The impact of China's growth slowdown on the developing world
The true impact of the Belt and Roads Initiative may soon be felt
Over the past decade, one international development scheme has dominated discussion over the geopolitical consequences of how emerging markets experience economic growth: China’s Belt and Roads Initiative.
The scheme is best defined simply as “a US$1 trillion global infrastructure program”. Through this China has funded infrastructure projects in developing economies across the world. However, the majority of the countries which have actually received infrastructure as a result of the scheme are developing economies in Africa and Asia.
However, the consensus in the West is that these projects, which typically are funded by Chinese loans and are often completed by Chinese companies, is that China is using the schemes to advance its own geopolitical interests as opposed to legitimately aiming to provide economic growth.
The most common criticism of the initiative has been that the Belt and Roads Initiative is that it is a form of ‘debt-trap diplomacy’; whereby China loans the developing country the money to fund the infrastructure project with the knowledge that they will likely fail to repay. When the country defaults on its loan China then seizes control of the infrastructure or continues to pursue full repayment at a higher interest rate.
It is this debt aspect that will be the focus of today’s post. China has been willing and able to provide the aforementioned loans for the past decade of rapid economic growth , even managing to grow during 2020; whilst almost every country in the world experienced a severe contraction as a result of Covid-19. However, this era, as I will discuss, is now over. As China has only been able to provide the Belt and Roads Initiative’s loans on the back of its own economic growth, what will the impact of a Chinese slowdown be on economies which have become over-reliant on Chinese loans to support their development?
Why China is/will experience a slowdown:
China has experienced multiple decades of almost uninterrupted economic growth, the fastest in history. However, cracks are starting to show.
Most notable is the slowdown in the Chinese property market. This has been caused by developers such as Evergrande increasing construction in anticipation of urbanisation due to the better employment opportunities of cities. However, this construction was largely fuelled by debt and when sales slowed down as a result of urbanisation nearing its peak, developers could no longer finance their debt and entered or neared bankruptcy. As many Chinese homebuyers have paid their mortgage deposit prior to the completion of their home, the failure of developers means that construction hasn’t been completed. Quite understandably, a significant number of Chinese homebuyers have been boycotting mortgage repayments, potentially placing stress on the country’s banks as they need loan repayment to continue making loans. This has the potential to result in a credit crunch.
Combined with disruption to manufacturing as a result of the government’s ‘Zero Covid’ policy halting operations, manufacturing still being the bedrock of the economy, this has the potential to cause a significant economic crisis in China as two of its key sectors, property and manufacturing, are experiencing downturns.
The potential for a recession in China may effect the Belt and Roads Initiative as it relies on the Chinese state for its funding. If a financial crisis occurs China may have to recapitalise financial institutions exposed to the mortgage crisis and increase aid to consumers affected by job losses. Therefore, as the Chinese state is focused on protecting its domestic economy it is less likely to focus on international development and, depending on the severity of the crisis, may severely reduce funding for the Belt and Roads Initiative.
What does this mean for the scheme’s participants:
As already mentioned, the recipients of the large scale infrastructure projects provided by the scheme are largely developing countries in Africa and Asia. As such these countries are likely reliant on foreign investment to support their economies. This is due to foreign investment being required to develop the economy by providing existing technical knowledge and experience, combined with financial capital, to establish sustainable businesses in the country; allowing the tax base of the country to expand, facilitating greater government investment, further growing the economy.
This reliance on foreign investment is exacerbated by the nature of the Belt and Roads Scheme in that it is heavily focused on infrastructure. As this infrastructure is necessary for the cycle of economic growth outlined to occur; for instance by facilitating trade via roads, railways and ports, it is required for future foreign investment from the private sector to be gained as it allows them to perform their operations in the same manner as in their home markets in developed countries.
Whilst the ‘debt-trap diplomacy’ idea rests on infrastructure projects becoming ‘white elephants’ and as such not providing the return on investment which would allow for repayment on loans by China, and this has been the case for a number of the projects, most notably a port in Sri Lanka, many of the projects have the legitimate potential to aid development. For instance, a rail line connecting Ethiopia and Djibouti transports a quarter of Ethiopia's exports to the coast; allowing for them to be shipped globally. Furthermore, the true benefit of these projects may only be realised in the long run. This is due to the purpose of infrastructure being to encourage investment and increasing the productive capacity of a country. The presence of time lags, due to TNCs needing time to gain the confidence to invest in emerging markets for example, combined with the global economic disruption of the last two years as well as rising geopolitical tensions between the West and China; and how these issues combine to reduce foreign investment in developing countries, it is possible that infrastructure projects as a result of the Initiative will provide a return on investment and allow for economic development in the long-term once the global economy and investor confidence have stabilised to result in greater foreign investment in emerging markets, meaning that the capacity added by the infrastructure is required.
