Montenegro, a country in the Balkans, is struggling to pay off Chinese loan for a highway project, which has put the country in a dire financial situation. The incident highlight "China's Debt Trap Diplomacy" and the consequences it has in the economies around the globe and India in particular.
What is Debt Trap Diplomacy?
The term was coined by Indian geo-strategist Brahma Chellaney in 2017. This type of diplomacy refers to offering projects/loans on terms that end up being too difficult for countries to repay, eventually compelling them to accept political or economic concessions.
Structure of the "trap"
Usually, the low and mid-level developing countries are lured by China's offer of cheap loans for transformative infrastructural projects, which require a considerable investment.
Because of their poor financial conditions, these countries are often incapable of carrying on with repayments.
This gives China an opportunity to demand concessions or advantages in exchange for debt relief.
Concession may include handing over strategically valuable facilities such as ports, natural resources, and lands.
Financial and economic dominance may also be converted into political leverage which can be used to influence domestic and foreign policy decision of indebt nations.Recent Incidents
In 2014, Montenegro signed an agreement to take out a $944 million loan from China's Exim Bank for the construction of a motorway that would link the port of Bar to the border with Serbia. Presently, Montenegrin debt is around 65.9% of its GDP with China holding 25% of its public debt.
Several other countries such as Laos, Kyrgyzstan, Maldives etc. are presently facing debt distress owing sizable portion of the debt to China. This has raised concerns regarding the use of debt-trap diplomacy. In 2018, a report by the Center for Global Development highlighted eight Belt and Road Initiative (BRI) recipient countries at a high risk of debt distress due to BRI loans. These countries included Djibouti, Laos, the Maldives, Mongolia, Montenegro, Pakistan, Kyrgyzstan, and Tajikistan. They are highly prone to mounting debt-to-GDP ratios beyond 50 percent, and around 40 percent of their external debt owed to China.
The Chinese Policy
It has been alleged that Chinese funding is often made for non-viable projects without appropriate risk assessment. For example, in 2014, Montenegro successfully concluded negotiations with Chinese partners to finance a highway project despite the fact that the project was deemed economically unviable by two feasibility studies.
China has invested heavily in middle and low-income developing countries which have a history of debt sustainability problems, lack the fiscal capacity to directly finance infrastructure, and are not commercially appealing for attracting investment.
China does not subscribe to any guiding multilateral frameworks, set down by the International Monetary Fund or the World Bank, to define its approach to debt sustainability problems, choosing instead to deal with countries on a case-by-case basis.
These acquired projects hold strategic importance beyond their economic use. For instance, Hambantota port in Sri Lanka can be used for increasing Chinese presence in the Indian Ocean Region.
Reasons why countries have been vulnerable to debt traps
Infrastructure investment is widely recognized as a crucial driver of economic and social development. However, middle and low-income developing countries lack the fiscal capacity to domestically finance infrastructure projects. Countries participating in the BRI are lured by the promise of socio-economic transformation and development.
Countries find it difficult to fulfill conditionalities for accessing development assistance offered by multilateral lending agencies such as the IMF. Such conditionalities may include structural and governance reforms, targets for macroeconomic indicators, accounting and auditing systems, etc. Governance issues such as lack of adequate pre-project viability analysis, corruption, reckless propensity to borrow, fiscal mismanagement, etc. have made it easier for China to push loans for even unviable projects.
Implications on India
With China making dominance in the Indo-Pacific region, one major factor of concern for India remains the issue of security risks with the possibility of the use of commercial assets acquired by China for military purposes, which is highly influenced by China's debt-trap diplomacy.
Also, the increased political influence of China on India's neighbors can put a strain on their diplomatic relations with India. Hence, countries should conduct a proper risk assessment and measure the economic viability of infrastructure projects prior to signing agreements.
Countries can become a member of the Paris Club to help countries find sustainable solutions to rising debts. India is an ad hoc participant (not a permanent member) of the Paris club.
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