An end to risky bets on the ‘red elephants’ of Beijing’s global financial diplomacy?
When China signed up to build Venezuela’s Tinaco-Anaco Railway in 2009, the scheme was hailed as proof of the effectiveness of socialist brotherhood. Gleaming new Chinese trains were envisaged, whisking passengers and cargo along at 137mph on about 300 miles of track. Hugo Chávez, the late Venezuelan president, called the $800m project “socialism on rails” and said the air-conditioned carriages would be available to everyone, rich or poor.
But the endeavour has become what locals call a “red elephant”, the vandalised and abandoned symbol of Venezuela’s deepening economic crisis. A slogan written in Chinese characters on an archway into a deserted construction site has taken on an ironic tone. “Dare to leap ahead,” it says.
For China, the project represents more than just an isolated example of a dream turned to dust. Over the past decade, the country has transformed itself from a marginal presence to the dominant player in international development finance with a loan portfolio larger than all six western-backed multilateral organisations put together. Outstanding loans from the two big Chinese “policy” banks and 13 regional funds are well in excess of the $700bn owed to the western-backed institutions, according to a recent study.
But in the process of “leaping ahead”, China’s state development banks and funds have taken on a welter of risk in some of the most unstable countries in Latin America, Africa and Asia. As projects turn sour, the largesse and unorthodox lending protocols that have characterised China’s global financial diplomacy are undergoing a thorough re-evaluation, Chinese officials say.
“When commodity prices were high, the Chinese policy banks saw all these loans as great investments to help Chinese firms go global, to diversify their foreign exchange reserves and make new friends,” says Kevin Gallagher, professor of global development policy at Boston University’s Pardee School for Global Studies. “Now a lot of it just looks a lot like risk and they are rapidly working to do better due diligence.”
A Chinese official with the influential National Development and Reform Commission, the government ministry responsible for economic planning, says frustration is mounting in Beijing over poor returns from unsatisfactory projects and a sense that state lenders have in the past taken on too much risk in unstable countries.
“China had no choice but to lend a lot to risky countries because they had the commodities we needed and because the western multilateral organisations already dominated the rest of the world,” the official says. “These days we need viable projects and a good return. We don’t want to back losers.”
Exposure to Caracas
When China began funding Chávez’s government in 2007, it was effectively betting that a country with a “junk” sovereign credit rating that had defaulted on or rescheduled its debts with overseas creditors four times over the preceding 30 years was somehow ready to embrace financial prudence.
Beijing was so convinced of this that it made oil-rich Venezuela its biggest client for development loans by far, doling out $65bn since 2007 in 17 tranches to fund refineries, gold mines, logistics, trade, the railway and a large number of unspecified items, according to the China-Latin America Finance Database, compiled by Mr Gallagher and Margaret Myers. For context, $65bn is more than the World Bank has lent to any country — with the single exception of India — since 1945, data from the bank show.
In May, Caracas engineered a negotiated default on its Chinese debts. With annual inflation running at as much as 800 per cent in Venezuela, food shortages and government contractors going unpaid, Beijing agreed to let the government of Nicolás Maduro postpone payments of the principal on its outstanding loans, officials in Caracas have said. Having to pay only the interest on an estimated $20bn-$24bn in outstanding loans is set to deliver annual savings of about $5bn for two years, according to Francisco Rodríguez, chief economist at Torino Capital in New York.
However, worse may yet to come for China. Concern is growing that Caracas may default on its international bonds, a development that would trigger the seizure of national assets held offshore by the country’s creditors. This could mean that overseas oil refineries owned by PDVSA, the national oil company, are confiscated and exports of crude — the government’s lifeline — would be disrupted, potentially threatening the oil supplies that Caracas uses to repay China.
All this is a far cry from China’s optimism of only four years ago. Liu Kegu, vice-governor of China Development Bank, Venezuela’s biggest creditor, explained then that because the bank’s loans were secured against Caracas’s huge reserves of oil, the credit line was insulated against default.
“Oil is very simple to drill. You drill a hole, put in a pipe and it comes out! And then you ship it. So Venezuela’s debt service ability is very strong,” Mr Liu was quoted as saying in a 2012 interview for China’s Superbank, a book by Henry Sanderson and Michael Forsythe.
China’s exposure to Venezuela runs much deeper than the $65bn in state-to-state lending. A phalanx of Chinese companies followed the lending splurge, eyeing the likely developmental dividends. In a population that the UN estimates at 31m, the largesse equated to about $2,100 per person.
CITIC Group signed to build railroads and housing, Sinohydro Group signed to build power stations, phone networks were supplied by ZTE and oil refineries and pipelines were erected by Sinopec and PetroChina — not to mention China Railway Group, the contractor for the mothballed Tinaco-Anaco line.
