Long read: What motivates China’s investment & lending practices in Africa?

3
3624
views
African leaders at the Forum on China-Africa Cooperation (FOCAC) in Beijing, China, in 2018. Photo: South Africa Department of International Relations.
Facebook Twitter Email

Since the wave of independence in the 1960s, African countries have faced numerous instances of debt distress in which they could not repay loans owed to foreign entities. In the 1980s and 1990s, the primary lenders to the African continent were the International Financial Institutions (IFIs), notably the International Monetary Fund (IMF) and the World Bank. In the late 1990s and early 2000s, many African countries negotiated with their lenders for debt reduction — and in some cases, elimination — through the Paris Club, an informal grouping of creditor nations. After two successful debt relief initiatives, African economies faced a brief respite before becoming indebted again, this time primarily vis-à-vis Chinese and private lenders.

Given the growth of Chinese loans in Africa over the past decades, this article examines the motivations for Chinese investment in Africa and China’s lending practices. This article first explains how Africa has benefited from China’s engagement on the continent, notably from increased demand for African exports and knowledge transfers. Second, it refutes the common Western misconceptions about Chinese lending, such as the claim that China is a predatory lender in Africa. Instead, it explains China’s economic and geopolitical gains from its ties to Africa, namely a source of labor and consumption, and diplomatic recognition. While the terms of Chinese loans (e.g., interest rates and loan length) may be less financially attractive for African borrowers than IFI loans, Chinese loans come with fewer stipulations. The ease of borrowing from China has caused African debt to rise. This article explains that China’s debt forgiveness practices resemble those of the Paris Club in the past, and that there is a coordination problem amongst lenders during debt renegotiations.

General Trends in Chinese Lending in Africa

China’s engagement in Africa — both through trade and investment — has brought tangible benefits to the continent. First, with China’s growing economy and increased domestic consumption, its demand for African exports has risen. This improves the terms of trade for countries that are net exporters of raw materials and provides those governments with a larger revenue source. Second, Africa’s trade with China has enabled Africa to diversify its import and export markets and thus become more resilient to regional shocks. This trend was evident in Africa’s rapid bounce-back from the 2008 financial crisis. In addition, China’s investment in Africa helps with the “soft side of development,” such as technological progress, the expansion of services, and knowledge transfers.

While these benefits are net positives for the continent, they are not spread evenly between and within countries. Although China’s increased demand for African goods helps African exporters, it simultaneously harms African countries that are net importers of raw materials, such as Morocco and Ethiopia. In addition, Chinese investments are often capital-intensive but do not always create many jobs for the domestic market. For instance, China is known to bring its own laborers to work on infrastructure projects, although this depends on the type of project and on the public policies of the borrowing country (Development Reimagined 2020). This fosters, at times, disparate views within a country on Chinese investments: African leaders and elites welcome closer ties to China while African workers see fewer substantial benefits.

Misconceptions about Chinese lending in Africa

China’s lack of transparency in its loan agreements has reasonably fueled skepticism around its intentions in Africa. According to Anna Gelpern, a lawyer and professor at Georgetown Law, Chinese contracts have confidentiality clauses that prevent borrowers from revealing the terms of a loan or the existence of debt. It is possible that the opaqueness of the lending contracts is intentional on the part of African leaders: perhaps the lending terms are not as favorable to African governments as publicly stated, and leaders prefer this information to be revealed only after they have left office. Yet, many Western politicians have instrumentalized this lack of transparency to perpetuate myths about Chinese lending. Research institutes such as the China Africa Research Initiative (CARI) have shed light on Chinese lending practices. This article, guided by CARI’s findings, refutes several false allegations about Chinese lending in Africa, such as the idea that China is a predatory lender and has replaced Western financing.

