In mid-April, Pakistan requested debt relief from China on Belt and Road Initiative (BRI) loans due to the economic crisis driven by COVID-19. Pakistan asked for debt relief specifically for power projects in the China-Pakistan Economic Corridor (CPEC), the flagship project of BRI— asking to ease debt obligations on $30 billion loans. If China agrees to this request, then Pakistan can expect an annual saving of around $500 million in annual cash flows.
Following Pakistan’s lead, several other BRI host countries made similar debt relief requests to China. Due to the COVID-19 crisis, several BRI countries in Asia and Africa have requested to delay interest payments. So far, China has not responded to these requests, but there have been indications from policy circles in Beijing that China is considering multiple options for relief.
This situation has presented an economic dilemma for China. On the one hand, Beijing feels the need to assist its BRI partners economically – through debt relief – so that they can pass through the COVID-19 economic crisis. On the other hand, if China agrees to debt relief requests on BRI projects, then it will set a precedent for the future, which could result in potential defaults in debt repayment by BRI host countries. This dilemma has put China into a catch-22 situation, and it is expected to make a decision in this regard very soon.
Understanding the issues that Pakistan faces is important in understanding the overall debt issue facing the Belt and Road Initiative as whole. Pakistan joined the BRI in April 2015, and ever since, it has been a topmost priority for China’s multibillion-dollar project. Pakistan’s economy has also taken a hit due to the COVID-19-driven recession. The GDP of Pakistan is forecasted to contract to a negative 1.6 percent for the current fiscal year. Prior to seeking relief from China, Karachi requested debt deferment of $1.8 billion from G-20 countries. It also secured loans of $1.386 billion from the International Monetary Fund (IMF), $305 million from the Asian Development Bank (ADB), and $500 million from the World Bank in order to avoid a balance of payment crisis. Still, Pakistan is in severe need of repayment relief to prevent a complete collapse of its economy.
China cannot afford a collapse of the economy of Pakistan for multiple reasons. Firstly, China needs a functioning economy in Pakistan for the success of CPEC. China has committed $50 billion in Pakistan under CPEC. If Pakistan’s economy collapses, it would be unable to repay CPEC, thus jeopardizing the entire project. Therefore, the failure of CPEC would equate to the failure of BRI, because the former is the flagship project of the latter.
Secondly, China supports Pakistan as a matter of strategic policy to counterbalance India. Given the current border clashes between China and India in Ladakh, the need to support Pakistan for China is more than ever before. So, if Pakistan’s economy collapses, then China will effectively lose a strategic ally on its southern flank. Therefore, China has to take account of all these factors before deciding on Pakistan’s debt relief request.
Likewise, for other BRI host countries in Asia and Africa, the economic situation is not much different from Pakistan. The COVID-19 pandemic has resulted in a decline in export revenues, and an increase in government healthcare spending, and this has negatively affected the ability of these countries to repay its dollar-denominated loans to China. Therefore, they are not in a position to meet their interest payment deadlines for BRI loans. Still, China needs them to have functioning economies, not only so that BRI projects can be completed on time, but also these countries are able to repay their debt back to China in the future.
Moreover, in order to help all of its BRI allies avert the COVID-19 economic crisis, China needs to provide them significant debt relief. Unlike its BRI allies, China does not have a major economic crisis still at hand. It can afford to defer the receipt of interest and principal amounts on BRI loans. In fact, it can also completely waive of some to the loans, and there is also precedent for that. From 2000 to 2018, China waived loans of $9.8 billion to its creditors in Africa. This flexible approach is one of the reasons why its BRI allies have made debt relief requests in the first place.
However, significant debt relief for BRI projects will create a set of other problems. China has made it clear time and time again that BRI loans are not foreign aid, and the host countries will have to pay them back. In order to uphold this principle, China needs to be tough on its allies when it comes to repayment of those debts. If China makes an exception for its allies during the current crisis, then it could result in a domino effect of debt default. One host country after the other will make a request to waive off debts owing to the economic crisis. It will be difficult for China to decline the request of one host country and waive those for others.
Moreover, a domino effect could create serious challenges for the sustainability of the BRI. China may need to stop funding further projects under the BRI if a significant portion of loans is not paid back in time. This will effectively prevent the BRI from becoming successful. So, China has to take this important factor into account before deciding on its debt relief dilemma.
In this context, it’s more likely that China will evaluate the debt relief request on a country-by-county basis and not make one decision for all such requests. China can give concessions to countries which have great strategic value for Beijing. Pakistan, Sri Lanka, Bangladesh, and Nigeria, among others, are such countries because China wants to retain their support for geo-strategic reasons. Even for these countries, China is likely to avoid waiving full loans.
Moreover, researchers at the China Development Bank have said that the most Beijing can waive off 20 percent of the debts, while any more would not be possible. Now, the challenge for Beijing will be how much it waives or defers interest payments for different countries and how to justify it. They also have to ensure that host countries feel as though they are receiving fair relief packages.
Lastly, this situation has provided China with a unique opportunity to address debt trap allegations over the BRI. The U.S government and other western countries have repeatedly blamed China for using the BRI to create debt traps for host countries to increase its influence. If China provides significant debt relief to host countries during this crisis, then this debt trap criticism on the BRI will not effectively work in the future.
However, this will come at the cost of taking the risk of the aforementioned domino effect for debt waivers. Therefore, it remains to be seen if Beijing will take the calculated risk of offering debt waivers for good optics, or instead focus on debt recovery. Normally, Beijing would be expected to do the latter based on their history on the subject, but now with the changing global dynamics, Beijing may be tempted to use this opportunity to hit back at any detractors of BRI. If this is the case, then not only will it signal a shift in China’s policy towards the massive infrastructure project, but also demonstrate a greater shift towards realpolitik in its global economic dealings. Hence, this unique economic dilemma can be used by Beijing to improve the global image of what has so far been a controversial Belt and Road Initiative.