Mahathir escapes China’s debt trap

After years of welcoming Chinese investment, the new government in Malaysia is applying the brakes, concerned a plethora of expensive projects are causing the country to take on excessive debt.

Malaysia’s new prime minister, Mahathir Mohammed, has picked up on a worrying pattern demonstrating the serious downsides for emerging economies trying to cash in on China’s Belt and Road Initiative (BRI).

In response, he has axed about US$23 billion in China-backed infrastructure undertakings driven by what he calls “unequal treaties”. The historic irony of the phrase is hard to miss. China, once victimised by unequal treaties imposed by European imperial powers in the 19th century, is now finding itself blamed for pursuing the same predatory behaviour towards other states in Asia and Africa. Instead of coming from western pundits, this accusation is now coming from one of Southeast Asia’s most prominent leaders.

With Chinese-backed projects in 78 countries, the BRI is one of history’s most ambitious development programmes. China’s president, Xi Jinping, has called the BRI the “project of the century” and says it will usher in a “golden age” of globalisation – but critics fear many of the projects do not appear likely to justify the price tag. In addition to trade, the network of ports, roads and railways built with Chinese funding and loans are increasingly being seen as exporting debt problems to the developing world.

According to the Financial Times, the top 10 Chinese construction and engineering contractors active outside China were nearly four times more highly indebted than the top 10 non-Chinese companies. This cycle of debt is being replicated in some of the world’s countries with the greatest inability to cope.

“Disconnects between the creditworthiness of a project or a country and the size of the loans that China offers have led to project delays, political turmoil and allegations of wrongdoing in contract-award procedures,” said Andrew Davenport of RWR Advisory Group, a US-based think-tank. Of the 78 countries selected by China, many are among the world’s most risky economies, according to OECD rankings.

According to the FT, on a scale of one to seven, the BRI partners show an average rating of 5.2, compared with the 3.5 average for emerging markets. The credit rating agency Moody’s puts their median credit rating at “Ba2” or a non-investment or “junk” level of default risk.

In Cambodia, a surge in imports of capital goods to supply construction projects has caused the national trade deficit to rise to 10 per cent of GDP. Foreign investment is largely paying for the overseas debts.

In Laos, a China Railway Group train line is costing US$6 billion. This is the equivalent of about 40 per cent of GDP in 2015, with machinery imports expanding the trade deficit.

An RWR Advisory study estimated that debt problems, public opposition, controversy over Chinese labour policy, delays and concerns over national security have meant about 270 of BRI 1,814 projects undertaken since 2013 are listed as “troubled”. This represents about 32 per cent of the projects by value.

In some cases, even the promise of potential Chinese investment is enough to secure compliance on the part of another government. This dynamic that has played out in the Philippines, where the unfulfilled promise of Chinese investment has nonetheless managed to bring the Duterte government onside, while alarming other Asean allies and critics of Chinese policy in the region, particularly Vietnam.

Beyond Asean, China is handing out loans to improve infrastructure in strategic locations like Djibouti. Both Malaysia and the East African mini-state sit on valuable shipping lanes, which helps explain China’s keen interest in securing infrastructural stakes. Djibouti also hosts numerous military installations, including a key US base for counterterrorism operations in a turbulent region.
China has helped Djibouti monetise this strategic position, installing its first overseas military base in the country that sits between Yemen and Somalia. Beijing has also lent money for a major new airport and an electric train. The newest flagship project is a US$3.5-billion free-trade zone that China’s Merchant Holdings company and Djibouti Ports will manage jointly.
All of this lending has raised red flags for the country’s solvency, with outside investors warning about the country’s economic viability. The commander of US forces in Africa warned in March that China’s presence could push American forces out of this strategic base for regional operations.
Those fears were stoked after Djibouti violated a contractual agreement and renationalised the Doraleh Container Terminal in February. The move sparked rumours Djibouti could hand the port over to China, although arbitration proceedings in London have ruled definitively in favour of the original contractor, DP World.

The idea is not far-fetched: Djibouti and other Belt and Road partners will eventually have to pay back the staggering sums they owe, or, failing that, hand over control of their Chinese-funded infrastructure. When Sri Lanka defaulted on debt payments, it had to cede its Chinese-funded US$1 billion port at Hambantota to Beijing.
Whereas Najib’s China-friendly policies led Malaysia down Djibouti’s path, will Mahathir’s decision to abandon these projects mark the start of a shift in how the rest of the world sees the BRI?
In reality, few leaders in emerging markets have the same will or political capital to stand up to China.

China’s Belt and Road port at Gwadar in Pakistan. Picture credit: Flickr