The Emergence and Fallacy of “China’s Debt-Trap Diplomacy” Narrative

Xu Shaomin & Li Jiang

n recent years, China has gained fruitful achievements in investment and infrastructure construction cooperation with countries along the proposed Belt and Road routes. At the same time, the West has begun Ito attack the Belt and Road Initiative (BRI) with fallacies, of which “China’s debt-trap diplomacy” is a typical example. By putting the blame for the debt crisis of some developing countries on China, it tarnishes China’s international image and creates obstacles for the BRI. Therefore, it is particularly necessary to have a thorough understanding of the cause and effect of the “China’s debt- trap diplomacy” narrative, to refute its erroneous nature and reveal the real root causes of the current debt crisis in many developing countries.

Socialization and Politicization of “China’s Debt-Trap Diplomacy” Narrative

With the development of the BRI, claims of “China’s debt-trap diplomacy” have widely appeared in the West. Driven by the joint hype of Western media and politicians, it has been rapidly socialized1 and politicized.

Xu Shaomin is Director and Associate Research Fellow at the Institute of Public Policy, South China University of Technology; Li Jiang is Visiting Research Fellow at the Institute of Public Policy, South China University of Technology. 1 “Socialization” here refers to the process in which traditional media and social media interact rapidly and extensively in setting the agenda for each other’s coverage, so as to rapidly transform it from a “meme” to a “narrative,” and effectively eliminate and suppress any other alternative narrative through passing news back and forth from media to media, finally forming an overwhelmingly dominating “official” narrative. The socialization mode of this kind of topic can also have a profound impact on political discussions, election campaigns and government policies. See Adam Breuer and Alastair Iain Johnston, “Memes, Narratives and the Emergent US- China Security Dilemma,” Cambridge Review of International Affairs, Vol.32, No.4, 2019, pp.432–435.

The Emergence and Fallacy of “China’s Debt-Trap Diplomacy” Narrative March/April 2020 69 “Debt trap” originally refers to the consequences for a government, or an individual, of borrowing at an interest rate which exceeds the rate of growth of its income, causing its current expenditure on items other than debt servicing to be increasingly reduced.2 In the 1970s, Western scholar Cheryl Payer attacked the International Monetary Fund (IMF) for controlling the economic policies of many Third World countries through ever-increasing loans, which eventually led these nations to submit to the economic dictates of developed capitalist countries. Payer described this as a typical “debt trap.”3 From the late 1970s to the 1990s, discussions on the nature, causes, impacts and solutions of the Third World debt crisis emerged one after another. Sovereign debt was no longer just regarded as a technical and economic issue, but an issue of international political economy involving politics and power games.4 The newly popularized term “China’s debt- trap diplomacy” is pointing fingers to China, accusing it of “deliberately” extending loans to developing countries with high debt risks. As a result, China would take the opportunity to acquire strategic assets or rights and interests should these countries not be able to repay, in order to achieve its strategic goals. After the financial crisis in 2008, discussions about China’s “debt trap” gradually appeared. It became an apparent trend after China launched the BRI. After 2017, the discussion on China’s “debt trap” rose sharply, and even exceeded the discussion on “debt traps” not involving China (see Figure 1). This phenomenon is especially true of the discussion on “China’s debt-trap diplomacy.” Before 2017, there were only very few reports and comments on this term, but since then it has increased rapidly and has become a hot topic in the global community. In short, “China’s debt-trap diplomacy” has been widely socialized.

2 Donald Rutherford, Routledge Dictionary of Economics (3rd Edition), London: Routledge, 2013. 3 Cheryl Payer, The Debt Trap: The IMF and the Third World, New York: Monthly Review Press, 1975. 4 Robert Gilpin, The Political Economy of International Relations, Princeton: Princeton University Press, 1987; Howard P. Lehman, Indebted Development: Strategic Bargaining and Economic Adjustment in the Third World, New York: St. Martin’s Press, 1993; Susan George, A Fate Worse Than Debt: A Radical New Analysis of the Third World Debt Crisis, London: Penguin Books, 1990.