First, the widespread view that China is seizing African assets has proven to be false. For instance, some politicians and scholars claim that China is engaging in “debt-trap diplomacy” — a form of predatory lending in which China writes contracts that allow it to seize a collateralized asset if a borrowing country cannot repay a loan. The allegation is that Chinese firms intentionally lend to financially irresponsible governments that will be unable to repay loans in order to take possession of collateralized assets. Yet, the majority of the claims about Chinese asset seizures are unsubstantiated. Deborah Brautigam, Professor of International Political Economy at the Johns Hopkins University School of Advanced International Studies, and her colleagues have conducted extensive research using data from CARI to investigate China’s lending practices. They have found no evidence that China has taken advantage of countries in debt distress or seized any asset from any government, such as the Hambantota port in Sri Lanka. In reality, even if China were able to seize assets through its lending contracts, it seems doubtful that China would exercise this option because it would substantially damage the image China seeks to convey of fostering a mutually beneficial South-South partnership. The unsubstantiated claims about Chinese lending likely derive from an anti-China bias that some Western politicians may have or from a general fear that China’s economic influence will soon dominate the West’s.

Another common misconception about Chinese lending is that China is replacing the West as a lender in Africa. In reality, loans from the West (i.e., from Western companies, governments, and IFIs) have been insufficient to meet Africa’s growing infrastructure needs over the past decades. China filled the void of Africa’s lack of access to capital. Thus, in most cases, African leaders are not picking between taking a loan from China and the West, but instead between taking a loan from China and not taking one at all. As economist Peter Stein and political scientist Emil Uddhammar highlight, “the concern is not that China has an increased economic and political presence in Africa, but that others have ignored it for long.” If the West wants to curb China’s economic ties to Africa, it must meet Africa’s development needs or, preferably, cooperate with China on how to jointly invest in the continent. President Biden has begun to do the former with the Build Back Better World initiative, designed to provide an alternative to the Belt and Road Initiative (BRI) to develop the infrastructure of low- and middle-income countries.

China’s Economic Motivations for Lending in Africa

China has numerous economic incentives that drive its investment in Africa, including reaching China’s development goals and benefiting from Africa’s growing population as a source of labor and consumption. China’s economic ties to Africa are essential to China’s continuous development. China has secured access to natural resources such as oil, steel, minerals, and food through trade and investment. While China used to be an agrarian society, since it has transformed into a manufacturing epicenter, it has become the world’s largest agricultural importer. Africa has played an essential role in meeting China’s growing agriculture needs. According to the Xinhua News Agency, 2020 marked the fourth consecutive year of growth of African agricultural exports to China.

In addition to meeting its own development needs, China stands to gain from Africa’s rapidly growing population, both as a source of cheap labor and as a market for export products. As China’s economy has become more sophisticated, its labor costs have increased. It is no longer as profitable to manufacture goods in China as it was in its early phase of development in the 1980s and 1990s. Shirley Ze Yu, a Fellow at the Harvard Kennedy School, notes that “by 2034, Africa’s labor force is forecast to surpass that of China and India combined” (Ze Yu 2021). Given Africa’s rapidly growing labor market, it will become increasingly profitable for China to produce goods in Africa. Moreover, with a growing population comes rising consumer demand. Africa’s middle class is currently approximately 350 million people, which is comparable to China’s middle class of 400 million people. China will continue to maintain close ties with African markets in order to export more of its products there, such as technology, energy, smart city development, pharmaceuticals, and financial tools.

Geopolitical Gains for China

While economic incentives are important motivations for China’s investment in Africa, China also gained geopolitically from its relations with Africa. Notably, China receives diplomatic recognition and political support from African countries to whom it lends. The People’s Republic of China has consistently lobbied African governments to be recognized as the sole ruler of China, pressuring them to sever ties with Taiwan. Wade Shepard, the author of a book titled “On the New Silk Road,” explains that “these political commitments were being repaid in concrete and steel, as China started building railroads, hospitals, universities, and stadiums throughout the continent.” Many African countries have also backed China on accusations of human rights violations addressed at the United Nations, such as the Hong Kong national security law and the treatment of the Tibetan people and the Uyghurs in Xinjiang. The African continent, composed of 54 countries, holds more than one-quarter of the votes at the UN General Assembly, so it can substantially impact policymaking and voting outcomes.

