Posted by: Bixmoor

High Tide in China’s Overseas Lending?

The current gathering of Africa leaders in Beijing provides a good opportunity to discuss China’s overseas development and strategy. We have recently commented on Beijing’s suggestion that it intends to adjust its overseas development lending towards more sustainable borrowing and projects that are more beneficial to the borrower. Another rising tendency seems to be to identify certain countries where it would like to curtail lending.

In 2017, according to Boston University’s Global Development Policy Centre, China’s finance for energy projects worldwide fell by 28 per cent compared with its funding in 2016. This trend has continued. By 2017 Venezuela had effectively disappeared from China’s overseas lending.

China has found the returns in recent years from investing in Africa unexpectedly low. At the same time, African governments have gradually been asking for more attractive terms. There has, for example, been some academic pressure on African governments to collectively negotiate for better arrangements. Conditions often attached to loans to evade open competition on bidding for projects has been described as “the single biggest downside of Chinese financing”.

A good example of Beijing’s growing reticence is Ethiopia, one of the world’s 12 most populous countries, with over 100 million people. The annual growth rate has been around 10 per cent and lenders, especially China, have been keen to be involved. The headline project has been the railway between landlocked Ethiopia and the port-state of Djibouti. This reduced the shipment time for goods from Addis Ababa to port from three days to 12 hours.

The difficulties result from insufficient utilization of the new railroad; exports are rising, but not as fast as imports; and foreign exchange reserves are dwindling. The anticipated 8.5 per cent future rate of growth would be amazing for some countries, but given where it has come from is seen as a disappointment. Public debt has risen from under 50 per cent to almost 60 per cent of GDP, leading to fears over debt sustainability.

These changes have been noted by China. In July the Chinese delegation to the African Union in Addis Ababa wrote on its website that “the intensifying repayment risks from the Ethiopian government’s debt reaching 59 percent of GDP is worrying investors”.

It also said that Chinese investment was declining and that “the China Export and Credit Insurance Corp was reducing the scale of its investment there”. There are probably some residual memories of 2001 and 2007 when China wrote off $142m of Ethiopian debt.

Reports of blunt reappraisal of Ethiopia by the Chinese have been circulating widely, for example, in the diplomatic community. “The Chinese have said they’ve reached their limit,” one diplomat in Addis Ababa recently said. “We’re way over-extended here.”

Angola is another example. At the end of last year, it claimed to owe $21.5 billion to China, which was half of the country’s external debt. It was seen as a safe bet owing to its extensive oil reserves.

However, as a result, much of the exported oil is spoken for under long-term deals with international oil majors for keeping the oil flowing and – increasingly –  debt repayments to China. Only a handful of oil shipments were gaining cash income.

There have been several signs in recent years of greater caution by Beijing towards lending to Angola. In mid-2016 it was noted that the 2015 $15bn credit facility from China Development Bank had been turned off. The reasons given were Angola’s “lack of contractual compliance” and attempts to “use the money for indeterminate ends”. This spring the Economist Intelligence Unit noted that Chinese lenders were focusing more on the “risk of projects with dubious repayment capacity”.

However, the recent recovery in the oil price has brought it back to levels we have not seen since 2009-14. This will have somewhat relaxed lenders. According to a Portuguese news agency, a fresh $4.4bn of loans was being negotiated in March. The improved oil price may also account for the extra $15.5bn of debt which was being negotiated by Angola in May.

Global Times in Beijing published a critical piece this May on “major challenges for increasing Chinese investment in Angola”. These included deficient power supply and unsustainable water supply and the very high inflation and consequent collapse in the currency, which has fallen by two-thirds in three years and 40 per cent since January.

The article also mentioned the lack of cross-border access to neighboring markets, the lack of skilled workers and the very challenging investment environment with particular focus on the problem of profit repatriation owing to currency controls.

