Prompted by the Georgian Government's recent decision to select a Chinese company for the implementation of the Anaklia Deep Sea Port project, ISET-PI’s recent policy note (July 11, 2024) provides useful insights into China's ascent as the largest bilateral creditor for low- and middle-income countries (LMICs), its lending practices and case studies, with that background analyses the risks associated with the Anaklia project and provides recommendations. Here is a summary of the main findings.

1. WHAT ARE KEY FEATURES OF CHINA AS A CREDITOR?

China is presently the largest bilateral creditor to low- and middle-income countries (LMICs). China’s lending mainly targets infrastructure, transport, energy, and mining sectors in developing countries driven by the strong push for a global infrastructure development strategy - the Belt and Road Initiative, adopted in 2013. Consequently, China has ascended to become the largest bilateral creditor to LMICs. As of the end of 2022, LMICs collectively owed China US$180 billion in public and publicly guaranteed external debt. Significantly, Sub-Saharan Africa (SSA), led by Angola, has seen marked increases in its borrowing from China since 2012 and SSA represented 44 % of the total debt obligations of LMICs to China.  Meanwhile, in South Asia, the debt to China witnessed a nearly sevenfold increase over an 11-year span, jumping from US$6.4 billion in 2012 to US$42.9 billion in 2022, with Pakistan accounting for two-thirds of this debt (Figure 1).

LMICs have access to different sources of funding from China which is primarily facilitated by state entities like government agencies, policy banks, and state-owned enterprises. Unlike traditional lenders (the World Bank, ADB, JICA), some special features of Chinese loan agreements include confidentiality of contracts, extensive default and cancellation clauses, and collateralized transactions which result in spectrum of contingent liabilities:

• Confidentiality: contracts contain clauses limiting the borrower from disclosing the terms of the contract, and in certain cases, even the existence of the contract, unlike contracts with traditional bilateral and multilateral lenders. This could limit the transparency for a country’s citizens and their cognizance of the full extent of the debts and obligations undertaken by the government.
• Default and cross-cancellations: contracts contain cancellation and cross-cancellation clauses permitting the creditor to cancel the contract if substantial changes in laws or policies occur in either the debtor's or creditor's country, terminating diplomatic relations, and asking for prompt repayments of various contacts.
• Collateralized debt instruments: China uses collateralized debt instruments for its lending for high-risk high-reward projects in developing countries. Collateralized loans give creditors rights over a borrower's assets and/or revenue streams. It can involve pledges of physical assets, financial assets, and present and future, related and unrelated revenue flows such as receivables.
• Off-take guarantees: these are guarantees on ensuring sufficient cargo volumes in case of transport infrastructure projects (ports, railways) and sufficient supply of energy and natural Figure 1. Low- and Middle-Income Countries’ Debt to China, by Region, 2012-22. US$ (billion) Source: Figure B1.7.1 from International Debt Report 2023 (World Bank, 2023). PAGE | 3 resources (hydro, oil, metals) in case of energy and extractive industries infrastructure projects. If cargo volumes fall below defined parameters, guarantees could be triggered requiring accelerated repayments and/or invoking asset pledges.
• Contingent liabilities: referred to as hidden debt in the recent literature, are often excluded from public debt because these are obligations that only arise if a particular event occurs in the future. Contingent liabilities arise from the host government’s ownerships in other borrowing entities (such as SOEs, PPPs, IPPs, and so on) and/or product/service off-take guarantees and collateral pledges. A potential financial obligation that may arise in the future as a result of past events or transactions, but its existence and/or amount is uncertain until one or more future events occur or fail to occur.

Despite being one of the world's largest bilateral creditors, China is not a member of the Paris Club, an informal group of official creditors focused on finding coordinated solutions to debtor countries' payment difficulties; instead, China opts for direct, often less transparent, bilateral negotiations for debt restructuring and relief, incorporating strategies such as extended loan maturities, interest rate adjustments, debt-for-resource and debt-for-equity swaps, while more recently also endorsing the G20's Common Framework for coordinated debt treatments.

Collateralized debt borrowing is associated with a higher risk of debt distress, and it has increased the complexity of some recent debt restructurings. Angola, Argentina, Chad, Ecuador, Ghana, Guinea, Malawi, Republic of Congo, Suriname, Zambia had a high risk of overall debt distress and received debt treatments which include debt restructurings since 2020 (Table 1). There are other debt contracts that are also deemed problematic and have been undergoing debt treatments since then (To view the study in full, see attached policy document above).