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Context

• Sri Lanka continues to grapple with its worst-ever economic crisis as it has defaulted on all of its external debt of about $51 billion – after running out of foreign exchange for imports, calling it the last resort.
• So while domestic policies are largely being seen as reasons for Sri Lanka’s economic collapse, many also blame China for the unprecedented crisis in the island nation.
• Defaults over China’s infrastructure loans to Sri Lanka, especially the financing of the Hambantota port are being cited as factors leading to the crisis.

In this article, we will try and understand China’s lending model and the reasons it is coming under increasing criticism from low & middle-income countries against unsustainable debt.

American statesman John Adams, who served as president from 1797 to 1801, famously said, “There are two ways to conquer and enslave a country: One is by the sword; the other is by debt.” China, choosing the second path, has embraced colonial-era practices and rapidly emerged as the world’s biggest official creditor.

What is Debt Trap Diplomacy?

• Loans to repay loans: The debt trap is a situation where one is forced to over consume loans to repay your existing debts.
• Political leverage is exploited: Debt-trap diplomacy is a term in IR which describes a creditor country or institution extending debt to a borrowing nation partially, or solely, to increase the lender’s political leverage. The term was coined by an Indian academic Brahma Chellaney.
• IMF and Chinese tools of coercion: Although the term is most commonly associated with China, it has also been applied to the International Monetary Fund (IMF); both allegations, however, are disputed.

Features of such diplomacy

• Lending is initially very indiscriminate
• Terms of the loans are often not publicized
• More conditional loans are offered to repay and restructure old debts
• Such loans benefit the lender by undue exploitation of the borrower
• Interest rates are hefty and unrealistic
• It seeks sovereign guarantee and sovereign leases
• Default leads to geo-strategic overtakes ex. PLA Navy being deployed at Hambantota Port

Roots of such policy

• There are many cases of countries in the 19th and early 20th century, the high-water mark of European colonialism and imperialism, using debt-funded infrastructure projects to embark on rapid modernisation.
• For instance, the French-led design and construction of the Suez Canal.
• It involved the issuing of £3.3 million’s worth of Egyptian bonds in 1863 on behalf of the Egyptian Khedive.
• In return Egypt, committed to provide labour and a 99-year operational lease to France (much similar to the terms of Hambantota Port).
• One of the earliest successes of China’s debt-trap diplomacy was in securing 1,158 square kilometers of strategic Pamir Mountains territory from Tajikistan in 2011 in exchange for debt forgiveness.

Sri Lankan Case

• Using its own brand of “strategic investments” China is now forcing smaller states to abide by its dictates.
• Sri Lanka’s case is a text-book example of the Chinese modus operandi in pursuing its strategic interests.
• In July 2017, the Sri Lankan government and CMPort (China Merchants Port Holdings Company), a state- owned Chinese company, signed an agreement.
• It granted China a 99-year lease of the Hambantota harbour and 15,000 acres of land in exchange for $1.2 billion.

How does China seek to achieve this?

• Belt and Road Initiative (BRI): The BRI is a trillion-dollar initiative, which makes large-scale loans available to countries seeking to build infrastructure projects.
• Ignorance to creditworthiness: Instead of first evaluating a borrower country’s creditworthiness, including whether new loans could saddle it with an onerous debt crisis, China is happy to lend.
• Secrecy of negotiations: The China allegedly keep negotiations very secret and non-competitive pricing of projects.
• Bidding is closed-door: Contracts go to Chinese state-owned or state-linked companies which charge significantly above-market prices.
• Bribing of the govt: China also shows up with bribes to senior leaders in countries, in exchange for infrastructure projects.

Worst outcomes

• Sri Lanka: It was forced to hand over control of the Hambantota port project to China for 99 years, after it found itself under massive debt owed to Beijing.
• Pakistan: It is literally sold to into the hands of the China over the development of China Pakistan Economic Corridor (CPEC).
• Gulf region: Similarly, in exchange for relief, China constructed its first military base in Djibouti.
• India: SL allowed China control over a key port positioned at the doorstep of its regional rival India, and a strategic foothold along a key commercial and military waterway.

Chinese prophecy of its policy

• Anti-China sentiments: Communist Party of China calls it a “meme” which became popular due to “human negativity bias” based on anxiety about the rise of China as a global superpower.
• Obsession for China over the West: Many nations, Pakistan being the best example finds China as an attractive partner for their development.
• Success of such loans: Most of the debtor countries voluntarily agreed to the loans and had positive experiences working with China.
• Already existing debt distress: CCP conforms that Chinese loans are not currently a major contributor to the already existing debt distress in Africa.
• Debt-Restructure Policy: China restructured or waived loan payments for 51 debtor nations (most of the BRI’s participants) without seizing state assets.
• Case par excellence: Hambantota is an exception for China’s since the project was proposed by former Sri Lankan president Mahinda Rajapaksa, not Beijing.
• Its borrowers who seek loans: China’s leverage in debt renegotiation is often exaggerated, and was realistically limited in power.
• Waivers are considered: Considering the particular case of Pakistan, asset seizures are a very rare occurrence, and debt write-off is the most common outcome.

