Over the past ten years, the world has witnessed the staggering growth of China from a developing nation to the worlds second largest economy by GDP. One of its most notable projects is its infamous Belt and Road initiative. This has led China to become the biggest creditor in the world, larger today than the International Monetary Fund (IMF) and World bank, driving billions of dollars of investment into many developing countries. Much of this investment has been focused on building infrastructure and deepening its global road, rail and sea connections. Xi Jinping’s Global vision included building airports in Ethiopia and expanding the harbors of Sri Lanka, creating connections within the world and establishing China as a major power.
However, 2020 arrived and the pandemic started to reveal cracks in the foundation of this plan, for both China and many developing nations receiving investment.
Zambia was the first to default. On 14th November 2020, the country missed its second foreign debt payment triggering a technical default as they broke the contract of their loans. Pressures on its healthcare system, already present before the pandemic, were compounded and the $1.7bn payment the African country had to make that year was untenable. On top of this, China’s banks were slow to negotiate, leading to little in the way of helpful restructuring and resulting in the negotiation of a $1.3bn loan from the IMF.
This was but the first of what became a rapidly progressing debt crisis facing many developing countries. China’s policy of slow talks and limited debt reconstruction, whilst opting for longer maturities at lower rates, contrasts greatly with western practices from the Paris club ( a group of mainly western countries that meet to help provide relief and restructuring to unsustainable debt in many developing countries). The second default came in Sri Lanka. On 10th July 2022, protestors occupied the presidential palace in the capital Colombo, protesting economic collapse and blaming the incumbent president (Gotabaya Rajapaksa) and his family’s grip on Sri Lankan politics for the downturn . Many were angry at the recent large investment in infrastructure, reliant on Chinese loans, which has yet to show returns. Furthermore, the attempt to save foreign currency for payments by halting fertilizer imports for seven months had significant impacts on food production and as a result has caused inflation to soar to a high of 69.8%.
Hoping for an economic boost from Chinese tourists towards the end of the pandemic, Rajapaksa waited too long for talks with the IMF and China. This led to a default of more than $50bn, resulting in another large bailout from the IMF ( $2.9bn), and slow progressing talks with Chinese banks. As a result, this may lead to longer maturities at lower interest rates, forcing the continuity of the problem going forward.
The two defaults were followed by Ghana on the 19th of December 2022; a country that has been dealing with mounting debt for many years .
This appears to have been just the start. Since the pandemic started, global debt for developing countries has grown by $23tn. One of the main causes being hikes in interest rates from the federal reserve, moving aggressively to 4.75% and causing the USD to soar. This is because there are hot money flows into the U.S, as foreign investors will get a higher risk adjusted return on their savings with the higher interest rates. The debts of developing countries also grow as they are usually denominated in USD, so as the currency appreciates so does the magnitude of their debt. This pressure, combined with closures caused by the pandemic, as well as the inflation from global supply shortages, has pushed many countries to the brink of defaulting.
Many are now finding it harder to fund their projects due to rising inflationary pressures . China is reducing the amount it lends due to Xi Jinping’s banking narrative : ‘Small is beautiful’. In doing so, the Chinese Communist Party is trying to decrease the amount of management they must do and to reduce the possibility of more defaults (as risk greatly increases in times of global slowdown and recession). This decline puts further pressure on internal issues in many of these countries that may ultimately push them to default.
Whilst many developed countries are relying on the stability of their governments and the ingrained power of their currencies to hold through the inflationary period, many developing countries find themselves on the brink of collapse.
For example, Pakistan is facing political turmoil. Rebuilding from devastating floods and struggling with the supply of electricity, the country now only has $3.7bn in foreign exchange reserves( compared to a total of $270bn of public debt.)Most of this debt is with China and its banks. If we see the same pattern that we have witnessed with Zambia and Sri Lanka in terms of slow talks, debt restructuring may come too late to save Pakistan from defaulting.
The economies that are on the brink of defaulting may now have to deal with internal issues with little help from outside creditors. Without this, these issues may exasperate into larger crisis that have the possibility to cause political upheaval, creating further instability within chinas sphere of influence.
The post-pandemic world is proving tough for many. China’s inexperience on the big stage is starting to show. The ambition of the belt and road project that has allowed for so many countries to be flooded with Chinese investment has also shown to be its biggest weakness. Being stretched out into so many countries via their large investments, China has sprung onto the global stage. However, maintaining this level of power by keeping those in its sphere of influence stable, and as such benefitting from this investment will prove to be much harder.
However, It is possible that China has started to learn. So far we have seen a scaling back of this project, but they must continue to adapt and cooperate through this great economic test. If they do not, this project will come crashing down all around them.