China’s new debt sustainability framework for the BRI

This is a guest post by Dr. Johanna Malm, independent researcher. She was previously researcher at Stellenbosch University’s Centre for Chinese Studies and PhD Fellow at Roskilde University’s Department of Society and Business. Read more about her research here; she can also be found on Twitter as @drjmalm.

In this piece, she analyzes China’s new debt sustainability framework, launched at this past spring’s Belt and Road Forum. She argues that while China has been responsive to some of the recent criticisms of its lending policies, its approach to development finance still differs significantly from that of the IMF.

China’s second Belt and Road Forum was held in Beijing in April 2019. In response to growing international critiques against Chinese lending abroad, China has acknowledged these concerns and adapted some of its practices.

As such, debt sustainability was a significant feature of the Belt and Road Forum. The Chinese leadership sought to address debt issues in several ways. In its official communication during the Forum, Beijing stated that China is committed to preventing and resolving debt risks. China’s Ministry of Finance also published a new document, the Debt Sustainability Framework for Participating Countries of the Belt and Road Initiative. China’s Finance minister Liu Kun encouraged China’s financial institutions, Belt and Road signatories, and international agencies alike to use the framework to improve debt management.

China and the IMF: Three Major Differences

Debt sustainability frameworks are often seen as technical documents that stipulate the recommended terms and amounts of public debt a country can sustainably acquire. However, such frameworks are also inherently political, embodying norms around debt sustainability, such as different conceptions of the relation between public debt and development. China’s approach to this matter differs from that of the International Monetary Fund (IMF).

China’s new debt sustainability framework marks the first time the country’s approach to debt and development has been articulated in an official document with an English translation, thus signaling that it is targeted for a Western audience. Previously, China’s approach had mostly been articulated by representatives from its financial institutions, most vocally by Li Ruogu during his tenure as President for China Exim Bank. As demonstrated by the new debt sustainability framework, China’s approach is still significantly different from the IMF’s approach to debt.

First, the framework makes no mention of Chinese lending terms. In other words, China has not articulated any commitment to provide financing exclusively on concessional terms (Note: a concessional loan has lower interest rates, longer grace period and longer reimbursement period). Although Chinese policy banks still extend loans to developing countries on concessional terms, loans extended at commercial rates are an important part of its lending portfolio. By not mentioning the lending terms in its debt sustainability framework, China leaves space for its banks to lend on commercial rates as they see fit. This can be compared to the IMF’s debt limits policy, which advocates for financing on fully concessional terms to low-income countries.

Second, the framework makes it clear that China does not see debt distress as an obstacle to continued borrowing. The framework states:

“[I]t should be noted that an assessment for a country as “high risk” of debt distress, or even “in debt distress”, does not automatically mean that debt is unsustainable in a forward-looking sense. In general, when a country is likely to meet its current and future repayment obligations, its [public and publicly guaranteed] external debt and overall public debt are sustainable.”

In other words, a country in debt distress can still take up loans from China if the individual loan-backed project is commercially viable and if the borrower is able to service its debts. This statement represents a sharp contrast to the approach of the IMF, which states that non-concessional borrowing to countries in debt distress “would be allowed only under exceptional circumstances” (p. 2 of PDF).

Third, China considers the relationship between debt and growth explicitly in its debt sustainability framework. It states: “Productive investment, while increasing debt ratios in the short run, can generate higher economic growth […] leading to lower debt ratios over time”. This indicates that China sees lending as a catalyst for economic growth, as opposed to the IMF’s debt limit policy, for which growth is enhanced if the loans are concessional.

Implications Moving Forward

Since the end of World War II, the IMF has been the most influential institution in setting public debt management norms for developing countries. China began to challenge the IMF’s position when it started to increase its overseas lending at the turn of the 21st century. As I have shown in previous research (see here and here), the IMF had no choice but to adapt its own debt sustainability framework in 2013 to allow for developing countries to take up loans on commercial terms from China. This policy change was born of the political impossibility of the IMF to prevent developing countries from taking up Chinese loans.

However, this shift in the IMF’s position was not widely publicized, and the Fund still hopes to get China to conform to its own ideas of debt sustainability. As the IMF notes, the effectiveness of its debt sustainability framework “hinges on its broad use by borrowers and creditors”. For instance, in April 2018, the IMF opened a China-IMF Capacity Development Center in Beijing, which organizes courses directed at Chinese officials working on BRI-related issues. The courses offered include a workshop on debt sustainability frameworks in low-income countries.

The IMF’s Managing Director Christine Lagarde reacted to China’s new debt sustainability framework by stating that the framework represents ‘positive steps’ by Chinese authorities. However, she also said that infrastructure financing through the Belt and Road should only go where it is needed and where the debt it generates can be sustained.

In sum, recent events show that, while China has grown more sensitive to international pressure around its role as a development finance provider – especially when the critiques emanate from other developing countries – its new debt sustainability framework also demonstrates that it is willing to challenge to the IMF’s approach. China’s approach to development finance reflects the country’s own experience as a borrowing country. State-led development finance worked well for China’s own development and it is this model that China replicates in its lending to developing countries today.

This also highlights that, beyond notions of ‘good’ and ‘bad’ lending, China’s and the IMF’s different approaches have different benefits and drawbacks. While China’s approach can spur growth by providing significant amounts of development finance to countries in dire need of investment, the IMF’s more cautious approach prioritizes lower debt burdens for developing countries. While respective definitions of “sustainable debt burdens” might differ depending on developing countries’ priorities both approaches might prove beneficial for borrowing countries.