By late August the concerns about debt stress were becoming so prominent that the Chinese ambassador to Angola had to dispute that Angola’s China debt was excessive, that it was unsustainable and that a crisis was possible. He felt it necessary to say that the debt levels were healthy and stable.

It seems likely that Angola was in Beijing’s mind when Qian Keming, the vice minister of commerce, said last month that “Beijing will adopt a more sustainable model for debt with African countries (and) Beijing would work to ensure that its projects on the continent met real needs”.

The most recent country for lending limitation is Nepal. China seems ready to drop its sponsorship of the West Seti hydropower project in the far-western development area of the country. Hydropower is critical to Nepal’s development. It is estimated to have a latent capacity of 42,000 MW.

First envisaged in the mid-1990s by the French government, the West Seti project became a B-O-T scheme, built by China, supplying electricity to India. In 2008, Nepal obtained a change to the scheme, so the country would receive 10 per cent of the electricity rather than 10 per cent of the revenues. Later the Australian developer pulled out.

Resettlement of affected communities has been a recurring issue as it is a major cost. This may require accepting a life-changing shock for those displaced. People from the remote far West will almost certainly have to move to the more commercial lowlands and adopt very different lifestyles. For a country with 93 languages, this is difficult.

Such projects are prone to domestic politics. The previous Nepalese government cancelled China’s contract for the much larger Budhi Gandaki dam.

The dam developer since 2012 – China Three Gorges (CTG) – complained about the potential profitability in 2017 and said that the installed capacity would need to be cut from 750MW to 600MW. This year they said that the alternative was to increase the power purchase rate. A government advisory panel has suggested the authorities either cancel the contract or raise the power purchase rate.

In May the state media in China reported that the project would in future be developed with Nepalese domestic resources. In June, Beijing denied that Nepal had ended the contract, saying that talks were continuing. In August CTG said they wanted to withdraw as the project is financially unfeasible owing to high resettlement and restoration costs.

CTG knows something about major resettlement. When they built the original Three Gorges dam in China it involved moving the equivalent of the population of Denmark, not once but sometimes twice as they discovered how geologically fragile the land was. As a comparison, the West Seti dam, which is in a seismically active area, is estimated to be 644 feet tall, when the tallest dam in the world is around 1,000 feet.

Nepal offered to cut the power requirement to 600MW and extend the length of purchase from 10 to 12 years for the same contract award of $1.2 bn. CTG’s response continued to be negative.

We do not know for sure whether CTG is posturing to get a better deal or whether it has genuinely decided that the rewards are not worth the risk. We do know that China is focusing more carefully on the financial logic of its projects in Africa since last month’s statement by the vice minister of Commerce. Logic suggests the new approach is likely to be applied more widely.

Just because the developing world is short of infrastructure does not mean that all infrastructure projects are justifiable. Last year China itself cancelled two underground railway projects in Inner Mongolia on the basis they were economically unjustifiable. This year Prime Minister Mahathir is cancelling Chinese projects in Malaysia for the same reason.

China has had the habit of not always looking closely at the viability of projects. Sierra Leone asked for a second soccer stadium. Even the Chinese ambassador was cited as saying that “from our point of view, it is not necessary to build another stadium…No African country has two [Chinese-built] stadiums.” Nonetheless it was allowed to proceed.

South Africa’s Standard Bank wrote earlier this year that “in 2017 alone, the newly signed value of Chinese contracted projects in Africa registered $76.5bn… However, despite a sizeable remaining infrastructure deficit on the continent, there is a concern that African countries’ debt-service ability will soon dissolve.”

Only two years ago, the Chinese Academy of Social Sciences stated that Chinese investors had taken massive losses in Africa owing to an inability to understand the operating environment and the impact of conflict.

It would not be surprising if a new cautiousness is spreading in Beijing. One might say it is somewhat overdue. Hopefully it will put greater rigor into the discussions about project viability.

Bixmoor is a primary bespoke research provider to business, governments and the financial community.