This article is more than 11 months old

This article is more than 11 months old

China has not engaged in deliberate “debt-trap diplomacy” in the Pacific, but the burgeoning scale of China’s lending, and institutional weakness within Pacific states, pose clear risks for small states being overwhelmed by debt, a new report argues.

And an infrastructure arms race between China and other countries with interests in the region – including Australia – might only exacerbate the problem.

The Lowy Institute report, Ocean of Debt?, says China’s Belt and Road Initiative has exposed the issue of unsustainable debt risk for less-developed countries, in particular for the small and fragile economies of the Pacific. But the report’s authors, Roland Rajah, Alexandre Dayant and Jonathan Pryke, argue China’s global infrastructure plan presents a more “nuanced picture” than the accusation of ‘debt-trap diplomacy’ and sovereign risk to small nations unable to service their debts.

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“The evidence suggests China has not been engaged in problematic debt practices in the Pacific as to justify accusations of debt trap diplomacy, at least not to date. Still, the sheer scale of Chinese lending and the lack of strong institutional mechanisms to protect the debt sustainability of borrowing countries mean a continuation of business as usual would pose clear risks.

“China will need to substantially restructure its approach if it wants to remain a major player in the Pacific without fulfilling the debt trap accusations of its critics.”

“Debt-trap diplomacy”, broadly defined, is where a creditor country intentionally lends excessive credit to a smaller debtor country, with the intention of extracting economic or political concessions when the smaller country cannot service the loan.

Because of small populations, fragile economies prone to external shocks (like oil price hikes) or uncontrollable events such as natural disasters, and weak institutions of government, Pacific states are acutely vulnerable to debts becoming unsustainable. Economic growth in Pacific states is “more volatile than it is fast”, and that unpredictably can make repaying large loans unsustainable, the Lowy report says.

China’s massively increased aid and development presence in the Pacific is made starkly apparent by its contrasting style to traditional aid donors in the region, such as Australia.

China has backed infrastructure development – usually large, landmark constructions such as bridges or significant public buildings – and usually through loans rather than through grants.

“Chinese assistance is perceived to be faster, more responsive to the needs of local political elites, and have fewer conditions attached,” the Lowy report says. “As one senior Pacific bureaucrat put it: ‘we like China because they bring the red flags, not the red tape’.”

China’s development presence was acutely apparent when the Australian prime minister, Scott Morrison, visited Fiji last week. In order to meet with the Fijian prime minister, Frank Bainimarama, Morrison’s motorcade had to drive over the Fiji-China friendship bridge, and past the construction site of a Chinese-financed 30-storey tower, soon to be the tallest building in the Pacific islands.

But the nature and quality of Chinese infrastructure projects have been criticised.

The former international development minister, Senator Concetta Fierravanti-Wells, accused Beijing of “duchessing” the Pacific, building “white elephant” infrastructure, “roads to nowhere” and “useless buildings”.

“Tied financing, little due diligence, outsized projects, weak project oversight, and fraudulent and corrupt practices are among the many criticisms that have been directed at Chinese projects,” the Lowy report said.

But a 2014 study analysing the impact and quality of Chinese projects in the Pacific found some performed far better than others.

“The evidence suggests that, if left alone, Chinese state firms will cut corners and inflate prices. If managed properly, they can deliver good quality infrastructure,” the Lowy report says.

The case of Hambantota port in Sri Lanka is held up as an exemplar of a “debt-trap” diplomacy.

After China’s Export Import Bank financed, and Chinese companies built, a new inland port in Hambantota – the home district of the former president Mahinda Rajapaksa, who greenlit the port, and after whom it is named – the Sri Lankan government ran into debt-related problems and a debt-for-equity swap was proposed, giving a state-owned Chinese firm a majority equity stake in the strategically located port from 2017.

Similarly, Tonga, a country of 100,000 people, still owes China’s Exim Bank $108m – about 25% of Tonga’s GDP – for loans taken out in 2008 and 2010 and since deferred twice.

In 2018, the then Australian foreign minister, Julie Bishop, said Australia wanted to ensure Pacific states were not “trapped into unsustainable debt outcomes” by Chinese loans. “The trap can then be a debt-for-equity swap and they have lost their sovereignty.”

And in August this year, the US Defence Secretary, Mark Esper, accused China of destabilising the region through “predatory economics and debt-for-sovereignty deals”.

China has fiercely rejected the accusations.

“Rather than pointing fingers at China’s good deeds, those who keep on making groundless accusations and speculations might as well do more themselves to provide help to the Pacific island countries,” Beijing’s ambassador to Samoa, Chao Xiaoliang, wrote in the Samoa Observer.

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“Some people questioned the purpose of China’s aid, even disregarded the facts and fabricated the so-called ‘China debt trap’ – this is either out of prejudice or ignorance of China’s foreign aid policy.”

The Lowy paper argues that in order to avoid its Pacific infrastructure projects becoming debt traps for small nations, China should reform its lending practices to be closer to those of the World Bank and Asian Development Bank, “the standard-bearers for international good practice”.

“If China wants to remain a major development financier in the Pacific without fulfilling the debt trap accusations of its critics, it will need to substantially restructure its approach, including adopting formal lending rules similar to those of the multilateral development banks.”

Despite a significantly decreased aid budget – currently a historic low 0.21% of GNI – Australia remains the dominant aid provider to the region. But, as part of the Pacific Step-Up it announced in November 2018, Australia is seeking to move more into providing loans, alongside aid grants, with the $2bn Australian Infrastructure Financing Facility for the Pacific (AIFFP) – $1.5bn in loans, $0.5bn in grants – as well as another $1bn in callable capital for Export Finance Australia (EFA).

The Lowy paper warns against an infrastructure arms race with China in the Pacific, arguing it could worsen the risk of debt traps for island nations.

“There are concerns that in seeking to compete directly with loans from China, Australia might simply exacerbate existing debt sustainability problems in the Pacific.”