Interview

Key Takeaways

Below are a few of the main takeaways from COVID-19 Africa Watch’s conversation with Scott Morris, Senior Fellow at the Center for Global Development, and co-author on the recent landmark report How China Lends, the first systematic analysis of the legal terms of China’s foreign lending.

• Development finance and access to external finance are critical for developing market governments, not just in crisis periods but also for long-term infrastructure financing. China has been a key source of this type of finance for Africa.
• The analysis of Chinese contracts, however, reveals unusual confidentiality clauses that bar borrowers from revealing the terms or even the existence of the debt, and Chinese lenders often seek advantage over other creditors, using collateral arrangements such as lender-controlled revenue accounts and promises to keep the debt out of collective restructuring (“no Paris Club” clauses).
• Cancellation, acceleration, and stabilization clauses in Chinese contracts potentially provide policy levers, allowing the lenders to influence debtors’ domestic and foreign policies.
• African countries arguably need to scrutinize the nature of the commitments they are making through debt contracts. At the same time, other bilateral lenders as well as the international community need to be more sensitive to the debt risks that these countries are facing, and to do more to provide countries with more viable financing alternatives.

The interview was conducted by Walter Pacheco, an IFC-Milken Institute Capital Market Scholar, who is the CEO of the Angolan Stock Exchange. A transcript is available below.

Transcript

Interviewer

Good afternoon Scott. Allow me to introduce myself. My name is Walter Pacheco. I’m a Milken Institute-IFC Fellow, and I spent the last three years as the head of the Debt Management Office at the Angolan Ministry of Finance. I am now the CEO of the Angola Stock Exchange. It is a pleasure to conduct this interview, and I will go straight to the questions.

We are all, and especially here in Africa, very focused on the best path for African economies to recover from the pandemic, including the terms of economic policy and fiscal space. Particularly in Africa, countries’ external debt burden has been considerably exacerbated by the pandemic.

At the Center for Global Development, you and your colleagues have recently published the first systematic analysis of the legal terms of China’s foreign lending, which is by the way, a very good paper. Can you tell us more about what motivated this paper and what the key insights are?

Scott Morris

Thanks for asking. I want to acknowledge the full array of collaboration in this project, because it was a very large project, three years in the making. We had partners at AidData at William & Mary, the Kiel Institute for the World Economy, Georgetown Law School, and the Peterson Institute for International Economics. Those constituted the co-authors. I should also note that if you look in the report itself and the acknowledgements, over a hundred research assistants were at work on this project, which gives you some sense of the scale of the effort. We can think of the project in two ways. One, it is disclosure of a hundred Chinese debt contracts to developing country governments. And we believe it is the first time there’s been the compilation and public release on this scale of contracts from Chinese governmental lenders.

And then, we go to significant effort to try to understand what is in the contracts, how should we understand the provisions, which provisions matter, and then compared to what. How should we understand China’s behavior as a lender through the debt contracts in relation to other official lenders, whether it might be European governments, the U.S. government, or commercial lenders, or multilateral lenders like the World Bank, the African Development Bank?

And I think really there are sort of three main areas, that we found to be notable, as we looked across these contracts. By the way, I should note that the contracts themselves are fairly globally diverse. We found contracts for countries in every region, but frankly, the biggest share of the contracts come from Sub-Saharan Africa. It’s not so much that most of these provisions are entirely unique to the Chinese, but it is more the degree of their use, the combination of their uses by the Chinese lenders compared to others.

I can unpack that a bit.

Number one is secrecy. When it comes to government borrowing and government lending, both sides of the equation, this is a notoriously non-transparent area. It is hard to see these debt contracts. That’s why it’s notable that we are publishing them. But what we see in the contracts themselves from the Chinese is enforced non-disclosure, particularly on the borrower. And again, what is notable about the Chinese is that it is not unusual to have non-disclosure requirements, certainly in commercial contracts, but typically the intent of those requirements is to protect the borrower, because the borrower is giving the lender access to sensitive information. And non-disclosure is typically meant to reassure the borrower that we will not disclose or otherwise make use of this outside of the contract itself.

“What we see in the Chinese contracts is an imposition on the borrower that the borrower itself shall not disclose… If the country is seeking some relief to the Paris Club, they are bound by these contracts not to disclose even the existence of the loan to the Chinese. And obviously that has the potential to create tremendous conflict and tensions.”

What we see in the Chinese contracts is an imposition on the borrower that the borrower itself shall not disclose, with an important exception that in cases where domestic laws say an obligation to report to the parliament requires disclosure. That is permitted, but not permitted under these non-disclosure terms are things like reporting to the Paris Club of creditors. If the country is seeking some relief to the Paris Club, they are bound by these contracts not to disclose even the existence of the loan to the Chinese. And obviously that has the potential to create tremendous conflict and tensions.

A second area that is notable are a number of provisions where the Chinese creditor is seeking to position itself vis-à-vis other creditors and essentially obtain seniority status in cases where there is some degree of debt distress or there is a need for haircuts. We see provisions where the Chinese creditor is seeking to obtain more senior status in two key areas: very extensive use of escrow and special accounts, where the creditor secures some future revenue stream from the borrowing country that is deposited into an account that the creditor has some degree of control over.

And then, entirely unique to Chinese creditors, we see this provision that is contained in quite a few of these contracts that essentially prohibits the borrower and country to seek Paris-Club-like treatment of the debt when it comes to the Chinese loan. It’s a pretty clear prohibition: If you seek a Paris Club arrangement for your other debts, don’t expect that you will receive that treatment from us. We will not be bound by comparable treatment standards under the Paris Club. And again, that sets up a very clear tension and challenge with other creditors, namely the official creditors of the Paris Club countries.