70 China International Studies The Emergence and Fallacy of “China’s Debt-Trap Diplomacy” Narrative

hold of both natural assets and the very sovereignty of the country. Thus, China had practiced “creditor imperialism.”7 Influenced by his articles, the international community began to discuss the so-called “debt-trap diplomacy” of China after 2018, and explored whether China had really set up “debt traps” in Southeast Asia, South Asia, Latin America, Africa and South Pacific island countries.8 Although the notion of “China’s debt-trap Diplomacy” is a fallacy in nature, it caters to the anxiety of some countries about China’s rise. Since 2018, the United States has been the main force behind concocting the “debt- trap diplomacy” narrative, and has been stirring up a series of controversies against China in the sphere of international public opinion. The Summary of the 2018 National Defense Strategy and the Indo-Pacific Strategy Report published by the Trump administration have clearly defined “China’s debt- trap diplomacy” as “predatory economics.” It has also cooked up the assertion that China had intimidated and coerced its neighbors to achieve its strategic interests regionally and globally.9 In June 2018, the White House Office of Trade and Manufacturing Policy released a report, which claimed that China used a predatory “debt trap” model of economic development and finance that proffers substantial financing to developing countries in exchange for a lien on their natural resources and for access to their markets.10 US politicians, including Vice President Mike Pence, Secretary of State Mike Pompeo and his predecessor Rex Tillerson, Secretary of Defense Mark Esper and his predecessor James Mattis, and former National Security Advisor John Bolton, also overstated “China’s debt-trap diplomacy” on different occasions. They made irresponsible remarks, declaring that China’s investment in African,

7 Brahma Chellaney, “China’s Creditor Imperialism,” The Japan Times, December 21, 2017, https://www. japantimes.co.jp/opinion/2017/12/21/commentary/world-commentary/chinas-creditor-imperialism. 8 Kari Lindberg and Tripti Lahiri, “From Asia to Africa, China’s ‘Debt-Trap Diplomacy’ Was under Siege in 2018,” Quartz, December 28, 2018, https://qz.com/1497584/how-chinas-debt-trap-diplomacy-came- under-siege-in-2018; John Pomfret, “China’s Debt Traps around the World Are a Trademark of Its Imperialist Ambitions,” The Washington Post,August 27, 2018, https://www.washingtonpost.com/news/global-opinions/ wp/2018/08/27/chinas-debt-traps-around-the-world-are-a-trademark-of-its-imperialist-ambitions. 9 US Department of Defense, Summary of the 2018 National Defense Strategy of the United States of America, 2018; US Department of Defense, Indo-Pacific Strategy Report, 2019. 10 The White House Office of Trade and Manufacturing Policy, How China’s Economic Aggression Threatens the Technologies and Intellectual Property of the United States and the World, June 2018, p.1.

72 China International Studies The Emergence and Fallacy of “China’s Debt-Trap Diplomacy” Narrative Latin American and South Pacific island countries was a “debt trap” aimed at using “debt diplomacy” to expand political and military influence. In a letter to Treasury Secretary Steven Mnuchin and State Secretary Mike Pompeo in August 2018, 16 US senators asked the government to take measures to counter the so-called “debt-trap diplomacy” of China.11 In May 2019, Rep. Brad Sherman, Chairman of the House Subcommittee on Asia, the Pacific, and Nonproliferation, brazenly announced the preparation for a “China Debt Trap Act,” while publicly urging related countries to “ignore” China’s loan offers.12 These remarks and actions confirm that the term “China’s debt-trap diplomacy” has been aggressively politicized by the United States. The socialization and politicization of “China’s debt-trap diplomacy” narrative has undermined the promotion of the BRI. According to statistics, the value of newly announced big-ticket deals in the ten ASEAN countries, i.e. investment commitments and construction contracts worth more than US$100 million, dropped around 50 per cent in 2018, down to its lowest in four years. In the second half of 2018, newly contracted Chinese megaprojects in the region slowed considerably, with only 12 recorded projects worth $3.9 billion, down from 33 projects worth $22 billion in the corresponding period of 2017. The slowdown in new projects was mainly the consequence of Southeast Asian countries having stepped up their scrutiny regarding China’s large infrastructure investments.13 Likewise, in Europe, Latin America and South Asia, the media in various countries, such as Montenegro, Guyana and the Maldives, frequently complain about the “debt risks” brought about by Chinese investments, which often leads them to hold relatively negative views of the BRI.14

