How Chinese Loans Can Serve as Financial Bailouts
Can countries wary of the International Monetary Fund (IMF) turn to China instead for a financial lifeline? According to new research presented as part of the Global China Research Colloquium, the answer is a conditional yes.
Countries that can repay their loans in-kind with natural resources, or are blessed with strategic importance to China, can receive loans from Chinese policy banks when few others will lend to them. Otherwise, China appears to pay more attention to debt sustainability than is commonly imagined.
The appeal of a Chinese bailout is simple. The IMF requires borrowers to undertake tough reforms that, while intended to fix underlying economic problems, are politically unpopular and may have deleterious effects on public health and inequality. By contrast, China’s requirements are often an easier lift: resource exports, or the hiring of Chinese construction firms for big infrastructure projects. As a result, countries as diverse as Angola, Ecuador, and Pakistan have approached China for loans to help with shortages of foreign currency.
Yet, while China’s potential to stand in for the IMF is well-understood, its actual behavior has remained less clear. Offering bailouts to every country that wants one is a quick way to lose money and become an unpopular debt collector, something hardly in line with China’s attempts to portray itself as a member and leader of the Global South. China has also refused to bail out some countries in the past – although these non-events have attracted less attention than the loans that did happen.
To better understand if China really competed with the IMF, and where, this research used new data on Chinese lending and econometric methods to tease out cause and effect.
China’s largest loans go to countries experiencing economic difficulties
Data on borrowers’ GDP growth and trade balance show that large Chinese loans tend to come as both are declining and follow a particularly steep drop from the year before. Repeating the procedure with country-years drawn at random makes the pattern clear: big Chinese loans go to countries that, compared with their peers, are undergoing an economic reversal of fortune. These are the same conditions that force governments to turn to the IMF, suggesting that China’s loans sometimes function as bailouts.
Figure 1: Borrowers’ Macroeconomic Health
Source: James Sundquist.
Chinese loans cause governments to not participate in IMF programs
Chinese loans can actually cause some governments to not begin an IMF program. The fact that China’s internal politics and economics drive aggregate swings in China’s lending proved key in uncovering rigorous evidence of this effect. A loan equivalent to one percent of GDP was estimated to lower the probability of a country starting a new IMF program by 6 percentage points, which translates to an enormous 60 percent decrease in relative risk for a typical borrower. Practically, this means that the expansion of Chinese lending over the past twenty years has almost certainly helped some countries avoid turning to the IMF – at least temporarily.
Reactions to this evidence depend largely on one’s views of the IMF: those who believe that the Fund’s mission is to set governments on a sound financial footing are likely to complain that China undermines this mission, while critics may be cautiously optimistic, and point out that the IMF itself sometimes operates in a way designed to please Western governments.
The pattern is strongest among natural resource exporters
Since natural resources are known to be a key means by which China (and others) guarantee repayment, countries were divided into two groups: those that averaged over $1.5 billion per year in natural resource exports, and those below. When the model was fit separately for each group, the effect size was found to be much larger for the resource exporters: 12 percentage points versus 4. This supports the idea that Chinese bailouts are easier to come by for countries that are able to credibly compensate China.
Resources are an important means of doing this, but not the only one: qualitative case studies suggest that countries of special diplomatic importance to China – by virtue of being nearby, or willing to switch their recognition from Taiwan – can also convince China to offer loans during economically distressed times.
Overall, these results confirm what had previously been supported only by anecdotal evidence: that Chinese loans can substitute for IMF assistance. At the same time, it suggests that the popular “debt-trap diplomacy” narrative may be painting China with too broad of a brush: loans and debt are undoubtedly part of the country’s foreign policy toolkit, but China has also chosen to pass on opportunities to deepen debt relationships with certain countries. As recently as this summer, rumors erupted that Lebanon would end talks with the IMF to borrow from China. However, as Lebanon lacks mineral resources and is not located in a region core to China’s security, a Chinese rescue seems unlikely.
Historically speaking, China’s behavior resembles that of other wealthy, powerful countries. The United States has provided balance of payments support to strategic partners such as Egypt, and France protected many West African countries from the IMF for many years. Both countries have also terminated support to client countries whose financial needs began to outweigh their strategic value, as China has with Zimbabwe.
Full details of the research will be published in a forthcoming Global China Initiative working paper. To receive notice of the publication and other GCI updates, subscribe to our newsletter.