This long-term benefit of the Initiative means that a reduction in investment due to a domestic economic crisis in China may be highly damaging to developing economies as it reduces their infrastructure development by reducing investment and production capacity; reducing the exports needed for these economies to grow.
Whilst I have so far focused on the denied benefits of the Belt and Road Initiative due to a Chinese slowdown, I must also turn to the potential for the negatives of the Initiative to be enhanced by a slowdown.
This is due to an economic crisis in China meaning that, due to the aforementioned reasons, the Chinese government is likely to need greater financial reserves to provide the necessary fiscal response. This means that China may decide to tap unpaid loans in order to increase its reserves. As such, China may demand immediate repayment, especially for debtors which have previously failed to meet repayments. If countries fail to make these immediate repayments, China may impose higher interest rates or seize the infrastructure, as was done with the Sri Lankan port. This will only heighten the ‘debt trap diplomacy’ idea as China is essentially forcing debtors into default in order to combat its own economic crisis.
The risk of this occurring is increased by additional global macroeconomic factors. The key one being the strengthening of the US dollar against other currencies globally; this being caused by the Federal Reserve being the first-mover on interest rate rises to combat inflation attracting flows of ‘hot money’ from global investors into American savings accounts, meaning that demand for the dollar is higher and so it appreciates in value. This affects developing countries due to the most common currency for loans to developing countries being the US dollar, as it is the global reserve currency. An increase in the value of the dollar against the home currency of the debtor means that the real value of the debt is greater and so a greater number of countries, who have previously only been able to marginally make repayments, are on the brink of default. This affects the Belt and Roads Initiative as the BRI loans are largely made in US dollars. Therefore, as the value of the debt has increased, the risk of default increases.
Therefore, the combination of a potential domestic economic crisis in China and a global macroeconomic crisis means that the situation over debt repayment for BRI debtors may potentially worsen. However, will this severely affect many countries or is the scale of BRI debt for individual countries limited? The scale of a China debt crisis depends on how reliant on China economies have become.
According to Canada’s National Post a “study found 42 low to middle-income countries, such as Laos, Papua New Guinea, the Maldives, owe debt to China exceeding 10% of their GDP”.
Owing over 10% of the value of GDP to a single creditor is needless to say an incredibly risky situation to be in. If full repayment is demanded, or a drastic increase in interest rates occurs, then a country experiencing internal macroeconomic difficulties already; currently inflation being a significant issue for instance, could enter a sovereign debt crisis.
The situation is of particularly high risk in certain countries. For example, according to the same National Post article, Congo’s debt to China is equivalent to 53% of GDP.
Furthermore, significant borrowing from China suggests that government’s are highly reliant on China to fund fiscal expenditure as, if governments had sufficient taxation revenue or could borrow from less aggressive lenders, it is unlikely that they would use a lender with a reputation such as China’s.
If China is the only country willing to lend these economies the finance necessary for them to develop, and they cannot raise this finance through taxation, then China is essential to fiscal spending and hence these countries are dependant on China.
Conclusion:
As the National Post article shows, a substantial number of developing economies are significantly exposed to Chinese debt.
Due to the potential for inaccuracy in the economic figures reported by the Chinese Communist Party, we do not yet know the scale of the financial crisis in China and what level of government intervention will be necessary.
However, if it is a significant crisis, combined with global macroeconomic factors, this could prove highly damaging to economies which have experienced Belt and Roads investment as China’s domestic needs will outweigh its foreign investment and as such repayment demand or repossession of assets may occur.
Currently there is debate over whether the 'debt trap' idea is correct. However, the impact of a Chinese economic crisis renders this debate irrelevant as if the theory is correct, the situation will only be worsened as demand for repayment and asset seizure will increase, whilst if the theory is incorrect widespread asset seizure may occur for the first time. Whether or not ‘debt trap diplomacy’ is real, the threat of asset seizures or forced repayment or higher interest rates exists if China experiences a severe domestic economic crisis.
Sovereign debt default or loss of control over infrastructure are both negative impacts on the debtors of the Belt and Road Initiative as it further increases the control over the economies and politics of these countries that China has. The potential for protests as seen in Sri Lanka also exists as government may have to accept debt restructuring which reduces government spending.
Many beneficiaries of the scheme may be about to find out whether or not they have truly benefitted in the long-term from accepting Chinese loans and infrastructure.