11 “Grassley, Senators Express Concerns over China’s ‘Debt Trap’ Diplomacy with Developing Countries,” website of US Senator Chuck Grassley, August 10, 2018, https://www.grassley.senate.gov/news/ news-releases/Grassley-senators-express-concerns-over-china-s-debt-trap-diplomacy-developing. 12 “China’s Growing Influence in Asia and the United States,” Hearing before the Subcommittee on Asia, the Pacific, and Nonproliferation of the Committee on Foreign Affairs House of Representatives, May 8, 2019. 13 Sarah Zheng, “As Questions Are Raised about ‘Belt and Road’, Projects Slow in Southeast Asia,” South China Morning Post, January 27, 2019, https://www.scmp.com/news/china/diplomacy/article/2183790/ questions-are-raised-about-belt-and-road-projects-slow. 14 Alicia Garcia Herrero and Jianwei Xu, “Countries’ Perceptions of China’s Belt and Road Initiative: A Big Data Analysis,” HKUST IEMS Working Paper No.2019-59, February 6, 2019.

The Emergence and Fallacy of “China’s Debt-Trap Diplomacy” Narrative March/April 2020 73 The Logical Fallacy of “China’s Debt-Trap Diplomacy” Narrative

The concept of “China’s debt-trap diplomacy” rests on four main arguments, namely suggesting that China would deliberately use huge infrastructure loans to increase the debt burden of indebted countries, indicating that China’s loans were loaded with hostile political motives, accusing China of using debts to plunder local resources instead of promoting local economies, as well as claiming that China was the “initiator” of some countries’ debt crisis. In fact, all of these accusations have been groundless.

Host countries are in urgent need for China’s infrastructure investment and experience On the one hand, China’s loans for infrastructure projects were granted at the request of the host countries. Infrastructure construction is the cornerstone for any economic development and enhancement of people’s livelihood, yet insufficient investment has been the biggest obstacle in realizing structural transformation in many developing countries. Since the 1960s, over $2 trillion have been provided as official development assistance (ODA) by the US and major European countries, but its effectiveness is still hotly contested. One of the main reasons is that the countries were so influenced by the Washington Consensus that they ignored the importance and necessity of infrastructure investment. Constrained by a narrow understanding of ODA, the share of aid by Europeans and Americans allocated for building infrastructure has remained at a relatively low level since the 1990s and cannot meet the huge demand for infrastructure investment in developing countries.15 For instance, Africa today has a financing gap ranging from $68 billion to $108 billion per year for power projects, ports, railways and airports.16 In recent years, some European and

15 Justin Yifu Lin and Yan Wang, Going beyond Aid: Development Cooperation for Structural Transformation, Cambridge: University of Cambridge, 2017. 16 “China Isn’t Trying to Lead African Countries into Debt Trap but Plays ‘Important Role’, Lender Says,” Reuters,August 31, 2019, https://www.scmp.com/news/china/diplomacy/article/3025081/china-isnt- trying-lead-african-countries-debt-trap-plays.

74 China International Studies The Emergence and Fallacy of “China’s Debt-Trap Diplomacy” Narrative American countries and commercial banks have turned away many African countries. In contrast, China has provided financing support through policy banks and various other channels, effectively reducing the financing costs of African countries. Moreover, China opened a joint Capacity Development Center with the IMF to train experts on policy and economics so that countries can make better informed decisions on whether to take up loans.17 On the other hand, China has built a large number of infrastructure facilities through borrowing, thereby laying a good foundation for economic growth and stimulating modernization for developing countries.18 Over the recent decades of its own development, China has accumulated rich experience in infrastructure construction, including both equipment and technical capabilities and management expertise, enabling it to rise from relative obscurity to a dominant position in the international infrastructure industry. As part of Beijing’s “Go Out” policy to encourage Chinese companies to engage in overseas investment, projects were almost exclusively financed by Chinese state-backed bilateral lenders and supported by industrial policies.19 To some extent, China’s experience of “building roads first if you want to get rich” can provide new choices for countries and nations in the world that hope to speed up development and strive to maintain their independence.

China’s outbound investment and financing do not serve political purposes but focus on long-term economic benefits Chinese President Xi Jinping clearly pointed out in his speech at the opening ceremony of the 2018 Beijing summit of the Forum on China-Africa Cooperation (FOCAC) that there should be “no seeking of selfish political

17 Sophie van der Meer, “Demystifying Debt along China’s New Silk Road,” The Diplomat, March 6, 2019, https://thediplomat.com/2019/03/demystifying-debt-along-chinas-new-silk-road/. 18 Justin Yifu Lin and Yan Wang, Going beyond Aid: Development Cooperation for Structural Transformation, pp.73–83. 19 Bushra Bataineh, Michael Bennon and Francis Fukuyama, “Beijing’s Building Boom: How the West Surrendered Global Infrastructure Development to China,” Foreign Affairs, May 21, 2018, https://www. foreignaffairs.com/articles/china/2018-05-21/beijings-building-boom.