Moreover, while non-interference in other countries’ domestic affairs is a founding principle of China, it is questionable whether China applies this tenet in practice. Some scholars highlight that China does not hesitate to intervene when it serves China’s pragmatic interestsCaitlin Dearing Scott, a Deputy Director of the International Republican Institute, contends that China is trying to export its governance model to Africa by training political parties, exporting surveillance technology, and increasing its media presence. According to the Australian Strategic Policy Institute, “Huawei has supplied surveillance technologies to 16 African countries, often funded by China Exim Bank loans.” Several news sources claim that Chinese investments cannot be directly linked to the Chinese government, especially when they are done through private companies or state-owned enterprises (SOEs). While China has a variety of lenders, the three most prominent ones are China Exim Bank, China Development Bank, and China Agricultural Bank. They are all institutional banks set up by the State Council of the People’s Republic of China. They are state-owned and state-funded, and they are “dedicated to supporting China’s foreign trade, investment and international economic cooperation.” Thus, it is clear that the Chinese government plays a vital role in determining the direction of these SOEs, and it will continue to do so to advance China’s geopolitical interests. The implications are that African governments may increasingly use Chinese technology to augment state control, leading to further democratic backsliding in the continent.

Comparing the Terms of Lending for Chinese and IFI Loans

As the quantity and share of Chinese loans in Africa have grown, scholars have assessed what makes Chinese loans more attractive than IFI loans. In the 1980s, most of the African debt belonged to western governments and IFIs. The Heavily Indebted Poor Countries (HIPC) initiative and the Multilateral Debt Relief Initiative (MDRI) in the late 1990s and early 2000s, respectively, allowed 37 countries, most of them in Africa, to receive full debt relief. After this debt forgiveness and after the 2008 financial crisis that led to a global credit crunch, Africa turned to emerging markets (in particular, to China) and private creditors for loans. According to the Jubilee Debt Campaign, as of 2018, Africa’s outstanding debt is owned approximately 20 percent by China, 35 percent by IFIs, and 32 percent by private lenders. Importantly, about two-thirds of new loans come from China, according to Shepard.

The increased share of Chinese loans cannot be explained by economic attractivity, as the terms of Chinese loans are generally less favorable than those of IFIs. In order to assess how economically beneficial Chinese versus IFI loans are, scholars and economists have examined the concessionality of loans, which is a metric of how much more favorable the terms of a lender are relative to what the borrower could get in the marketplace. Scott Morris, a senior fellow at the Center for Global Development, and his colleagues determined that World Bank loans in Sub-Saharan Africa are significantly more concessional than Chinese loans. Specifically, they estimated World Bank loan concessionality to be 60 percent and Chinese loans to be 22.5 percent. They explained that these differences are due to three reasons: “China consistently has higher interest rates, shorter maturity lengths, and shorter grace periods.” As described above, in some cases, China is the only available lender to African governments, but in other instances, African governments choose Chinese loans over IFI loans. This leads one to ask: if Chinese lending terms are worse than those of IFIs, why do African governments still choose to borrow from China?

A primary reason why African countries choose Chinese loans is that they have fewer conditions than IFI loans. IFIs are subject to public pressures to comply with environmental, social, and governance criteria. Thus, their loans tend to have more stipulations and are slower to obtain. In contrast, Chinese loans are often easier for governments to secure because there have fewer provisions for good governance, anti-corruption, and environmental protection. As Wenjie Chen, an economist at the IMF, and her colleagues uncovered, China’s FDI is uncorrelated with rule of law measures. As a result, Chinese investment in strong and weak governance environments is about the same, but its share of foreign investment is higher in the fragile governance states, given that IFIs do not lend as much to them. This is not to suggest that the IFIs should mimic China and overlook the harm caused by lending to corrupt governments that disregard public wellbeing. After all, the IFIs have a shameful history of propping up non-democratic regimes in the 1980s by giving loans that fostered clientelism. This controversy led to the inclusion of good governance provisions in the “Augmented” Washington Consensus of the 1990s. But the sharp contrast between the IFIs’ history of funding dictatorships and the present conditionality clauses on loans does not sit well with many African leaders. Many of these leaders thus prefer Chinese lending with “no strings attached.” Therefore, the primary motivation for African governments to borrow from China is likely not the economic attractivity but rather the ease of borrowing due to fewer stipulations.

