[SCMP Column] Debt and systemic stress

March 29, 2018

One of Rex Tillerson’s final acts, as he emerged from his long Africa tour only to be tweet-sacked from Washington by his boss, was to warn the world, and his African hosts, about the dangers of being seduced by the siren call of Chinese loans supporting big-infrastructure Belt-and Road projects.

In emerging markets around the world “China offers the appearance of an attractive path to development, but in reality (is) trading short-term gains for long-term dependency,” Tillerson said. He called on borrowers to “carefully consider the terms” of agreements with Chinese lenders, and to take care “not to forfeit sovereignty”.

In a tour through Latin America less than a month earlier he gave a similar set of warnings. “Latin America does not need a new imperial power,” he noted. Clearly the one existing “imperial power” is quite enough.

In certain ways, Tillerson’s comments should be well-taken. Economies across Asia paid a very high price during the Asian Financial Crisis in 1998 for having gorged on too much corporate and government debt – much of it in foreign currencies. The painful lessons learned at that time have been well taken. Today, governments and companies alike rely more heavily on local currency debt. Bond markets have been developed to help companies rely less heavily on potentially volatile bank lending. Overall levels of debt have been kept more carefully in check.

The numbers underpinning Tillerson’s warnings seem to emerge from a single common source – a report lead-authored by John Hurley at the Washington-based Centre for Global Development on “The Debt Implications of the Belt and Road initiative”.

The study is well researched, and concludes that 23 of the economies embraced by the Belt and Road Initiative are “at risk of debt distress”, and that for eight of these (Pakistan, Laos, the Maldives, Mongolia, Djibuti, Montenegro, Tajikistan and Kyrgystan) “future BRI-related financing will significantly add to the risk of debt distress”.

“The Belt and Road provides something that most countries desperately want – financing for infrastructure. But when it comes to this kind of lending, there can be too much of a good thing,” Hurley comments.

That is about as far as Tillerson took the issue. But if you turn to the full report, there are other findings worthy of attention. Noting that the BRI is forecast to drive infrastructure projects worth US$8 trillion over the coming two decades, Hurley says: “An $8 trillion initiative will leave countries with debt overhangs that will impede sound public investment and economic growth.”

He then concludes: “Our analysis finds that the BRI is unlikely to cause a systemic debt problem in the regions of the initiative’s focus”, but that there would be “significantly increased risk if projects are implemented in an expeditious manner and financed with sovereign loans or guarantees.” I presume “in an expeditious manner” he means “too fast”.

So are these BRI projects putting impoverished economies in peril? For sure, any government seeking infrastructure financing should be cautious about the risks linked with projects that will be paid for over 30 or 40 years. Indeed, one might make a case that Pakistan, gorging on US$62bn worth of projects that are being 80 per cent funded by Chinese lenders, needs to tread with great caution.

So too Sri Lanka may be wringing its hands over the need to give control over its ambitious Hambantota Port to China Merchants Port Holdings in a debt-for-equity swap because it could not afford interest repayments.

But where we know the details of China’s financing terms for BRI projects (and often we don’t), there is no evidence of extortion. For example, the US$6bn China-Laos railway has been supported by a $465m 25-year loan at 2.3 per cent interest, with an initial five year grace period. The Hurley report itself notes: “China has demonstrated a willingness to provide additional credit so a borrower can avoid default,” as with a RMB15bn loan to Mongolia last year.

In short, there is urgent need for infrastructure investment worldwide amounting to at least US$26 trillion, and if the BRI is putting money where its mouth is for US$8 trillion of this, then this must in net terms be for the good. And we should be working on where the other US$18 trillion may be coming from, how we can channel it into the most beneficial projects, and how we can ensure appropriate financing is available.

For my money, a much bigger issue than BRI debts – and one for which the US rather than China bears the greatest responsibility – is the awful debt overhang that has been accumulated worldwide over the decade since the 2008 financial markets crash in the US. To preempt a total meltdown in 2008, governments’ “quantitative easing” policies have slashed interest costs close to zero, and huge amounts of debt have been flushed into the global economy. Total global debt – government, corporate and household debt combined – has more than doubled over the decade, to reach $233 trillion at the end of last year. Put baldly, that amounts to US$30,000 for every man, woman and child on the planet.

The US Fed is predicting that the 1 percentage point increase in interest rates since eaqrly last year will add $15bn to US corporate interest rates this year, and $39bn in 2019. The Congressional Budget Office says interest costs in the US will triple over the coming decade, from US$269bn last year to $818bn in 2027.

In the UK, the government says interest rate increases through 2017 mean that 700,000 households are now paying at least 50 per cent of their take-home pay on debt service. That was based on average mortgage interest rates hovering at 2 per cent. As interest rates worldwide are expected to rise by 1 percentage point this year, and another 1 percentage point in 2019, imagine the future pain of UK mortgage-holders as their costs of servicing this debt approximately double.
As the IMF warned in January: “Sheer size of debt could set the stage for an unprecedented private deleveraging process.”

In short, the policies of the Fed, and the still-unfolding costs of the 2008 US crash, are likely to cause immeasurably more “debt distress” than China’s BRI initiatives spread over the next two decades. Was Tillerson trying to distract us from this grim reality?
David Dodwell researches and writes about global, regional and Hong Kong challenges from a Hong Kong point of view. Opinions expressed are entirely his own.

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