The Emergence and Fallacy of “China’s Debt-Trap Diplomacy” Narrative March/April 2020 75 gains in investment and financing cooperation with Africa.”20 In light of the fact that many countries and regions along the BRI routes are in an early stage of development or are even underdeveloped, China should explicitly insist that the BRI works “without attaching any political conditions” and provides “low threshold” loans so that developing countries can have the opportunity to break away from the economic control of the West. Yi Gang, Governor of the People’s Bank of China, pointed out during the second Belt and Road Forum for International Cooperation in 2019 that Chinese financial institutions had provided more than $440 billion for the construction of the BRI.21 Faced with such a high volume of investment, China cannot take high risks and set up what the West calls “debt traps,” because if that were the case, China would most likely fall into its own pit.22 Any investment, however, is commercial in nature, and China’s outbound investments are no exception.23 The return period of infrastructure investments is long, and it is unlikely to be profitable in the short term. Therefore, China attaches more importance to long-term benefits. This is also why China’s infrastructure projects include the element of industrial development. After World War II, most economies that have achieved development have seized the opportunity of industrial adjustment and have carried out their own industrialization and modernization plans by hosting labor-intensive industries. Now China’s labor-intensive industries are about to be released, and the countries along the proposed Belt and Road routes are likely to seize the opportunity and develop as fast as the “Four Asian Dragons”24 in those days. China Merchants Port Holdings Company, which participated in the construction of the Hambantota Port in Sri Lanka, said that they built the Hambantota Port according to the

20 “Full Text of Chinese President Xi Jinping’s Speech at Opening Ceremony of 2018 FOCAC Beijing Summit,” Xinhua, April 25, 2019, http://www.xinhuanet.com/world/2018-09/03/c_1123373881.htm. 21 “Central Bank of China: Private Sector Investment Will Become Main Force of BRI Investment and Financing,” China News, April 25, 2019, http://www.chinanews.com/cj/2019/04-25/8820465.shtml. 22 Matt Ferchen, “China, Venezuela, and the Illusion of Debt-trap Diplomacy,” Asia Global Online, August 16, 2018, https://www.asiaglobalonline.hku.hk/china-venezuela-debt-trap-diplomacy. 23 “15 Misunderstandings about the Belt and Road Initiative,” Belt and Road Portal, April 24, 2019, http://www.brfmc2019.cn/201.shtml. 24 Lin Yifu, “China’s Four Comparative Advantages in the ‘Belt and Road Initiative’,” Caixin, December 4, 2017, http://conferences.caixin.com/2017-12-04/101180174.html.

76 China International Studies The Emergence and Fallacy of “China’s Debt-Trap Diplomacy” Narrative “Shenzhen Shekou model,” that is, to drive the development of the industrial park through port development first, and then the urban development of the whole Hambantota area.25 This is also the intention behind China’s active promotion of the establishment of overseas economic and trade cooperation zones, also known as “overseas special economic zones.”26 This experience, which closely combines overseas capital, infrastructure building, development of export-oriented industries and construction of special economic zones, may help other developing countries to better realize economic and social development and ultimately achieve win-win or multi-win outcomes.27

The model of resources-for-infrastructure helps promote local economic development Following the logic of the “debt-trap diplomacy” narrative, if China intended to plunder local resources, it would not reduce any debt nor agree to a debt moratorium for indebted countries. But the fact is that developing countries have renegotiated about $50 billion of Chinese loans in the past decade, with term extensions, refinancing agreements and debt relief as the most frequent outcomes.28 Furthermore, the loans provided by China are not fully concentrated in natural resources development.29 Objectively, the resources-for-infrastructure model is relatively new, and it is not even unique

