DEBT RESTRUCTURING IN THE GRIP OF CHINA

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In the most recent update to Parliament on International Monetary Fund (IMF) negotiations, Prime Minister Wickremesinghe stated that a Staff Level Agreement (SLA) with the IMF should be available around August 2022. Other Government sources, however, say an agreement with the IMF may become available earlier than that i.e., as early as the 3rd week of July if events proceed as expected given the escalating economic difficulties faced by the country.

With neither cash nor oil, the economy looks to be grinding to a halt. Central Bank of Sri Lanka (CBSL) Monetary Policy Review on 7 July offered the current reality– Headline inflation was forecast to reach 70% with policy rates on balance being hiked further by 100 basis points with a notable contraction in the economy as the short-term outcome. The political system also looks to be in disarray, unable to unite on a common framework that will attract both internal and external confidence in undertaking reform as a necessary concomitant of debt restructuring to obtain and sustain IMF support and finance.

The President, however, is said by government sources, to be rather relaxed based on a presentation by Lazard that conveyed a more positive message of concluding the restructuring process successfully despite obvious difficulties. The presence of Russian negotiators on the ground after a call with President Putin may be another reason for his upbeat outlook.

The message conveyed by Lazard, according to government sources, is said to be based on the various scenarios that are under review in terms of the debt restructuring efforts currently underway. According to sources, Lazard has expressed confidence that some 50% of all external commercial debt holders captured by the Committee of Creditors will agree to one of the several scenarios that carries a mix of ‘haircuts’, lower rates and longer duration on the aggregate $51 billion of external debt owed by Sri Lanka that is not being serviced.

A clarification, sourced from CBSL, is required here on the $51billion. Total Commercial Debt subject to restructure is put at $14.5 billion. It comprises $12.5 billion of International Sovereign Bonds (ISBs) issued by Sri Lanka and $1.4-2 billion of other debt obtained from commercial lenders such as Chinese Exim Bank. CBSL source also clarified that the External Public Debt subject to restructuring is put at $33.67 billion from which $9.38 billion is due to Multilateral Agencies. Such debt CBSL sources clarified that it is not subject to restructuring as they carry mandatory repayment in full and carries no discounts.

Thus, total external debt attributable to the Central Government is $24.29 billion to which must be added an amount of $1.4 billion being Chinese commercial debt obtained for the plant in Norochcholai thereby increasing it to $25.69 billion.

It should be noted that the $25.69 billion excludes commercial debt on the balance sheets of other State-Owned Enterprises. Of the $25.69 billion noted above, 26% amounting to some $6.8 billion comprises debt owed to China indicating the size of the grip held by China on Sri Lanka

Returning to the Lazard presentation as quoted by government sources, of the remaining 50% of commercial debt, another, roughly half, is also likely to agree with some adjustments leaving a hardcore of circa 25% that needs to be brought within the net. A 75% level of agreement among the Commercial Creditors, however, can trigger the SLA with the IMF. Lazard, it is said, may be able to submit such a restructuring report by 10 July to the government. A 75% agreement, government sources point out provides “sufficient assurance of financing” and hence good to go in submitting to the IMF to secure the SLA.

Government sources say if Lazard provides debt restructuring clearance at the 75% level, then with immediate submission of their report to the IMF, sign-off on the SLA can be expected towards the third week of July. Submission thereafter to the IMF Executive Board for final approval of the funded facility before the August vacation period hits at the US administration system, is the somewhat optimistic hoped-for outcome by the government and the source perhaps of the relaxed mood on which the president is said to be floating presently.

The above outcome forecast by Lazard carries several conditions according to government sources. Their reference to 75% to trigger the SLA covers only external commercial debt with no count of any domestic debt in the equation. Restructuring of domestic debt can, however, be discounted as the steep, near 70% inflation and nearly similar depreciation of the Sri Lankan Rupee versus the US Dollar has rendered a similar effect. Government sources also point out that Lazard has indicated that missing the August window to reach the IMF Executive Board will delay the outcome by several months as the vacation period takes many weeks to unwind. Finally, Lazard has intimated, according to government sources, that the 75% level noted above must include the debts of China to render the deliverance and resurrection of Sri Lanka unambiguous and irreversible subject only to conditions imposed by the IMF.

