China needs to fundamentally reform its delivery of development finance aid in the Pacific region to ensure it does not create a “debt trap” for vulnerable island nations through its Belt and Road Initiative, a report has warned.
The report published on Monday by the Lowy Institute warns if the current $6bn lending splurge from Beijing into the region continues in a “business as usual” manner then it poses a significant risk of future debt sustainability problems.
However, accusations from critics that Beijing is deliberately financing “white elephant” infrastructure via loans with the intention to expose small nations to default are alarmist and wide of the mark, it says.
“China has not been engaged in deliberate ‘debt trap’ diplomacy in the Pacific. Nonetheless, the sheer scale of China’s lending and its lack of strong institutional mechanisms to protect the debt sustainability of borrowing countries poses clear risks,” says the report.
The South Pacific, which encompasses some of the world’s poorest island nations, as well as strategically important sea lanes, is at the centre of a battle for influence between China and western powers.
The report, Ocean of Debt: Belt & Road and Debt Diplomacy in the Pacific, warns that increased geopolitical competition and an influx of debt finance risks undermining efforts to promote domestic reform and good governance in the region.
Beijing has emerged as one of the largest suppliers of development finance in the Pacific, the report says, announcing $6bn in concessional loan commitments between 2011 to 2018 — equivalent to 21 per cent of regional gross domestic product — for roads, port and other projects.
China’s largesse has alarmed the region’s traditional benefactors, including Australia, the US and UK.
Last year Australia’s then international development minister, Concetta Fierraventi-Wells, accused Beijing of financing “useless buildings” and roads to “nowhere” in the Pacific, prompting a formal protest from China. Since then Canberra has responded by announcing a “Pacific step-up”, which includes a new A$2bn ($1.37bn) infrastructure financing programme for the region, as it seeks to bolster its own diplomatic positioning in a region it considers is within its own sphere of influence.
Three Pacific economies — Tonga, Samoa, and Vanuatu — appear to be among those nations most heavily indebted to China of any in the world, according to the report.
The Lowy Institute warns a lack of transparency and official information about the Belt and Road Initiative, as well as fewer conditions attached to loans from China when compared with traditional partners, increases the risk of nations getting into financial difficulties.
Listen to the new weekly podcast from Gideon Rachman, the FT’s chief foreign affairs columnist, and listen in on his conversations with the decision-makers and thinkers from all over the globe who are shaping world affairs
As one senior Pacific bureaucrat put it: “We like China because they bring the red flags, not the red tape”, says the report.
The Lowy report shows that China supplied just over a quarter of all official loan disbursements in the Pacific while the Asian Development Bank and World Bank accounted for just over half of concessional loans. Much of Australia’s aid was in the form of grants.
Loans provided by the multilateral lending institutions and Japan tend to be more generous than Chinese finance, which typically has an interest rate of 2 per cent, a five- to seven-year grace period, and a 15- to 20-year maturity. In contrast, the multilateral lenders tend to offer interest rates in the range of 1 to 2 per cent, a grace period of five to 10 years, and loan maturity of 25 to 40 years.