Why do countries go for Chinese offers?

• Distressed under-developed /developing countries: In retrospect, China’s designs might seem obvious. But the decision by many developing countries to accept Chinese loans was, in many ways, understandable.
• Negligence by World Bank and IMF: Most developed nations got neglected by institutional investors, since they had major unmet infrastructure needs. Countries that don’t want to go the IMF for a bailout when they’re in trouble, they went to China instead.
• Former colonists turned blind eyes: Most African and Asian countries turned troubled after de-colonization. Their finances were literally sucked up by colonists in post WW2 recovery.
• China empathized when nobody else did: So when China showed up, promising benevolent investment and easy credit, they were all in.
• Blaming Beijing is the easier option:  It became clear only later that China’s real objectives were commercial penetration and strategic leverage; by then, it was too late, and countries were trapped in a vicious cycle.

Do you know?

The State Bank of Pakistan (SBP), the central bank is no more a sovereign bank unlike the RBI. It has now become a commercial bank!

Has India taken any loans from China?

Ans. No. It’s the AIIB Loan.

• India has not entered into any loan agreement directly with China.
• However, it has been the top borrower of Asian Infrastructure Investment Bank (AIIB), a multilateral bank wherein China is the largest shareholder (26.6% voting rights) and India is the second (7.6% voting rights). 
• China’s vote share allows it veto power over decisions requiring super-majority.
• Loans provided to India could also pave the way for Chinese firms to enter and gain experience in the promising Indian infra market.

Impact of Chinese policy on India

• Almost all neighbours got lured: Most of India’s neighbours have fallen prey to China’s debt trap, and ceded to China’s $8 tn project – One Belt One Road Initiative (OBOR).
• India’s sovereignty concerns disregarded: CPEC requires India to accept that the Kashmir-controlled Pakistan region, is Pakistan, because that’s where some of the projects are.
• Perception change against traditional partners: China through OBOR can hence increase India’s political cost of dealing with its neighbours. Ex. Bangladesh now cherishes Chinese affinity more than its liberator.

A critical assessment

• Of course, extending loans for infrastructure projects is not inherently bad: The projects that China is supporting are often intended not to support the local economy, but to facilitate Chinese access to natural resources, or to open the market for its low-cost exports.
• Several projects are now bleeding money: In a sense, it is even better for China that the projects don’t do well. After all, the heavier the debt burden on smaller countries, the greater China’s own leverage becomes.
• Chinese morale are now high enough to prey its small neighbours: China has used its clout to push Cambodia, Laos, Myanmar, and Thailand to block a united ASEAN stand against China’s aggressive pursuit of its territorial claims in the South China Sea.
• China is establishing its monopoly: In financially risky countries, China now demands majority ownership up front. For example, China clinched a deal with Nepal this month to build another largely Chinese-owned dam there, with its state-run China Three Gorges Corporation taking a 75% stake.
• Debt for a debt has become crème de la crème: In exchange for rescheduling repayment, China is requiring countries to award it contracts for additional projects, thereby making their debt crises interminable.
• China is becoming increasingly opportunistic and seizing assets: Countries that are not yet ensnared in China’s debt trap should take note – and take whatever steps they can to avoid it.
• Deadly obligations are pre-conditions: China does obligate the borrower to exclude the Chinese debt from any multilateral restructuring process, such as the Paris Club of official bilateral creditors, and from any “comparable debt treatment.”
• China has taken over exclusive development rights:  In small island nations, China has converted big loans into acquisition of entire islets through exclusive development rights. It took over a couple of islets in the Indian Ocean archipelago of the Maldives and one island in the South Pacific nation of the Solomon Islands.
• Some developing economies are regretting their decision: Protests have erupted over widespread joblessness, purportedly caused by Chinese dumping of goods, which is killing off local manufacturing, and exacerbated by China’s import of workers for its own projects.
• Rise of neo-imperialism: By integrating its foreign, economic, and security policies, China is advancing its goal of fashioning a hegemonic sphere through security links. If states are burdened with high levels of debt as a result, their financial woes only aid China’s neocolonial designs.

Do you know?

Yuan is now the official currency of Zimbabwe!

Way forward

• India needs to loop in: Getting ready to challenge China’s profile by enhancing its own regional role as an economic and security actor is the need of the hour for India.
• Ring-fencing of its neighbours: India also needs to maintain its influence in the region and counter the growing debt-trap initiatives via cooperative strategies and humanitarian aid, a move aimed to ring-fence its strategic interests.
• Countering China in maritime sphere: At a time when China is strangling India in the north with its attempts to change facts on the ground, it is imperative for India to strategically think of using the maritime sphere to break Beijing’s growing dominance in its periphery.
• Alternatives for finances: India needs to push these small countries to improve its ties with the US and the West. The so called ‘assistance’ should be as per international standards or as per the interest rate imposed by the World Bank, the Asian Development Bank and others.

Conclusion

• Thus it is very much clear that- China often begins as an economic partner of a small, financial weak country and then gradually enlarges its footprint in that state to become its economic and political master. 
• Atmanirbharta (Self-reliance) is the key to all such miseries.