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How Debt Traps From China’s Belt and Road Initiative Could Upend the IMF

Daniel McDowell Tuesday, Aug. 14, 2018

No stranger to political controversy, the International Monetary Fund may soon find itself embroiled in one that pits China’s interests against those of the United States. Beijing’s hugely ambitious international development project, known as the Belt and Road Initiative, is raising fears of debt crises in the developing world, and the IMF may be called in to clean up the mess. 

The U.S. is poised to oppose any IMF deal providing funds that would ultimately go to pay off Belt and Road-related tabs. How the IMF handles this situation could give clues about how the institution will deal with competing American and Chinese interests in an increasingly multipolar world. 

Launched in 2013, the Belt and Road Initiative is an international investment program that promises to pour $8 trillion in Chinese money into infrastructure and other development projects across nearly 70 countries in Africa, Asia and Europe. Despite a clear need for infrastructure investment across the developing world, many observers quickly warned that all these Chinese-led investments would be driven by political, rather than economic, considerations. 

Five years into the program, many of these fears appear prescient, as reports of Beijing-funded “white elephant” projects come to light. A high-ranking Australian minister recently remarked that, thanks to China’s initiative, the region is now “full of these useless buildings which nobody maintains.” 

What does this have to do with rising debt concerns? These projects have typically been financed through loans from Chinese financial institutions like the state-owned China Development Bank and Export-Import Bank of China. 

This summer, Sri Lanka became the poster child for Belt and Road-related debt troubles. Its government borrowed heavily from China to build a new port that largely went unused. Rather than struggle to pay what it owed Beijing for a port that was not generating much income, Sri Lanka handed over control of the port to a Chinese conglomerate for 99 years in exchange for debt relief. The move has raised security concerns throughout Asia. 

Sri Lanka is not alone in its struggles. Earlier this year, a troubling report from the Center for Global Development identified eight countries where Chinese financing of Belt and Road projects will “significantly add to the risk of debt distress.” Of these eight countries, two—Sri Lanka and Mongolia—are currently under an IMF assistance program, and one—Pakistan—is reportedly mulling a request for economic aid from the IMF. Over the next several years, more countries could follow, and this could put the fund in a tricky spot. 

Take Pakistan, which is facing a widening current account deficit, falling foreign exchange reserves and an increasingly unsustainable debt load. Meanwhile, the Belt and Road’s fingerprints are everywhere in the form of a development plan known as the China-Pakistan Economic Corridor, or CPEC, which includes the deepwater port at Gwadar and a string of power plants. Despite its financial troubles, the Pakistani government has pledged to move forward with another $60 billion in CPEC projects—80 percent of which will be paid for through fresh Chinese loans that carry steep interest rates. 

In light of its economic problems, Karachi is mulling a potential $12 billion IMF loan request. But it is the Belt and Road link, not the purported size of the loan, that makes this such an important case. If Pakistan asks for help, it could set up a fight between the U.S.—the IMF’s largest shareholder—and China, which is now the third-most powerful country within the institution, after the U.S. and Japan, following a recent reshuffling of voting power. 

The Trump administration has been a vocal critic of China’s grand international development plan. While attending meetings at the IMF this April, U.S. Treasury Secretary Steven Mnuchin warned of the potential for debt crises in the developing world. Not mincing words, he pointed the finger at “non-transparent emerging sovereign creditors like China.” 

In the coming decade, the IMF is likely to face more cases where it finds itself torn between Washington and Beijing.

Last month, U.S. Secretary of State Mike Pompeo referenced the Pakistan situation directly in an interview, and in no uncertain terms. “Make no mistake. We will be watching what the IMF does,” he said. “There’s no rationale for IMF tax dollars, and associated with that American dollars that are part of the IMF funding, for those to go to bail out Chinese bondholders or China itself.” 

American consternation about the potential for a Belt and Road-induced debt crisis extends beyond the White House, too. A bipartisan group of U.S. senators recently wrote a letter to the Trump administration urging it to use its sway within the IMF to prevent it from indirectly bailing out Chinese interests. 

Beijing has mostly held its tongue in the face of American criticism. But when asked about the row over a potential Pakistani bailout, China’s Foreign Ministry spokesman noted that the IMF has its own rules. “I believe they will handle it appropriately,” he added.

How the IMF deals with such a controversial request for assistance could reveal a lot about how the institution will handle future disagreements between two of its most powerful and important members. Just three years ago, the IMF handed China a significant symbolic victory by adding its currency, the yuan, to its very short list of elite global reserve currencies. That decision came even though the yuan clearly did not meet the traditional standards for such a label. To some, the move was evidence that the IMF was trying to win approval and support from Beijing. At the time, the U.S. chose not to object.

That may not be the case this time around. If a deal with Pakistan that satisfies both parties cannot be found, the IMF will be forced to take sides between Washington and Beijing. 

If the Trump administration were to get its way and block a Pakistani loan program, China may cry foul. Beijing could point to many instances over the past 40 years where the IMF has bailed out American banks and bondholders from their own risky, ill-advised foreign lending activities. It would raise questions in Beijing about how well the Washington-based IMF can incorporate Chinese political and economic interests into its decision-making. 

On the other hand, if the IMF ignores American warnings, it could find itself in the crosshairs of an administration that has no problem tearing down international institutions that the U.S. once helped to build—just ask the WTO. 

In the coming decade, the IMF is likely to face more cases where it finds itself seated between the interests of its two most important member states. That’s why both Washington and Beijing will be closely watching how it handles Pakistan’s looming loan request.

Daniel McDowell is an associate professor of political science in the Maxwell School at Syracuse University, specializing in international political economy. He is the author of “Brother, Can you Spare a Billion? The United States, the IMF, and the International Lender of Last Resort,” and a regular contributor to World Politics Review.


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