25 Zhou Zhiyu, “Pioneer of the Belt and Road Initiative: Globalization of ‘Shenzhen Shekou Model’,” 21st Century Business Herald, December 21, 2017, https://m.21jingji.com/article/20171221/ a175941abe1dd66e77970b8794f5d92f.html. 26 Huang Yupei, “The Development of China-Africa Economic and Trade Cooperation Zone: Challenges and Paths,” International Studies, No.4, 2018, pp.112-126 27 Thomas Farole, Special Economic Zones in Africa: Comparing Performance and Learning from Global Experience, Washington DC: The International Bank for Reconstruction and Development/The World Bank, 2011, p.36; Deborah Brautigam, “African Shenzhen: China’s Special Economic Zones in Africa,” Journal of Modern African Studies, Vol.49, No.1, 2011, pp.27–54. 28 Tom Hancock, “China Renegotiated $50bn in Loans to Developing Countries,” Financial Times, April 29, 2019, https://www.ft.com/content/0b207552-6977-11e9-80c7-60ee53e6681d. 29 For example, Deborah Brautigam, an expert on African issues in the United States, and her research team pointed out that from 2000 to 2014, China provided Africa with a total of about $86 billion in loans, of which investment loans on energy and mining accounted for about 30 percent. See also Deborah Brautigam and Jyhjong Hwang, “Eastern Promises: New Data on Chinese Loans in Africa, 2000 to 2014,” Working Paper No. 2016/4, China-Africa Research Initiative, School of Advanced International Studies, Johns Hopkins University, 2016.

The Emergence and Fallacy of “China’s Debt-Trap Diplomacy” Narrative March/April 2020 77 to China.30 China did not impose this model on its partner countries, but adopted it based on both sides’ interests, which can be reflected especially in China’s infrastructure loans to African nations. On the one hand, China is developing rapidly and has accumulated substantial financial assets, has a booming construction industry and is in urgent need of commodities to satisfy its fast-growing economy. On the other hand, the African continent, generously endowed with largely unexploited natural resources, is lacking the infrastructure and capital to transform its advantages into wealth and eliminate poverty.31 If it works properly, the model of resources-for-infrastructure will help realize a win-win situation. In fact, China’s investment in and financing of overseas infrastructure have indeed contributed to local economic development. As Chinese Foreign Minister Wang Yi has pointed out, the BRI is not a “debt trap” that some countries may fall into, but an “economic pie” that can be shared to benefit the local population. For example, East Africa now has its first motorway, the Maldives has built its first inter-island bridge, Belarus is able to produce passenger vehicles, Kazakhstan is connected to the sea, Southeast Asia is constructing a high-speed railway, and the Eurasian continent is benefiting from the longest-distance freight train service. In Kenya, the Mombasa-Nairobi Railway, built with Chinese assistance and dubbed “a project of the century,” has created nearly 50,000 local jobs and boosted Kenya’s economic growth by 1.5 percentage points.32 During the second Belt and Road Forum on International Cooperation, then IMF Managing Director Christine Lagarde gave a speech appreciating the BRI for stimulating infrastructure investment and unleashing previously untapped economic potential.33 Thus, the point is not that China is setting up a “debt trap,” but

30 Håvard Halland, et al., Resource Financed Infrastructure: A Discussion on a New Form of Infrastructure, Washington D.C.: International Bank for Reconstruction and Development/The World Bank, 2014. 31 Ana Cristina Alves, “China’s ‘Win-Win’ Cooperation: Unpacking the Impact of Infrastructure-for- Resources Deals in Africa,” South Africa Journal of International Affairs, Vol.20, No.2, 2013, p.208. 32 “Wang Yi: BRI Not a ‘Debt Trap’ but an ‘Economic Pie’ that Benefits the Local Population,” China Daily, March 8, 2019, http://cn.chinadaily.com.cn/a/201903/08/WS5c81ddfaa31010568bdce544.html. 33 Christine Lagarde “BRI 2.0: Stronger Frameworks in the New Phase of Belt and Road,” April 26, 2019, https://www.imf.org/en/News/Articles/2019/04/25/sp042619-stronger-frameworks-in-the-new-phase- of-belt-and-road.

78 China International Studies The Emergence and Fallacy of “China’s Debt-Trap Diplomacy” Narrative that overseas infrastructure investment and financing under the BRI represents “globalization with Chinese characteristics.” That is to say, the BRI promotes a form of globalization which is more open, inclusive, balanced, and sustainable.

