Why are the terms of Chinese loans often undisclosed?

Last week, China's foreign minister announced that it had agreed to waive 23 loans to 17 African countries under its Belt-and-Road Initiative.

This news sounds good for the debtor countries. Who doesn't want their debt wiped out? Two things make the story even more interesting. First, China is the world's largest bilateral lender and the second-largest creditor after the World Bank. Most of the emerging economies’ loans are to China. Reports show that about 50 developing countries owe China debt worth about 17% of their GDP. Of those fifty, 12 (like the Maldives, Democratic Republic of Congo and Niger) owe at least a fifth of their nominal GDP to China in loans.
 

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The second thing that makes China's debt forgiveness news more relevant is that many emerging countries are at risk of defaulting on their loans, thanks to Covid and Russia. In some cases, countries have resorted to barter to pay off their debt, like how Sri Lanka plans to send Iran $5 million worth of tea every month until it can repay its $251 million debt. Other countries like Zambia first requested a pause in their interest payments but, when they couldn’t get this request, cried to the world's largest creditors for debt restructuring.

Now, more than ever, these emerging economies need debt forgiveness and restructuring to prevent a debt default.

While we applaud the good news, it's important to note that China's debt forgiveness is mainly targeted at interest-free loans that will mature in 2021. Yet most of China's loans to its debtors are commercial loans. And as we've explained, commercial loans come with high-interest rates, particularly for countries with a risk of high debt default.

With very little information on the beneficiaries of China’s debt forgiveness and how much of their debt is being waived, these countries will most likely still be heavily indebted to China and at risk of default. But what happens when they default on these loans depends on their loan contracts' terms.

However, knowing how China lends to emerging economies is not enough. We also need to consider the Chinese institutions loaning money to emerging economies because that determines the lending terms.

This article will thus discuss the terms of sovereign loans (government-issued debt) from various Chinese lenders. We will use data from AidData's analysis of over 100 loan contracts from the China Development Bank (CBD), Export-Import Bank of China (China Eximbank), state-owned commercial banks and trade credit providers. The analysis also compared these Chinese loans to contracts from other emerging economies' lenders.

The data is limited because it's just a sample and is not all the loans from Chinese lenders to emerging economies. Also, most of the contracts analysed (76 out of 100) are from China Afreximbank, with the others split across various other creditors. In some cases, like the Bank of China, only one contract was analysed. However, this database remains the most extensive dataset on Chinese loans.

So, let’s dive in. What are the typical terms of a Chinese loan contract?
 

He who pays the piper…

One way to know the terms of a loan is by first knowing the source of the loan—the creditor. The creditor’s goals inform the structure and reason behind the loan. For sovereign debt—a debt owed by the government of a country, the creditor could be either a multilateral lender, a bilateral lender, a development or policy organisation. Multilateral lenders like the World Bank or International Monetary Fund (IMF) are typically more forgiving and considerate, focusing more on terms that would ensure that a country's fiscal situation improves so that the country won't slip into a fiscal crisis.

Bilateral lenders represent creditors from other countries. These countries could give concessional loans or not. Where they're concessional, bilateral lenders are also quite lenient with their policies, offering cheaper and longer-term loans. This is because bilateral lenders focus on strengthening their diplomatic relationships with borrowers beyond just lending to other countries. They want to lend to a country which they believe would be instrumental to the growth of their (the lender’s) country.

When it's non-concessional, the loans are commercial and profit-driven. Here, countries want to lend with the hopes of earning a significant profit, so their interests depend on the borrowing country's ability to pay.

Ultimately, who you borrow from informs what the terms and conditions are.

So, when it comes to Chinese debt, we first need to clarify the source of these loans. Loans from China to emerging economies typically come from its development banks (like the China Development Bank (CDB), State-owned banks (e.g. Bank of China), and trade credit organisations (like Sinosure).

These banks are primarily state-owned organisations, but they operate like commercial organisations. It’s similar to how the federal government partly owns NLNG. Yet, the company operates like a private gas refining company, unlike a public parastatal. Likewise, these banks that offer loans to other governments, although owned by the Chinese government, are still expected to take on the function and operations of typical development or commercial banks. That is, they carry out their usual function on behalf of the Chinese government.
 

Who has the upper hand?

The reports' findings focused on two key themes that cut across most Chinese lenders (the CBN, China Eximbank and more).

The first is that Chinese lenders typically protect themselves from default by having more leverage than the debtors and other creditors of the debtor. Second, China can alter the debtor country's economic and foreign policies to ensure this commercial leverage. For instance, in some of the debt contracts between the CDB and the debtor countries, China could eliminate all diplomatic relations with the debtor country. 

In this article, we'll focus only on how China includes terms that give it more leverage than the debtor.

One of the ways that China protects itself from default is through the confidentiality clauses of its loans. Typically, these confidentiality clauses are such that debtors are bound by law to keep the loans and their terms secret. In some cases, the loans are kept out of the debtor's balance sheet, so the people in the country have no idea there's a loan. This prevents the lender from disclosing their financing and lending terms to other lenders and past debtor countries. It also favours the borrowers in that they’re not held accountable for the size of the loans and the agreed-upon terms.

Sometimes the debt is so hidden that some government officials do not know about the loans. A debt transparency assessment by the World Bank shows that about 40% of Low Income developing countries (LIDCs) did not meet their minimum debt transparency requirement between 2019 and 2020. This was because they neither published their debt data nor updated them in about two years.

AidData reports that all the terms, conditions and fee standards for loans from the China Development Bank after 2014 were required to be confidential unless mandated by law. According to reports, hidden sovereign debt by emerging economies to China is more than $350 billion.