The ease of borrowing from China has contributed to the re-emergence of a long-standing issue on the African continent: a heavy debt burden. Even before the outbreak of the Covid-19 pandemic, Africa faced a looming debt crisis, with 6 African countries in debt distress and ten at high risk of becoming so, according to the IMF. The pandemic has only exasperated these statistics. In 2022, the IMF announced that 7 African countries were in debt distress, and 16 were at high risk of becoming so. Given these alarming fiscal issues, this article examines the debt relief practices of Africa’s lenders.

Comparing Debt Relief Practices for Chinese and IFI Loans

In order to overcome this debt burden, African governments may need to turn to China or the IFIs for debt relief, the latter of which is negotiated through the Paris Club. This article notes that China’s debt relief conditions are similar to those of the Paris Club in the 1980s and 1990s but that, unlike the Paris Club, China negotiates debts on a bilateral basis, which can be problematic for African governments.

The Paris Club has evolved in its debt relief practices from extending the term of loans to granting complete debt forgiveness. The Paris Club initially offered the “Classic Terms,” which consisted of debt rescheduling, and then the “Houston Terms,” which granted longer grace and repayment periods. It was not until the “Naples Terms” and the “Cologne Terms” that the Paris Club reduced the debt stock of its borrowers, although with strict conditions such as having an agreement with the IMF, receiving input from civil society, and tracking future government expenditures.

China’s debt relief conditions are similar to those of the early years of the Paris Club (i.e., the “Classic Terms” and the “Houston Terms”). China’s debt moratorium for most loans involves extending the loan term without reducing the principal or interest rate. Starting in the 2000s, China began offering limited debt write-offs, but this was only for interest-free loans that borrowing countries had defaulted on in the 1980s debt crisis. Contrary to popular belief, these debt write-offs are not part of the BRI but rather part of a special foreign aid program, which makes up less than 5 percent of Chinese lending in Africa. Moreover, only in rare cases does China reduce the interest rates of loans. The evolution of China’s debt forgiveness practices is slow and limited. Still, it is reasonable to assume that China will eventually progress in a similar direction as the Paris Club, which will help alleviate Africa’s debt burden.

However, a significant issue with Chinese debt relief is that China generally negotiates bilaterally on a loan-by-loan basis. Until recently, China refused to engage with the Paris Club lenders, which multilaterally renegotiate an entire country’s debt portfolio. Debt relief talks happen separately between China and the Paris Club. Because these lenders have different priorities and practices, it is difficult for African governments to negotiate favorable terms. Some scholars explain that China did not want to join the Paris Club because the G7 countries dominate it. They suggest that China and Paris Club members should create another platform for debt negotiation in which China plays a central role. One such initiative was implemented during the Covid-19 pandemic: the “Common Framework for debt treatment beyond the DSSI,” launched in 2021. So far, only three borrowing countries have participated. Nonetheless, the Common Framework is an important milestone as it marked the first time that China joined a multilateral commitment for debt relief.

Looking to the future

Overall, Chinese lending has been largely beneficial to African development. China has provided increased demand for African exports, diversified African trade, and provided technological knowledge. Yet, the covertness of China’s lending practices has sparked widespread debates over Beijing’s grand strategy in the Global South. This article explains that the allegations of China acting as a predatory lender and China replacing the West as an investor are false. Instead, Chinese lending is motivated by economic and geopolitical gains in Africa, such as reaping the benefits of Africa’s growing population and receiving political backing from African governments.

If the West wants to curb China’s influence in Africa, it must step up to fill Africa’s infrastructure gap, such as with the Build Back Better World initiative. However, this will likely be insufficient, as Chinese loans have fewer stipulations than IFI loans and thus are often more attractive to African borrowers. In this case, Western creditors cannot lower their lending standards due to a risk of facing domestic political backlash; they must thus accept China’s greater influence in authoritarian African countries.

Because Chinese loans are easily available, a problem familiar to the African continent has re-emerged: a heavy debt burden. If the current path of fiscal unsustainability continues, African borrowers will need to renegotiate debt agreements with their lenders. While the Paris Club has improved its debt relief practices to help African governments repay their loans, Chinese debt relief practices are archaic — they mainly focus on extending the terms of loans. In order to prevent another African debt crisis, China should move towards full debt relief and work closely with other lenders in Africa to renegotiate debt on a multilateral basis.