China is not the only creditor of many countries in debt risks Numerous countries that are facing debt risks have many creditors, including the US, European countries, Japan, the World Bank, the IMF, etc. China is of course not the only creditor. If China is related to the debt risks of some countries, other creditors are equally to blame. In recent years, international public opinion has repeatedly hyped up the allegation that Chinese loans were the direct cause of Sri Lanka’s debt crisis, which is totally unfounded. After all, Sri Lanka has maintained a high government debt ratio since the 1990s, higher than most developing countries. More importantly, although China’s loan to the Sri Lankan government has increased rapidly since 2006, China is still not Sri Lanka’s primary creditor.34 Of the 17 African countries considered by the IMF as under critical debt risks, China is the largest creditor only to some, and most of the debt of these countries come from creditors other than China. Only in a few cases, such as Djibouti, the Republic of the Congo and Zambia, China’s total loans account for more than half of the total foreign debts of these countries. Therefore, it is grossly incorrect to blame China for the debt risks of the majority of these countries. For most African and Latin American countries, “China’s debit and credit is very important” and the accusation that the Chinese government had deliberately “ensnared” indebted countries is “baseless.”35

Causes of Debt Crisis in Developing Countries

To analyze the “China’s debt-trap diplomacy” narrative comprehensively and rationally, we must clarify the causes of the current debt crisis in developing

34 Song Yinghui, et al., “Analysis of ‘China’s Debt-Trap Diplomacy’ Narrative from the Perspective of Sri Lanka’s Government Debt Problem,” Contemporary International Relations, No.6, 2019, pp.5-6. 35 Deborah Brautigam, “Is China the World’s Loan Shark?”

The Emergence and Fallacy of “China’s Debt-Trap Diplomacy” Narrative March/April 2020 79 countries. As a matter of fact, the debt crisis of developing countries is the combined result of internal and external factors.

High debt ratio has been a common feature of developing countries since the end of World War II The conventional view is that governments can stimulate aggregate demand and economic performance in the short run by increasing public debt to make up for fiscal deficits. Some economists even suggested that governments should implement an expansionary fiscal policy during an economic crisis, using debt as a means of financing to maintain social welfare and economic growth.36 After World War II, developing countries’ economic growth was accompanied by a rapid increase in the amount of debt. High debt ratio has been a common feature of developing countries since the end of World War II. It has not suddenly appeared only after China put forward the BRI.37 The debt problem is mainly caused by the weak position of developing countries in the global value chains. In other words, developing countries are mainly engaged in the production and export of raw materials and primary products while importing manufactured goods. In addition, the industrial structures among developing countries are almost identical, which may lead to competition and insufficient gains from trade.38 Therefore, in order to stimulate economic growth and promote industrial transformation and upgrading, many developing countries have allowed the expansion of credit and foreign debts domestically. For example, from the early 1980s to the end of the 1990s, the sovereign debt risks of two types of countries attracted great attention from the international community: the first type includes 17 highly indebted middle-income countries, 12 of which are in Latin America and the Caribbean, with Brazil, Argentina and Mexico as typical examples. The second category consists of low-income

36 María del Carmen Ramos-Herrera and Simón Sosvilla-Rivero, “An Empirical Characterization of the Effects of Public Debt on Economic Growth,” Applied Economics, Vol.49, No.35, 2017, p.3495. 37 Li Ruogu, “Correctly Understanding the Debt Sustainability of Developing Countries,” World Economics and Politics, No.4, 2007, pp.63-72 38 Zhang Guimei, “Research on the Developing Countries’ Gains from Trade under Division of Labor in the Global Value Chains,” doctoral dissertation of Liaoning University, 2011.

80 China International Studies The Emergence and Fallacy of “China’s Debt-Trap Diplomacy” Narrative countries in sub-Saharan Africa, which are also heavily indebted. The foreign debt of the first group of countries mainly comes from Western commercial banks, while the foreign debt of the second group of countries is mainly held by official creditors including the World Bank and the IMF.39

Western quantitative easing has further increased foreign debt of developing countries after the financial crisis After the financial crisis of 2008, the overall foreign debt level of developing countries further increased and reached a peak of $10 trillion in 2018. The debt ratio increased to about 30 percent, significantly exceeding the safety line of 25 percent. Latin America, Eastern Europe and Southeast Asia saw the largest increase on the foreign debt scale.40 Some countries such as Ukraine, Sri Lanka, Malaysia, Chile and Turkey have reached debt ratios as high as 87.68 percent, 66.16 percent, 63.92 percent, 61.75 percent and 57.51 percent respectively in 2018.41 In order to tackle economic difficulties after the 2008 financial crisis, the central banks of the developed economies, led by the United States, successively launched quantitative easing (QE) policies in 2008, 2012 and 2014. As a result, global liquidity rose sharply.42 As the US dollar is the world’s primary reserve, investment and financing as well as trade settlement currency, the sustained loose monetary policy of the US has continuously stimulated the US dollar’s arbitrage nature. In view of the sluggish recovery in developed economies, developing countries, mainly emerging markets, have been experiencing fast economic growth and have shown more attractiveness to capital. Moreover, in order to improve the system of national accounts and stimulate economic growth, a massive amount of US dollars has flowed into developing countries, and net capital inflows continued to increase, eventually causing the extent of foreign debt to expand constantly. According to Figure 2, there is a close relationship between the increase in foreign debt of developing countries and the monetary