Creditors ensure non-disclosure of the terms and even the existence of these loans to protect themselves from situations where they either can't give the loans due to public scrutiny of the terms or where they can't protect themselves from default. For instance, in situations where lenders plan to take ownership of a country's mineral resources as collateral for a loan, revealing the terms of the loan might prevent them from doing so, especially when there’s backlash from citizens of the debtor country.

For debtors, keeping a loan secret can be quite detrimental. On the one hand, the countries take on much more than they can afford to pay back. On the other hand, when the debt is made public, the country's credit risk increases, which may cause a higher interest rate or withdrawal from other creditors. 

However, debt transparency isn’t peculiar to China. There's no standard practice on public debt disclosure, so creditors choose if and when to share based on their discretion. The AidData report acknowledges that the Arab Bank for Economic Development in Africa, the Islamic Development Bank, the OPEC Fund for International Development and the Kuwait Fund for Arab Economic Development typically include confidentiality clauses that prohibit the borrower from sharing the lender's documents and correspondence.

But it doesn't stop there; even in the West, the call for debt transparency has risen. A prominent example of where debt opaqueness has affected emerging economies is Mozambique's $2 billion "Tuna bond", which was financed by French, Russian and Swiss Banks: Credit Suisse, VTB and BNP Paribas in 2013 but was kept partially hidden until 2016. When the debt was revealed, the World Bank suspended its development policy financing (DPF) to Mozambique for over six years and got classified as a country in debt distress.

The Mozambique loan was so controversial that some investors who bought the bond through Credit Suisse sued the bank for fraud. But the idea is that debt confidentiality is not new in sovereign debt agreements.

In a conversation with Stears, Fola Fagbule, Deputy Director and Head of Advisory at the Africa Finance Corporation, echoed this. "You would hardly see a facility agreement that is made public in its entirety, it's generally a confidential document, but key terms may be made public for various reasons: transparency, due diligence or for whatever reason. A good practice is that there should be transparency, where Chinese are different in that they don't disclose the general terms under which they give out loans," he said.

Also, some large Chinese lenders like Sinosure are just as transparent as multilateral lenders like the World Bank, which gives the public an easy access to its loans through its website and financial reports.

One category of lenders not specified in the AidData analysis is the unofficial Chinese institutions, companies or contractors that take on capital projects and debt exposures in Africa. "Let's say you're a Chinese contractor that won the rights to build a road in an African country, and then you bring money from China—unofficial sources, there's no transparency as to where the money is coming from, only the government of the country can choose to disclose. That's what you see in cases like Zambia, Mozambique and Malawi", Fagbule explains.

Confidentiality is a central theme for most sovereign loans. But the degree to which it's done is different. While most multilateral and western lenders are more prone to disclose some key facts about the loans they give to countries, others choose to disclose based on discretion. However, China is generally more discreet about the terms of its loans. Also, countries with weak institutions that lack accountability are less prone to disclose their debt and its terms.

This might mean that as more and more countries near debt default, more debts to countries will become exposed, showing the debt sustainability situation of most countries. On the plus side, however, with more loans being exposed, there might be room for debt restructuring, which would give the debtor countries more fiscal room.
 

Collateralised loans

Another fondly touted term for loans from Chinese lenders is that most of them are collateralised. That is, the borrower countries give the lenders access to some form of collateral. Three out of four loans analysed by AidData from China Development Bank (CDB) are collateralised, while China Exim Bank securitised 22% of its loans. This loan securitisation is mainly a function of the loan size given by both lenders; the average CDB loan is about $1.5 billion, while China Exim's is $200 million.

This collateral could be the sale proceeds of mineral resources for resource-rich countries. In 2004, to pay back a $2 billion loan from China Eximbank, Angola had to deposit its daily income from selling 10,000 barrels of oil from Sinopec's four oil blocs in Angola into an offshore account. Likewise, to pay off its $110 million loan to China, Zimbabwe had to deposit its tobacco sales revenue.

Debtors sometimes grant companies access to existing assets yet to be explored, like minerals still under the ground and not yet explored. In 2006, Zimbabwe gave China 50% rights to its platinum deposits, which were to be relinquished when the debt was fully repaid.

Collateralising loans is a debtor's way of guaranteeing the creditors that their debt will be repaid, even when the country has credit risk. The creditors know that debtors have limited access to financing because of their credit risk, but to secure their funds in the face of a possible default, they securitise the loans.

With securitising debt, debtors have more loan options. The downside is that the countries are selling off some of their equity to the creditor, which could push the country into more dire liquidity situations in the future when it cannot pay back its loans. Another downside is that when commodity prices are low, the debtor countries would be expected to pay more in terms of the quantity of their mineral resources than when the prices are high or usual.

Here’s one of the situations where debt transparency might be detrimental. Where the collateralised assets or income is controversial, members of the debtor country (and even the international financing community) might oppose the loan.

Again, debt securitisation is not a Chinese concept; several creditors securitise their debt to hedge against the risk of non-payment.

"It's typical of countries to pledge future oil receipts from the sale of commodities to financiers providing capital upfront. It gets unusual if it is shrouded in secrecy, where it's unclear who the counterparties are unknown like in Angola's case or Mozambique's where the money is not even provided," Fagbule says. 

So far, we've seen that Chinese creditors are not too different from creditors in other countries. Debt securitisation gets tricky when there's no accountability in the debtor countries.  Similarly, the confidentiality clause’s favourability depends on who the creditor is and how strong the institutions are in the debtor countries.