China may have to cancel loans as countries struggle to pay

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With the development of the Belt and Road initiative, Poland will be able to export its food products to China by rail, according to the Polish State Railways Cargo.

Jaap Arriens | Xinhua | Getty Images

China could find itself forced to cancel massive loans as countries that owe Beijing money for its huge infrastructure project are struggling with growing debt in the fallout from coronavirus, according to analysts.

China’s massive infrastructure investment plan – also known as the Belt and Road Initiative (BRI) – is highly controversial and widely criticized for having taken on debt from many countries.

It is an ambitious project to build a complex network of rail, road and sea routes stretching from China to Central Asia, Africa and Europe. It also aims to boost trade. Chinese financial institutions have provided hundreds of billions of dollars in funding to countries involved in the BRI projects.

“Many countries in the BRI initiative have borrowed heavily from China to invest in new projects, but the pandemic is disrupting economies and will make repayment plans difficult,” Kaho Yu, senior analyst for Finance, told CNBC. ‘Asia at Verisk Maplecroft.

The coronavirus pandemic has spread to more than 180 territories and countries around the world and has infected more than 4.1 million people so far, according to data from Johns Hopkins University. At least 282,694 deaths from Covid-19 have been reported since its first appearance at the end of last year in China.

According to Simon Leung, banking and financial partner at the law firm Baker McKenzie, several major BIS projects – such as those in Indonesia, Malaysia, Cambodia, Sri Lanka and Pakistan – have been blocked by roadblocks.

The epidemic has also disrupted BIS projects, which are often highly dependent on labor and supplies – but the two were unable to reach the sites due to the closings, Leung said.

“The decline in export earnings, coupled with increased domestic spending in the aftermath of the epidemic, has resulted in a significant depreciation of the local currency and, in turn, has affected borrowers’ ability to repay foreign currency debts owed to Chinese banks, “said Leung. , referring to increased spending in terms of stimulus packages. Less demand for a country’s goods also usually means less demand for its currency, which causes it to weaken.

All of this affected the ability of debtor countries to repay their loans denominated in Chinese dollars.

More than 130 countries are under the BRI initiative, according to the Beijing-based research firm Green Belt and Road Initiative Center. Many of these countries are found in Europe, Africa and Central Asia.

According to Yu, the low-income countries of Belt and Road are already asking China for debt relief. This could take the form of interest relief, extension of payment periods or complete suspension of payments in the medium term.

Pakistan and Sri Lanka may be among the most disadvantaged and may not be able to honor their overall debt this year due to the pandemic, analysts said.

Barter trading

The countries have also signed “barter agreements” with China, and they are “in an even more difficult position,” said Yu.

Some Chinese loans are said to be denominated in barrels of oil – a practice the World Bank has reported to be opaque, as they mask the true amounts of the payments.

“Since the pandemic hit oil prices, they will have to produce more oil to pay off the loans. However, the pandemic has also disrupted all kinds of industrial activity, making it impossible for these countries to reach the required level of production, “said Yu. “As a result, Chinese companies will likely be given control of joint ventures or be reimbursed with assets. “

However, it is increasingly likely that Chinese lenders will be forced into a larger debt forgiveness due to force majeure or other arrangements.

The economic intelligence unit

China has a proven track record in asset recovery when countries cannot pay back their loans. A highly publicized example is Sri Lanka, which had to cede a strategic port to Beijing in 2017, after being unable to repay its debt to Chinese companies.

According to reports, China’s loans to the countries have been concealed, with Beijing often demanding public sector assets as collateral. Between 2000 and 2017, other countries’ debt to China increased tenfold, according to a study last year.

“Press” to cancel loans

China will be “under pressure” to extend or even write off the loans, according to the research firm Economist Intelligence Unit. It has already “signaled its willingness” to offer debt relief programs to certain low-income countries, said the EIU.

“There is, however, an increasing likelihood that Chinese lenders will be forced into a larger debt forgiveness, due to force majeure or other arrangements,” said the EIU. Force majeure occurs when unforeseeable circumstances – such as natural disasters or, in this case, a pandemic – prevent a party from fulfilling its contractual obligations, exempting them from sanctions.

“Widespread debt cancellations could generate a negative feedback cycle that would discourage future Chinese lending activity during the rest of 2020 (and until 2021),” said the research firm.

Most loans are made through two political banks – the China Development Bank and the Export-Import Bank of China, both of which are “closely linked” to the Chinese government, said Leung of Baker McKenzie.

“These banks have government support and backing and, therefore, debt renegotiations may involve political dialogue,” he said.

Most importantly, Beijing may be motivated to write off debts due to the importance of the BIS to China. “We suspect that China will eventually reschedule and forgive some of the debts to the BIS countries, especially for projects that are strategically important,” said Homin Lee, macro strategist for Asia at Swiss private bank, Lombard Odier .

“Debt problems will be very idiosyncratic, especially since China has strategic stakes in many transnational projects and also has an economic interest in ensuring the long-term success of the program,” he said. CNBC in an email.

Back in the country, Chinese banks are already preparing for an increasing accumulation of bad debts, consumers and businesses suffering the brunt of the pandemic. Earlier this year, China’s central bank said state lenders should tolerate higher levels of bad debts to support companies affected by the coronavirus.

This story has been updated to reflect the full quote from Homin Lee on China which could reschedule and cancel some BIS debts.

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