Now consider the three scenarios described below – one at home in Sri Lanka, another not too far from home in Pakistan and the other not too close at all, in Zambia. All three scenarios are current with the dynamics not entirely in the hands of the three countries involved. Instead, their fate lies with a fourth country playing a larger-than-life role across the globe. The country is China, the second largest economy in the world and the largest bilateral lender to low-income countries as illustrated by the graphical presentation –

The three scenarios referred above are:

On 24 June 2022, Miftah Ismail, Finance Minister of Pakistan announced that a consortium of Chinese banks had agreed to provide $2.3 billion in new loans to roll over a similar amount that was due in June/July of 2022. The new funds will allow Pakistan to pay off existing loans without recourse to their fast-disappearing foreign exchange reserves. The agreement is the second such loan extension after Beijing agreed to roll over another $2 billion in loans to Pakistan in March 2022.

A similar outcome seems to be playing out in Zambia. Within months of his election in 2021, President Hakainde Hichilema of Zambia had succeeded in agreeing a $1.4 billion IMF bailout for his debt-stricken southern African nation. A deal, however, with all its creditors, chief among them China, looks to be taking much longer. It is notable that in this case, China agreed to co-chair a committee of foreign creditors to renegotiate the Zambian debt on the basis of sharing the burden equally. Completion of the process successfully will enable Zambia access the $1.4 billion in IMF funds that China uncharacteristically and in contrast to its current delaying tactics, urged the IMF to deliver post-haste. As of late June 2022, however, negotiations remain deadlocked and Zambia is cash strapped.

The third is the case of Sri Lanka where the recently departed IMF Team advised the Government of Sri Lanka that the country must restructure its external debt in accordance with the principles of debt sustainability prior to consummating any relief from them. Chief among such foreign debt, accounting for some 26% of the total at $6.8 billion are from Chinese banks. In the main, the total is split among two entities, namely EXIM Bank of China and China Development Bank. Both entities are State-owned and are the largest ‘policy banks’, so labelled to reflect the pivotal role they play as building blocks of the Chinese economy. Beijing like in the case of Pakistan and Zambia seems to be pushing back. Recently its envoy to Sri Lanka, Qi Zhen Hong said that China supports Sri Lanka’s appeal to the IMF, but it remains reticent about engaging in multilateral debt restructuring, preferring instead for bilateral negotiations.

According to World Bank data, the poorest countries of the world face an estimated $35 billion in debt-service payments to public and private sector creditors in 2022. Over 40% of the total of $35 billion, it should be noted, is due to China.

Despite such outsize concentration of debt-service payments, Beijing has kept a low profile, not only on lending conditions but also on how it renegotiates with borrowers in distress.

The pressure now, however, is rising on China to take a more active role in helping strained economies overhaul their debt burdens. Leaders of the G7 countries have also called on China specifically when urging creditors to help countries heavily affected by debt.

According to analysts, the deployment of such extensive debt by China is rooted in its Belt and Road Initiative unveiled in 2013. Proclaimed as a platform for international cooperation in infrastructure, trade, investment and finance linking China with other parts of Asia, the Middle East, Europe and Africa, it has extensive tentacles.

“Chinese ‘Belt and Road’ money is everywhere – so we will see this over and over in sovereign debt restructurings,” is how one legal expert described the phenomenon. 

Chinese lending is mostly extended by State-controlled agencies and policy banks and is often opaque. A working paper of the US based National Bureau of Economic Research found half of the 5,000 loans and grants extended to 152 countries from 1949 to 2017 have not been reported to the IMF or the World Bank, despite China being a member of both multilateral agencies.

“Opacity is a recurrent problem with some of these Chinese loans,” is how a senior analyst close to negotiations described the situation, adding China had stricter confidentiality clauses on its commercial loans. Others say they found terms and conditions of loans made by Chinese
State-owned banks require borrowers to prioritise them for repayment.

Sources also quote a Georgetown University survey of some 100 Chinese loans to 24 low- and middle-income countries that showed, when compared to those of other bilateral, multilateral and commercial creditors, demands for an unusual level of confidentiality. The survey pointed out that in some cases such confidentiality covered “even the existence of the contract.”

Sources also say that where China has agreed to ease debt burdens, details are often unclear. The plethora of Chinese lenders also adds to complexity, though Export-Import Bank of China and the China Development Bank feature most heavily. Communication among them is also said to be an issue with no uniformity in their requests from the borrowers.

Zambia, Pakistan and Sri Lanka are test cases of the willingness of China to take the lead in restructuring the debt obligations of their defaulting client States. For the most part, China seems to prefer to negotiate with its borrowers behind closed doors, on a one-to-one basis.

Thus, at a time of rising economic stress among three of its client borrowers, two of them in default and another close to it, other countries that are heavily indebted to China are likely to be keeping a close eye on proceedings both in Colombo and Lusaka. Not only are other such client borrowers of China likely to be keen observers but also international creditors, in particular those who have significant amounts at risk via their ISBs.

