AFRICA INSIGHT: Next Debt Crisis Won’t Be China’s Doing

LAGOS (Capital Markets in Africa) – China has lent and will lend huge sums to African countries, creating concerns they are becoming too indebted. But rather than Chinese activity, which is increasingly a good thing for Africa, the bigger debt risk comes from Eurobonds issuance.

• Lending from China has risen, partly due to the Belt and Road Initiative.
• A narrower focus of this lending to support infrastructure projects will lift the continent’s debt-servicing capacity in the long run.
• Excessive Eurobond debt issuance is a more serious threat to sustained economic growth. In many cases, the proceeds are funding unproductive day-to-day spending.

China’s Lending to Africa Has Surged
China has been accused of driving Africa toward a new debt crisis with its extensive lending, which now runs in the hundreds of billions of U.S. dollars. The upcoming 7th edition of the Forum on China-Africa Cooperation (FOCAC) — in Beijing in September — is likely to result in a new increase of pledged financing for Africa (it was tripled to $60 billion at the latest summit, in December 2015). Lending from China has undoubtedly played a part in boosting economic growth, and indebtedness, in Sub-Saharan Africa over the past decade and will undoubtedly continue to do so.

The Type of Lending Matters
But Chinese lending is not only increasing, it is also changing, both geographically and in its uses, with consequences for Africa’s economic development. The first phase of Chinese lending to Africa in the 21st century (China financed and constructed the Tanzania-Zambia railway in the 1970s) focused on securing the resources deemed necessary to sustain economic growth. Part of the lending went to finance infrastructure projects, but generally left the recipient government free to spend the funds how they wished, as long as it was backed by future commodity shipments (this has been labeled the Angola or Sudan model after two of the initial focus countries involved).

Infrastructure Projects Driving Chinese Lending Higher
The chart above illustrates how gradually this pre-financing of commodity imports shifted toward China taking a large stake in improving Africa’s infrastructure, be it in power, transport or communication. The latter categories accounted for 65% of total lending in 2012-2015 compared to only 42% in 2010-11.

The gradual emergence of the Belt and Road Initiative, formally launched in 2013, has played an important role in this development by tying a higher degree of loans to infrastructure projects (see chart below). This was even more the case during the shift from lending to the initial core countries (Djibouti, Kenya, Ethiopia and Tanzania) to what we call Extended Belt and Road (inland East African countries and coastal West Africa).

Loans Spent Well Make a Difference
The rise in the World Bank’s Logistics Performance Index score for a number of the countries in the ‘core’ and ‘extended’ Belt and Road Initiative groups in recent years indicates that the shift in China’s lending to Africa is contributing to an improvement in infrastructure across the continent. Still, the lack of a strong correlation between Chinese lending and improvements in the LPI score — we looked at both the headline scores and the infrastructure sub-scores — highlight that the agency of the recipient government matters more than the source of lending.

Extended BRI Countries Already Making Headway
This is unsurprising given that other sources of financing are also available, such as international financial institutions (like the World Bank) and export agencies. Like these institutions, China generally lends at more attractive terms (longer maturities and lower interest rates) than commercial debtors. Moreover, we expect China to be more willing to renegotiate debt terms than holders of commercial debt, which are less strategic in their reasons for lending and don’t have the loss-absorption capacity of Beijing’s $3 trillion stockpile of foreign-exchange reserves.

Nonetheless, Beijing will wish to be associated with the success stories in Africa, rather than those struggling with large debt overhangs from financing recurrent expenditure and unproductive investments. Diversifying lending to avoid concentrated exposure is one way to achieve this.

We expect China’s lending in the coming years to focus mostly on a number of countries that fit a wider definition of its Maritime Road part of the Belt and Road initiative, which are so far less indebted to Beijing than their peers. This is likely to include countries such as Burkina Faso, which switched its diplomatic allegiance to Beijing from Taiwan at the end of May.

Existing BRI countries that have successfully executed previous investment projects and maintained debt-servicing capacity are also likely to be able to continue to draw on China for lending. Other countries are likely to struggle to convince Beijing that they can make good use of and repay any additional borrowing. As a consequence, they are likely to face sharper economic shocks as other available lending sources, such as Eurobond issuance, also dry up.

Eurobond Issuance is the Bigger Problem
Also of little surprise is that the borrowing that come with no strings attached have generally been spent less wisely. Much of the commercial market borrowing in the form of Eurobonds has mostly gone to finance recurrent expenditure rather than infrastructure investment, as claimed in initial issues. Not all recurrent spending is bad — health and education are investment in human capital. But Ghana’s debut bond in 2007 is a good example of money spent on things other than those initially advertised.

Eurobond Issuance Driving Debt-Servicing Burden Higher
Ghana and Zambia, the two most profligate Eurobond issuers in recent years, are among the countries with the highest external debt servicing ratios in Africa. The cost of servicing the Zambian government’s external debt almost trebled in U.S. dollar terms between 2014 and 2018, according to the IMF. Bloomberg Economics calculates that Eurobond coupon payments accounted for around two thirds of that sum. A lot of this borrowing is at longer maturities than domestic bond issuance, meaning a debt crisis is unlikely in the near term. Still, African countries borrowing in foreign currency will one day have to face up to their choices.

Mark Bohlund covers Africa for Bloomberg Economics in London. He has previously worked as an economist at IHS Global Insight, BMI Research (now part of Fitch Group) and the Swedish Foreign Office.