Can Domestic Factors Explain China’s Debt Relief Record?

There has been significant criticism of China’s participation in the Common Framework for Debt Treatments (hereafter, the Framework), which was established in November 2020 at an extraordinary G20 Finance Ministers’ and Central Bank Governors’ meeting held during the Riyadh G20 Leaders’ Summit.

As the largest bilateral lender to developing countries, it has been widely acknowledged that China’s commitment to, and active involvement in, the restructuring of sovereign debt of developing countries in debt distress is critical for returning those countries to debt sustainability. However, China’s participation in the Framework has been criticized to be slow at best and “strategic” (or intentionally disruptive) at worst.

We argue that China’s overall approach to provision of debt relief may have been misunderstood. While the delays and the lack of transparency in the process have perhaps justifiably fueled suspicion about its intentions, China has provided meaningful contributions in the context of both the DSSI as well as the Common Framework, without unduly delaying the processes.

We put forth five hypotheses that may shed light on China’s behavior within the Framework to date. These hypotheses—the underpinnings of which are historic, ideological, institutional, and political in nature—are difficult to test directly but are nevertheless important to keep in mind before inference can be drawn about China’s behavior and recommendations made on the way forward.

Reason no. 1: China’s distrust of, and extreme caution with respect to, US-led initiatives and institutions, which it has perceived as extensions of the US foreign policy

Chinese perception of the Bretton Woods System as an expression of the US’s global hegemony after WWII, one that inter alia helps impose the US dollar as the global reserve currency, is an example of this. As a result, China has spearheaded efforts to strengthen ties with the Global South by setting up institutions, such as, the Forum on China-Africa Cooperation (FOCAC), Asian Infrastructure Investment Bank, and New Development Bank , suggesting a degree of juxtaposition to the US as a rationale for China’s drive toward more independence, and at least partial progress, in its international financial dealings.

Reason no. 2: China’s perception of being mistreated on the international stage

Events like the US bombing of the Chinese embassy in Belgrade in 1999 and the 2019 Hong Kong protests, along with a series of military actions in areas the South China Sea, worsened the growing mistrust between West and China. China often protests against what it perceives as wrongful accusations by the West, dismissing the criticisms as hostile double standards, and defamation aimed at deterring China’s rise.

Reason no. 3: China’s lack of familiarity with, and mistrust of, the standard Paris Club approach to debt restructuring—and having a different approach to sovereign debt sustainability and restructuring

Although China joined the IMF in 1980, its dealings with sovereign debt restructurings before the 2010s have been limited to cases led by the IMF and the World Bank. China in effect has not had the experience of restructuring its unsustainable exposures to countries it has lent the way the US had with countries in Latin America during the 1980s. However, having learned the ropes over time, China developed its own approach to debt restructuring and relief.

Reason no. 4: China’s complex financial institutions and bureaucratic system related to foreign lending and debt relief decisions

China’s decision-making process related to bilateral lending is layered and top-heavy, making the delivery complicated and drawn out. Banks and departments involved in the process vary in their jurisdiction, prerogatives, and structure, such that complications can also be caused by misalignment in policy priorities and objectives among different departments involved. In addition, the culture of personal liability and loss avoidance, lack of information and complicated process of applying for sovereign debt relief, along with other institutional and legal bottlenecks may have contributed to delays in internal deliberations on the delivery of debt relief under the Framework.

Reason no. 5: China’s tense domestic political environment and growing economic challenges

Facing some recent domestic protests and a decade of slowdown in economic growth and post-COVID economic challenges accompanied by a precarious domestic political environment, the Chinese leadership is likely to prioritize building domestic economy (by driving scientific and technological innovation) over provision of foreign debt relief, contributing to the delays in its response to Common Framework-related demands.

The way forward

Despite these idiosyncrasies and constraints facing China and its bureaucracy, we argue that cooperating within the Framework is low-hanging fruit for both China and the leaders of the Paris Club and should be viewed as mutually beneficial and non-threatening.

Experience gained by Chinese institutions and banks in dealing with the Framework will undoubtedly help since it will become increasingly more difficult for China to claim lack of experience in the future. The possibility that the Western nations too may have learned from their experience of dealing with China in the context of the Common Framework should help bring the two sides together.

While on issues related to global security, regional conflicts, and bilateral trade, the relations between China and the US remain complicated (following the trade war and accusation of espionage), their economic ties have become more important to both sides than ever. Recently, Treasury Secretary Janet Yellen became the first Biden Cabinet-level official to visit China twice as of April 2024.

In September 2023, the US Treasury Department and China’s Ministry of Finance launched the Economic and Financial Working Groups to establish direct channels of communication between the respective Ministries of Finance. Since then, these two groups have met four times and discussed both macroeconomic and structural issues in areas such as trade and sovereign debt. At a higher level, the Biden-Xi meeting in San Francisco too offered hope as it appeared to have set the floor on some critical security and defense issues, aimed at managing “competition responsibly to prevent it from veering into conflict, confrontation, or a new Cold War.”

Against the backdrop of poor US-China relations, Yellen’s notable Chinese visits and the economic working groups show promising signs that economic pragmatism might trump ideological and political differences at a time when both countries face challenges. As we argue elsewhere,[1] in the context of the Common Framework, China could be offered a leader’s spot along with the US, while acknowledging China’s own approach to provision of debt relief (i.e., reprofiling, which could become one of the standard menu options for debt exchanges under the Framework).

There may be some signs indicating willingness by China to reassess its position on low-income country lending. At the 2024 FOCAC in September, China reaffirmed its commitment to strengthening its relationship with African and signaled a new financial strategy that will shift the investment focus from large-scale projects to smaller and more sustainable ones. This commitment (although falling short of offering debt relief and pre-COVID levels of investment to African countries) may signal China intension to take a more granular look at its investment strategy by avoiding large sum lending without thorough due diligence.