Commentary | 23 October 2019

Debt-trap diplomacy not happening yet, but cause for concern

Originally published in The Australian.

Originally published in The Australian.

China’s growing influence in the Pacific has taken centre stage over the past two years as officials in Canberra, and their counterparts in Washington, have become increasingly worried about the region falling under China’s sway.

Warnings of so-called debt-trap diplomacy have, however, fallen on deaf ears in the Pacific. Last month, Solomon Islands and Kiribati switched diplomatic ties from Taiwan to China. Hu Chunhua, a Chinese Vice-Premier, has also been in Samoa for a major China-Pacific Islands economic development forum, although we are yet to find out the details of what will emerge from this.

Does China really engage in debt-trap diplomacy — actively seeking to cause debt problems in order to later extract geopolitical concessions? The debate, both globally and in the Pacific, is still undecided, with some arguing such accusations lack foundation while others remain far more circumspect.

In a new Lowy Institute report, we provide a systematic review of the evidence in the Pacific using unique data from the institute’s recently updated Pacific Aid Map.

Contrary to the debt-trap narrative, China has not been the main driver behind rising debt risks in the Pacific — the region’s high exposure to major natural disasters, for instance, has played a much bigger role. Nor has China suddenly become the dominant creditor in the region and therefore able to exercise significant leverage over Pacific nations. Across the region, traditional creditors, notably the multilateral development banks, still play a much larger role.

Only in Tonga is China the dominant creditor. But this has not exactly been an advantageous position, with China having twice agreed to defer repayments while getting little in return.

China’s lending terms are also hardly predatory. Whereas China’s overseas lending in many other parts of the world often comes at market rates, it appears to have been much more careful in the Pacific — with the overwhelming majority of China’s loans in the region having been concessional enough to qualify as aid.

Perhaps the most important question is whether China has been lending to countries when they are already facing debt sustainability issues. We examined this question in detail by comparing Chinese loans with the prevailing debt sustainability rating of the International Monetary Fund for the borrowing country at the time each loan was signed.

What we found was that, in 90 per cent of cases, China’s loans were provided to countries where there appeared to be scope to sustainably absorb such debt at the time. That leaves 10 per cent of cases where Chinese lending looked potentially problematic. But comparing China to other official lenders in the region suggests it has not been a necessarily huge outlier in this regard.

Hence, the evidence suggests that China has not been engaged in debt-trap diplomacy in the Pacific, at least not yet.

Nonetheless, looking ahead we still find plenty of cause for concern due to the sheer scale of China’s lending and its lack of strong institutional mechanisms to protect the debt sustainability of borrowing countries.

Most of the Pacific nations currently indebted to China have little scope to take on more debt. As a result, China cannot remain a major player in the region through its current model of doling out cheap loans without eventually fulfilling the debt-trap accusations of its critics. To avoid this, it will need to substantially restructure its approach, particularly by switching towards providing far more grant assistance rather than loans.

For Pacific nations, our analysis provides a simple conclusion: whether Chinese debt is a problem or not depends — quite obviously — on the circumstances of individual countries. For those where debt is already high — such as in Samoa, Tonga and Vanuatu — taking on significantly more Chinese debt would carry significant risks.

But for Solomon Islands and Kiribati, it’s easy to see why they are not particularly worried about getting suckered into a Chinese debt trap — debt in both countries is relatively low, most of it is highly concessional, and any Chinese loans would probably be reasonably concessional too.

That does not mean there is nothing to be concerned about. The real danger at this point, however, is not excessive debt but the risk of poor management and governance problems that can often accompany Chinese aid. This is what requires attention.

The problem with blanket warnings of a China debt trap is that it risks being an unhelpful distraction.