And then finally, there are a range of provisions that we describe as policy levers. Very broadly written cancellation and cross-default clauses. Broad in the sense that there can be a wide range of triggers, including policy triggers, policy changes in the borrowing government or in the creditor government, namely in China, that could be the basis for canceling the loan and calling it early. And in the case of cross-default, it is at least by appearance a mechanism where Chinese lenders can be protecting each other. We highlight one case in Argentina where China Development Bank employs the cross-default language in a threatening manner with the government of Argentina when the government was considering canceling the China Exim Bank project.

Interviewer

Going forward, what does that mean for African countries? What kind of recommendations you have for African countries?

Scott Morris

I’ll acknowledge here that development finance and access to external finance are critical for developing countries and particularly for developing country governments, not just in crisis periods when they need this kind of fiscal support, but for infrastructure finance generally. These countries have fundamental infrastructure needs that do need sources of financing, and the Chinese have been one of those sources. And we want to support that.

“One interesting potential implication of our work is that at least when it comes to the Chinese creditors, this array of provisions, some of which clearly are problematic, do seem to be what it is takes to access Chinese money.”

One interesting potential implication of our work is that at least when it comes to the Chinese creditors, this array of provisions, some of which clearly are problematic, do seem to be what it is takes to access Chinese money. And to some degree, that’s understandable, particularly in perhaps the highest risk environments where you don’t see other lenders – certainly you don’t see commercial lenders, but even institutions like the World Bank might be reluctant to finance certain projects, and yet the Chinese lenders are there. Well, you know, part of the explanation for that in fact is what we see in these kinds of contracts: they have ways of mitigating that risk. For instance, the use of special accounts certainly could be an effective risk mitigation strategy.

So I think we have to come to terms with that. And I think African countries in particular would do well to scrutinize the nature of the commitments they are making through these debt contracts, from a basic cost-benefit perspective. I think there are also implications for these countries as they try to obtain some relief, for those countries that are in debt distress.

The nature of these entanglements that we see in these debt contracts clearly are a complicating factor in moving forward with that. I mentioned the Zambia case. It’s clear that simple understanding and a lack of transparency around the position of all the creditors has stood in the way of being able to move forward in a timely way. Namely, other official creditors, the multi-lateral creditors wanting to understand the full array of commitments,  and the nature of those commitments with the non-Paris Club creditors, namely the Chinese and potentially others. So there’s clearly a transparency agenda that deserves priority going forward.

“Certainly borrowing countries themselves would be in a better position if they had a clearer picture across not just in their own circumstances, but if they were able to observe what these contracts look like in other countries.”

But, in not being transparent and as a creditor, China’s not unique. If I want to understand US Exim Bank loan contracts, it is very difficult for me to access them from outside the institution. And no doubt, I could go through a foyer process of petitioning the US government to release these, but that is a cumbersome process. There clearly is a broader agenda here when it comes to all official creditors in the world. And, certainly borrowing countries themselves would be in a better position if they had a clearer picture across not just in their own circumstances, but if they were able to observe what these contracts look like in other countries. I think that would put them in a stronger position going forward.

Interviewer

So having said that, in the short and medium term, African countries have to fund their infrastructure needs. What is the role of the international community in fostering infrastructure to fill these gaps, and which will increase if the Chinese loans are not available?

Scott Morris

It’s important to have, no matter who the lender is, a clear sense of the whole picture of the project, in terms of costs, the expected return is on the project. All of those are going forward, but particularly as we hope to emerge from this crisis, a critical factor is concessionality: official sources of lending are sensitive to the debt risks that these countries are facing. So certainly, for the low-income countries, the highly concessional lending that that is on offer from institutions like the World Bank, the African Development Bank, needs to be as robust as possible, and donor governments have a role to play there in stepping up and ensuring a robust support for that.

Countries like the United States, which see themselves increasingly in competitive positions with China, also have an obligation. If they want to step up in this space again, they need to be sensitive to debt risk and offer financing that is appropriate to the circumstances of these countries. So it is both a challenge of scale (infrastructure projects are not $10 million projects, they are a $100 million, $1 billion projects), but also of terms that are appropriate and sensitive to debt risk.

Interviewer

Thank you. Thank you very much, Scott. So looking at my country, Angola is one of the biggest recipients of Chinese loans. These loans were critical in a stage where we were at the end of a civil war and were critical in promoting the reconstruction process, what we call the re-reconstruction of the key infrastructure in the country. And while we joined the G20 DSSI Initiative and also restructured debt with each biggest bilateral creditor, my question to you is, given the comprehensive expertise you have, what kind of recommendation you would give to countries such as Angola?

Scott Morris

Well, I want to have appropriate humility in responding to this question, and particularly with you posing the question, I would frankly prefer to hear your answer to mine. But let me take the opportunity just to emphasize once again, the role that transparency and even contract transparency can play. It has a salutary effect on the behavior of both sides of the transaction in terms of the two governments. I think it will improve behavior, but it’s also a fundamental aspect of accountability to the citizens. And Angola is certainly one of those cases of a very high degree of concentration with China as a lender.

“Better disclosure of the terms of the contracts themselves would certainly be better practice going forward, and in times of stress, it can facilitate quicker and easier engagement with the key multilateral actors.”

Better disclosure of the terms of the contracts themselves would certainly be better practice going forward, and in times of stress, it can facilitate quicker and easier engagement with the key multilateral actors that are called upon (like the IMF) to step in and sort these things out. So that’s the one area that I’d like to stress more than others.

Interviewer

Thank you. Thank you very much, Scott, for this interview. I would like to congratulate you once again for your amazing work on this topic. Thank you very much.

Scott Morris

Thank you, Walter. It was a pleasure to be with you.