Both, the Zambian and Sri Lankan cases also illustrates how Chinese loans originate from a variety of government institutions whose interests often vary, adding an extra layerof complexity to efforts in reaching a settlement. As indicated above, in the case of Sri Lanka, a significant percentage of the debt is sourced from two State institutions whose interest in safeguarding their lending may not be the same although their ownership remains the same.

Taking the total debt across the three countries concerned, different Chinese entities from the policy banks to commercial lenders have participated in the now distressed loans, each with their own priorities. Thus, negotiations are fragmented with no single party to negotiate with as in the case of ISB Investors who appoint their own Financial and Legal Advisers.

Little is also known about the terms and conditions on which China has extended the loans and how Beijing will behave when their client borrowers and hence their loans are in distress. China is not a member of the Paris Club, the organisation authorised to restructure loans extended by western governments.

The likely lengthy loan workout in all three cases points to a wider flaw in the handling of sovereign defaults globally. The World Bank has warned such defaults could soon balloon to levels last seen in the 1980s.

Lazard, advising both Sri Lanka and Zambia, is on record saying that a common framework, initiated during the pandemic by the G20 group of large economies, to enable the restructuring of debt quickly, was too vague to be implemented in all cases. They pointed to shortcomings in guidance on co-ordination not only among debtor countries but also among creditors, be they private or government.

The World Bank for their part has called for a rethink of the common framework. According to them commercial creditors should sit alongside their sovereign counterparts during debt negotiations, rather than being presented later with a fait accompli.

With some $1 trillion in BRI (Belt & Road Initiative) Debt, China remains the largest bilateral lender globally. Put another way, China is currently the largest single creditor in the world, with outstanding loans to other countries in excess of 6% of global GDP. A recent study published by the Harvard Business Review found that among the 50 developing countries with the highest levels of debt, about 15% of total obligations were owed to China. Hence a comprehensive debt restructuring reform appears unthinkable without their participation and buy-in.

In contrast to other commercial creditors, Chinese lenders have adopted a different approach to the art and science of debt restructuring. They have been willing to extend maturities and grant payment holidays to struggling debtors, but reluctant to accept any reduction in the amount of money they are owed over fears, observers say, of the political backlash in Beijing.

This puts them at odds with commercial creditors such as ISB holders who are forced to accommodate ‘haircuts’ in arriving at IMF imposed debt sustainability ratios and other similar risk management criteria. Nevertheless, China has voiced concerns about such tough measures imposed by the IMF on distressed debtors when seeking relief.

Beijing, however,recognises that it is under pressure to put forward new solutions to the resolution of their extensive debt portfolio, if problems loans escalate. In this context it should be noted that China announced recently to suspend debt repayments for 77 low-income countries as part of the G-20 debt relief programme, although the motivation here may be to obtain some political boost and not so much in terms of managing problem loans.

Existing methods of managing problem loans via the extension of final maturities and relief via interest-free loans are not looked upon too favorably. The issue seems to be differences in opinion between the Ministry of Finance in China and its central bank, the Peoples Bank of China (PBoC). The Finance Ministry is said to be more cautious in agreeing to concessions as doing so exacerbates its fiscal burden. As the shareholder of the policy banks, it will have to bear the losses resulting from restructuring their debt. In contrast, in the case of commercial lenders which are regulated by PBoC, a variety of restructuring methods are possible including write off depending on circumstances. Both institutions, however, are likely to work together to minimise losses.

There is no doubt that China plays a major role in the global debt market as well as a dominant role in certain geographic areas. In doing so it has acquired market power to be counted in any debt restructure involving the debtor countries. Given that position, it is unlikely to forgo any advantages that such a role bestows upon them. Debtor countries for their part should have negotiated their debt undertakings skillfully without relying entirely on the expertise of Advisers, be they financial or legal, when trouble surfaces. In the circumstances,the outcome for Zambia, Sri Lanka and Pakistan, will depend not only on the Advisers and what they are able to extract as concessions from bondholders to show Beijing but also on the nature of the relationship between the individual countries and China. Seeking to play a global role on many fronts, the current global debt dynamics and deteriorating global economics offers an opportunity that China cannot ignore in enhancing their profile. That China will make full use of the hand so delt should favour the three nations now in their grip.

Among the three nations identified here, the case of Sri Lanka is dire and worsening with little visible reversal underway except the IMF negotiations noted at the outset and perhaps any relief via the Russian negotiators that arrived on 8th July.
Sri Lanka and its 22 million inmates now imprisoned by circumstances of their own making, wait as the tempo in the country rises to bursting point.

(The Writer is a Senior Staff Journalist with over 20 years’ experience in financial journalism –[email protected])

By Ishara Gamage