Such provisions could only be found very sporadically among creditors in the comparison group. According to Christoph Trebesch, research director at IfW Kiel and co-author of the study, China's secrecy has even increased over time. Since 2014, every contract examined contained a corresponding confidentiality clause.

From the authors' point of view, confidentiality is not only problematic because, in the end, the taxpayers of the respective countries would have to pay for the repayment of the loans, but they lacked the information about the conditions and scope of the loans to critically monitor the projects. The lack of transparency also makes it impossible for other lenders to reliably assess a country's creditworthiness.

China often awards bundle contracts to countries where there is a great need for investments in infrastructure, for example. Projects are funded by Chinese loans and built by Chinese companies.

According to Trebesch, the special thing about China's contracts is that they are not classic intergovernmental loan agreements. Parts are standardized, other formulations are "very unusual". The expert therefore speaks of "hybrid contracts", which included elements of private and public credit agreements. Often there are similar clauses, such as those found in contracts of private banks, but sometimes formulated much more far-reaching.

If the debtor's policy is not satisfied, the credit will burst

According to the international research team, it is surprising that in many contracts a decision can be made relatively suddenly to terminate loans or to request accelerated repayment. China can withdraw the loan if it does not agree with developments or policies in the debtor country. The state-run China Development Bank, for example, treats the severance of diplomatic relations with China as a "default event". According to Trebesch, this gives the Chinese state banks great bargaining power, as they can flexibly decide whether or not to continue projects. "Some of the formulations are worded so broadly that even a policy change in China can trigger a default event after which the entire loan must be repaid immediately."

There are also extensive third-party default clauses (cross default) and cross cancellation provisions. This means that if a state wants to end a Chinese project, this may have consequences for other loans. That was the case in Argentina, when the new government under President Mauricio Macri no longer wanted to build the dams planned under the previous government and financed with Chinese loans. The state lender China Development Bank then informed the new government that these were linked to the projects to modernize the Belgrano Cargas rail network and that a halt to the dam plans would also mean an end to the expansion of train traffic.

So-called stabilization clauses can also be found in the contracts. Changes in labor or environmental law, for example, that have a negative impact on Chinese projects can result in penalties or the termination of a contract. This significantly limits the options for action by governments and successor governments, as it is not easy for them to get out of Chinese treaties or to change legislation that is to the detriment of Chinese creditors and investors.

"One way you can read these contracts is that China is providing additional protection because, unlike other financiers, it is willing to take high risks and invest in unstable countries over the long term," says Trebesch. For example, the Chinese government prevents the risk that a new government will come and call projects that have already started into question again. Another interpretation, however, is that China, regardless of the political situation, gains considerable bargaining power through these treaties and could not only focus on the pure protection of the contractual components, but also on the more fundamental implementation of its political and economic interests in the respective country.

Haircut does not apply to China

According to the international research team, it is also noteworthy that most Chinese loan agreements contain clauses that explicitly prohibit debtors from rescheduling Chinese loans in coordination with other creditors. For example, in the context of Paris Club negotiations, in which state creditors meet debtor countries that have difficulties repaying loans.

A haircut agreed with the Paris Club usually applies to all creditors, private as well as government. So for China too. The Chinese treaties partially exempted countries from the obligation to go along with other actors in the event of a Paris Club agreement. Actually, an international standard that has been practiced for decades. "This enables China, at least in theory, to get its own, better deal than other creditors," says Trebesch.

The researchers did not find similar regulations in any other contract in the comparison group. From their point of view, the Chinese banks are deliberately positioning themselves as primary creditors and, in some cases, severely restricting the debtor countries' options for action in the event of insolvency. In the end, it is entirely up to China to decide whether, when and how it grants debt relief to countries in need.

The researchers write that debt service is often secured by foreign accounts and project income. Almost a third of the contracts required borrowing countries to hold significant cash balances in bank or escrow accounts that Chinese banks can seize in the event of default. These informal security arrangements put the Chinese lenders at the top of the repayment line.

For many countries, deals with China are still attractive. They lack the basic infrastructure, capital and investors willing to take the risks. China is ready, so it is offering something that other investors and creditor countries do not offer, even if the contracts are accompanied by restrictions, as the research group clearly shows.