China’s infrastructure finance model is changing. Here’s how
For several years now, as debt levels in a number of African countries have risen to alarming heights, Chinese and African officials have been looking for new ways to evolve the traditional resource-for-infrastructure (RFI) deals.
Critics on both sides of this relationship say it saddles African countries with unsustainable loans while simultaneously exposing Chinese creditors to unacceptably high levels of risk.
Meanwhile, these RFI deals also spurred China’s most vocal international critics, namely the United States, to promote the message that China is entrapping poor developing countries in Africa and elsewhere by loading them up with vast amounts of debt that will invariably not be repaid and will result in the forfeiture of vital national assets upon default, according to this controversial premise that has been widely debunked by scholars around the worlds.
“The Angola Model”
China’s engagement in Africa in the contemporary-era began around the mid-2000s as an outgrowth of Beijing’s “Go Out” policy that started to ramp up during President Hu Jintao’s administration. The Chinese economy then was rapidly expanding but Beijing also wanted to increase the country’s international exposure and open new markets for its State-Owned Enterprises (SOEs) that had tremendous excess capacity, particularly in the steel sector.
But Chinese firms back then had very little experience operating internationally and often encountered expensive regulatory obstacles in markets like the U.S., Europe, and some Asian countries. Africa, by contrast, had very low barriers to entry and presented the ideal market for these SOEs to take some of their first steps overseas.
But there was one very big problem: African countries were poor. Too poor to buy most of what these Chinese SOEs had to sell.
To resolve this issue, Chinese officials looked back to their own history in the 1970s for some inspiration, according to acclaimed China-Africa scholar Deborah Brautigam in her 2011 book “The Dragon’s Gift.”
Back then China was desperately underdeveloped, much poorer in fact than most African countries, but had an abundance of natural resources, namely minerals and oil, that were desired by Japan whose rapidly industrializing economy needed vast amounts of natural resources.
But China, given that it was so poor back then, had no way to get these resources out of the ground and to sell them to the Japanese.
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So the Japanese and Chinese came up with this innovative plan that would allow Japan to extract those raw materials and rather than pay for it in cash, the Japanese government would instead build roads, bridges and other infrastructure in China.
Fast forward now to the mid-2000s when the Chinese identified Angola as a potentially major supplier of oil. But back then, Angola was in horrific shape following a brutal decades-long civil war that ended in 2002.
The country then was littered with landmines, destroyed roads, and very little functioning infrastructure. So China’s huge state-owned construction companies saw a giant opportunity: we’ll help you rebuild your country and you won’t have to pay a thing, instead, we’ll set a price for all the infrastructure we’re going to provide and then you can pay us back with oil rather than cash.
$2 billion later, The so-called “Angola Model” was born.
At first, things were great. Everyone seemed happy. Angola’s increasingly democratic politicians (still plagued by corruption though) liked the idea of delivering new roads, hospitals and housing to constituents while the Chinese were thrilled about the prospect of diversifying their oil supply. But over the years, two key problems emerged that really fundamentally undermined this new development financing model in Africa:
- Angola was selling so much oil to the Chinese in exchange for infrastructure that wasn’t selling it for cash on the open market. Since Angola doesn’t really sell much else, it wasn’t able to generate enough actual money to circulate in the economy and that triggered a massive spike in inflation.
- As part of the deal between the Chinese and Angolans, they fixed the price of oil. Now that works in Angola’s favor when oil prices are high, say around $100 a barrel, but not so much when a financial crash comes like the one in 2008 and the price of oil collapsed by half. The Angolans, bound by a contract, are forced to borrow money to make up the difference to repay the Chinese for the two billion dollars of infrastructure that was in the initial agreement. Now, we have the making of a burgeoning debt problem.
Everyone Knew There Was a Problem
By the mid-2010s, RFIs or the “Angola Model” had spread across Africa as part of the Chinese building boom that is still underway today. But stakeholders on both sides of these deals have become increasingly nervous about the viability of this kind of barter arrangement.
Projects were being built that didn’t always make a lot of sense, the Chinese were no longer as dependent on African resources as their Belt and Road Initiative took shape and across Africa, concerns mounted about the longterm financial implications of this arrangement. One insider with firsthand RFI negotiating experience told me “everyone knew there was a problem, but didn’t know what to solve it.”
The urgency to find a new financing mechanism intensified when the U.S. government, then led by President Barack Obama, started to accuse the Chinese of engaging in a form of “predatory lending” in Africa. At first, former Secretary of State Hillary Clinton’s warnings were largely dismissed by Beijing officials as just another manifestation of “China-bashing.”