While reducing the debt level is crucial, one lesson from the HIPC and MDRI is that eliminating current debt is insufficient to guarantee Africa’s sustainable economic development. In order to prevent future debt accumulation, African governments must ensure that they spend any new loans on projects that increase productivity and foster Africa’s long-term growth. This would allow them to repay future loans through increased government revenue and avoid creating a new debt burden in the African continent.

Irene Ezran is a student at the Johns Hopkins School of Advanced International Studies, specializing in international economics and China studies. She has previously worked as a Research Analyst at the Federal Reserve and at the World Bank Group. 

3 COMMENTS

  1. “China’s lack of transparency in its loan agreements has reasonably fueled skepticism around its intentions in Africa. According to Anna Gelpern, a lawyer and professor at Georgetown Law, Chinese contracts have confidentiality clauses that prevent borrowers from revealing the terms of a loan or the existence of debt. It is possible that the opaqueness of the lending contracts is intentional on the part of African leaders: perhaps the lending terms are not as favorable to African governments as publicly stated, and leaders prefer this information to be revealed only after they have left office.” This apparent lack of transparency in capital project contracts is a serious bone of contention on the continent of Africa. And I agree that the said opaqueness may be intentional on the part of African leaders.

    I enjoyed reading this tour de force, thank you, Irene Ezran! It has come at fortuitous time for me as I am busy researching a podcast to celebrate Uganda’s 60th Independence anniversary come October 2022. The title of the podcast is, “What Next For Uganda After 60 Lost Years?” – in which I will have the pleasure of interviewing Professor Amii Omara-Otunnu. The podcast will go live on 10 October.

    Returning to your piece, I think the central issue is not whether or not Chinese lending and investment policies are detrimental to Africa’s economic development; after all, Western lending and investment policies have very little to shout about, despite enjoying an open field in Africa for the last 60 years. But rather, whether Africa has the wherewithal to take advantage of whatever is on offer on the international stage. If we take Uganda by way of example, Uganda’s lack of wherewithal has made her hostage to fortune, so much so that she appears not to even possess the resources to negotiate a simple coffee contract. Now if she has no resources to negotiate a simple coffee contract, it surely follows the night the day, that she will not be able to negotiate a meaningful financial deal that benefits all her peoples – whether the deal is with the Chinese or Western institutions.

    The above scenario suggests that Uganda has got many of her priorities wrong; and if she does not sort out these priorities, Uganda will always be indebted to one global financial entity or other. It really does not matter which financial entity it is – be it Chinese or Western. This is the reason I argued in my blogpost, “I see in Uganda an opportunity, not a lost cause” – that: “The Uganda of [2022] is crying out for meaningful change; a Copernican revolution in the way she thinks about her fortunes. She’s in need of a new practical vision. … The situation in Uganda is anguished. The issue at hand is not between change and the status quo, but between two forms of change: one that makes change work for all Ugandans, young and old, rich and poor; and one that may regrettably lead her many tribes to choose to secede with a view of forming new nation state(s) whose leaders actually serve their people(s), and are not mercenary overlords who rob them blind. ….. For in this opportunity I see an urgent need for a root and branch reformation of a nation called, the Republic of Uganda. This may lead to both a new constitution and a new social contract between the Ugandan state, the private sector and her citizens; it should start with rebuilding consent through citizen’s assemblies up and down the country, with a wide remit to re-imagine the Republic of Uganda’s constitutional settlement.” See, https://thekamugasachallenge.com/uganda/

    • Thank you very much, Stephen Kamugasa, for your detailed response and insightful comments. I’m glad that you enjoyed the article. Thank you also for linking to your interesting blog post, and I look forward to listening to your podcast. I very much agree that if a country such as Uganda does not spend its resources on projects that will benefit her citizens, whether the loan comes from a Chinese or Western entity, the country will not progress. Thus, while it’s important for countries to understand the exact lending terms of various institutions, one should not lose focus of the goal of the loan — ensuring the prosperity of citizens.

  2. This is I believe an important read contributing descriptive to the International Lending Financing conversation specific to African emerging states requiring financial assistance. Important for me is ensuring monies deployed are used in manner method responsible subject to full external audit.

Join in the debate... let us know what you think!