Outwardly, Beijing shows little sign of concern, eschewing any temptation to criticise Mr Maduro in public. But in private discussions with Venezuelan officials, the tone is blunter, analysts say. Chinese officials have also informally made contact with the Venezuelan opposition coalition.
“Even by 2011 or 2012, the Chinese were starting to get nervous,” says Evan Ellis, professor of Latin American studies at the US Army War College. “Money was being siphoned off from various projects and China Development Bank was sending in multiple teams and making lots of recommendations that didn’t make any difference.”
Mr Ellis says that unless things change for the better in Caracas, China is no longer willing to “put good money after bad, unless it is the only way for it to avoid losing its entire position through the collapse of the regime”.
‘We look forwards’
Venezuela may be an extreme case, but it is far from the only risky bet that China’s overseas development finance regime has become entangled with.
Six of the top 10 recipients of Chinese development finance commitments between 2013 and 2015 were classified alongside Venezuela in the highest category of default risk ranked by the Paris-based OECD. By contrast, only two of the top 10 recipients of World Bank development finance fell into the same category.
Part of the reason for this comes down to a philosophical divergence. “We assess risk differently than western agencies because we look at the potential for development of a country,” says an official at a Chinese policy bank.
“They look backwards, we look forwards. We know that maybe all they need is infrastructure and if you build that infrastructure then their economy will grow,” he added.
Nevertheless, there is ample evidence that Beijing, buffeted by a mounting domestic debt problem and dwindling returns to state-owned enterprises, is starting to take a colder, harder approach to its overseas development agenda. At the country level, some borrowers are seeing their credit lines curbed while, at the project level, Chinese institutions are driving a harder bargain to ensure a viable return.
Russia, which with $15.7bn was the top recipient of loan commitments between 2013 and 2015, according to data compiled by Grisons Peak, is expected to see dwindling support from China.
“Chinese lending this year and next is likely to fall off from the level of recent years because they are keen to keep their own resources and because they do not see so many attractive opportunities within Russia for their investment,” says a senior Russian government official, who declined to be identified.
In March, Chinese premier Li Keqiang stated that western sanctions had not deterred Chinese investment in Russia. But Chinese private businesses have been vocal about the difficulties of doing business in Russia, and even large state-to-state oil projects are still subject to intense talks long after official deals are signed. The weak rouble has also affected Chinese investment interest.
Henry Tillman, chief executive of Grisons Peak, says China is starting to strike a balance between the strategic partnerships it forms with countries and the necessity to mitigate credit risk.
“In some cases policy banks have been increasing proposed interest rates, in some cases shortening maturities [on loans], in some cases refusing to fund previously committed second tranches of loans,” Mr Tillman says.
In tandem, the newly launched China-led multilateral development banks and funds such as the Asia Infrastructure Investment Bank are spreading risk by lending alongside partners such as the World Bank, Asian Development Bank and European Bank for Reconstruction and Development, he says.
In Africa, the chill in China’s embrace is evident. A cancellation by the Ghanaian government last year of half a $3bn loan extended in 2010 was the result of CDB tightening terms on the loan. The bank raised the volume of oil it demanded as payment for the loan from 13,000 to 15,000 barrels a day, making it uneconomic, according to a paper by Thomas Chen, former economic officer at the US Embassy in Ghana.
Shades of Ghana’s experience are being felt elsewhere on the continent. Countries that once saw China as a cash cow are starting to return to other sources of global capital due to a rise in Chinese interest rates, says Tang Xiaoyang, a China-Africa scholar at Tsinghua University.
“A lot of China’s newly pledged loans are not [official development assistance loans] but are rather market activity, so African governments are less interested in taking them if they can find other better sources,” Mr Tang says.
Another factor in the flagging popularity of Chinese finance is that it is often tied to the execution of an infrastructure project by Chinese companies sourcing Chinese equipment and employing mostly Chinese workers. For as long as the costs of such projects were far lower than competitors, recipient countries were willing to accept such terms. But recent examples of white elephants are forcing them to rethink.
High-speed railway diplomacy is a case in point. Agatha Kratz, associate policy fellow at the European Council on Foreign Relations, says such projects are rarely commercially viable because of the technology and construction costs involved. Even though about 20 Chinese high-speed rail projects are officially under discussion around the world, only one in Turkey is operational outside China, Ms Kratz says.
It is not only the railways that have deviated from the original plan. As part of celebrations to mark the 67th anniversary of the People’s Republic of China at the end of last month, Venezuelan and Chinese government officials gathered with foreign diplomats at a reception in Caracas. When the time came for speeches, according to one of those present, the Chinese side talked of joint investments to build a better future.
In response, the Venezuelan side waved socialist flags and called for the two nations to join together to smash global capitalism, one small example of how China and its beneficiaries have lost touch with one another.
Reporting by James Kynge, Jonathan Wheatley, Lucy Hornby, Christian Shepherd and Andres Schipani