But the U.S. charge never relented, even after Obama left office and a new American administration took over. Although President Donald Trump seems to personally admire his Chinese counterpart, Xi Jinping, his administration firmly regards the Chinese government as a strategic rival and fully embraced the “debt trap” messaging — not just in Africa but around the world.
China uses so-called “debt diplomacy” to expand its influence. Today, that country is offering hundreds of billions of dollars in infrastructure loans to governments from Asia to Africa to Europe to even Latin America. Yet the terms of those loans are opaque at best, and the benefits flow overwhelmingly to Beijing” — US Vice President Mike Pence
The U.S. has been so effective at labeling the Chinese as “predatory lenders” that it’s now taken as a given by a large number of reporters, scholars and analysts and also evolved into a popular, enduring meme on social media. The U.S. efforts to brand the Chinese financing model as a “debt trap” has been extraordinarily effective and one that Beijing has, so far, been unable to shake-off.
A New Year, A New Decade, A New Financing Model
For the past two or three years, Chinese think tanks and policymakers have been working on a new financing model that would address the problems that bedeviled the RFI mechanism. Now, for the first time, we’re starting to see the broad outlines of what this new formula looks like. Although there’s been no official pronouncement by the government on any change in their approach to resource and infrastructure financing in Africa, some scholars have started to call the new method as “The China-Africa Swap.”
The swap formula was introduced to permit African leaders to leverage their resource wealth as collateral to access credit at a manageable interest rate as well as a viable reimbursement option. The formula frees both China and African nations from higher transaction costs of having to do conversions into dollars” — Dr. Ehizuelen Michael, Zhejiang Normal University
In a December 2019 column written for the Chinese international broadcaster CGTN’s website, Dr. Ehizuelen Michael, Executive Director of the Center for Nigerian Studies at the Institute of African Studies at Zhejiang Normal University, explained that the new Swap formula marks a radical departure from the RFI model by incorporating more private investors and spreading the risk so both the Chinese creditor and African borrower both effectively have a financial stake in the deal. “It involves a package in which a government grants a resource development production license to a private investor,” said Dr. Ehizuelen. “And the government receives funding for infrastructure connected to the resources,” he added.
I spoke with Dr. Ehizuelen by email to get his insights on the evolution of the “China-Africa Swap” model and how it differs from the traditional RFI that has been used so widely in Africa.
ERIC OLANDER: How are these “Swaps” different than the traditional resource-for-infrastructure deals, or the so-called “Angola Model”?
DR. MICHAEL EHIZUELEN: As for this part, some parts of my answer will come from what I read from Johnston Lauren’s paper published in Asia & the Pacific Policy Society where she emphasizes that the Sino-Africa swap formula pact is a step away from the “Angola Model”. She affirms that the swap formula provides loans in advance for African nations development projects at a completely fixed price for the settled supply of resources.
Basically, the swap formula is something of a fixed interest rate pact- the risk being on whether the agreed price of the resources soars or decline against that benchmark. Based on her narrative, the formula removes this uncertainty for African borrowing nations and provide a shift around the loan and price volatility risks in the process. It can be said that the formula is a type of novel fixed interest rate development loan – the kind where payment is in the form of a fixed price commodity.
With that said, the swap formula acts as an effective agency of restraint on the part of the African government and mitigate the threat of corruption. Based on this, the formula permits African governments to invest in public works nowadays, paying for them with future exports.
ERIC: What problem is this new financing model trying to solve?
DR. EHIZUELEN: In spite of being extensively acknowledged as a connectivity and infrastructure development scheme for seven years’ now, the Belt and Road Initiative (BRI) has come in for finger-pointing by some, with a few even calling the initiative a “debt trap” that could lead to debt distress for some African borrower nations.
As such, in order to solve this problem, the swap formula was introduced to permit African leaders to leverage their resource wealth as collateral to access credit at a manageable interest rate as well as a viable reimbursement option. The formula frees both China and African nations from higher transaction costs of having to do conversions into dollars. On top of that, it helps to lessen the lender’s risk in African nations without good credit rating as well as recognizes the context of recipient nations and prioritize reimbursement rather than generating external debt distress.
The formula demonstrates a vast shift away from mega loans and towards a direct swap formula. As for Beijing, the formula offers a solution to vital resources and a workaround to finger-pointing of China’s debt trap issues connecting to the BRI. As for African nations, the formula offers a solution for a loan-free means and an avenue to transform the continent’s natural resources advantage into development advantage.
In this way, the continent would not be looked into dependence on the production of raw material alone.
This article first appeared on The China Africa Project