39 Stephen P. Riley, ed., The Politics of Global Debt, New York: St. Martin’s Press, 1993, p.2. 40 The data comes from CEIC Data Company. 41 Ibid. 42 Athanasios Orphanides, “Central Bank Policies and the Debt Trap,” Cato Journal, Vol.37, No.2, 2017, pp.223–246.

The Emergence and Fallacy of “China’s Debt-Trap Diplomacy” Narrative March/April 2020 81 expansion of developed economies, with the coefficient being 0.97. Generally speaking, monetary easing aims at meeting the financing needs of all sectors of the market, especially the real economy, by lowering real interest rates and increasing risk appetite. However, the marginal effect of increasing leverage to stimulate the economy is decreasing, which is true for developing countries as well as developed economies. According to data provided by the Bank for International Settlements, the driving effect of increase of debt per unit on the nominal gross domestic product (GDP) in developing countries and developed economies is continuously diminishing, especially in the latter. In 2001, the nominal GDP of developing countries and developed economies could be increased by 0.9 and 0.47 units respectively for each additional unit increase of non-financial sector debt. In 2009, the figure dropped to 0.7 and 0.37 units respectively. In 2018, the data of developing countries further dropped to 0.55 units, while that of developed economies remained at 0.37 units. Although a small number of developing countries were able to restore economic growth soon after the 2008 financial crisis, the global economic recovery is still slow, especially in some European economies. This means that monetary easing policies in developed economies have obvious drawbacks, which not only makes no contribution to satisfy their own economic needs, but also brings about negative effects on the debt problems of developing countries.

Tightening of global liquidity led to sharp rise in the debt risk of developing countries In a loose monetary environment, low interest rates reduce the debt service coverage ratio (DSCR), making it easier for the government to roll over debts and conceal the pressure of debt service, thus facilitating the government to increase its debts. However, once the expectation of monetary easing is reversed and interest rates rise, the hidden debt problem will be exposed quickly. With the tightening of liquidity by the central banks of developed economies led by the US Federal Reserve in recent years, the rise in interest rates, the appreciation of the US dollar, the general decline in commodity prices and the rise in the import prices

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2017, the Federal Reserve started to shrink its balance sheet. At the end of 2017, it raised the benchmark interest rate, causing the debt risk of developing countries represented by emerging markets to surge sharply.44 In December of the same year, the narrative of “China’s debt- trap diplomacy” strongly gained in popularity immediately after it was hyped by Chellaney. There may be a relationship between these two elements. In a word, the internal cause of the debt crisis in many developing countries is the sensitivity and fragility of their domestic economies. The external core factor is the US financial hegemony with the US dollar liquidity as its main manifestation, rather than any “debt trap” made by China.

Conclusion

To sum up, the assertion of “China’s debt-trap diplomacy,” concocted by Western media and politicians headed by the United States, cannot withstand scrutiny because its nature is merely to smear China. Chinese leaders, government agencies and official media have repeatedly refuted the narrative. In the long term, China needs to make efforts to show that the BRI is part of a new round of China’s opening-up to serve the “globalization of shared development,” which is different from the “unequal globalization” led by the West in the past. China could take the opportunity to criticize the notion of “China’s debt-trap diplomacy.” Therefore, by systematically disseminating the BRI, China’s opening- up policy and the globalization concept of shared development, China can point towards a way out for the world that has suffered from anti- globalization and trade protectionism.

44 Chen Weidong, et al., “Evolution of Financial Risks in Emerging Markets under the Background of an Interest Rate Hike in the US,” International Finance, July 2019, p.8

84 China International Studies The Emergence and Fallacy of “China’s Debt-Trap Diplomacy” Narrative