Stephen Kaplan: China faces ‘creditor trap’ in lending to Latin America

China will be more cautious about extending loans to Latin American countries after difficulties securing repayment suggest it has sometimes fallen into a “creditor trap,” according to the author of a new book on Beijing’s lending to the region.

Yet China won’t abandon state-to-state lending as it still sees loans as a tool to boost exports, Stephen Kaplan, a former economist at the New York Federal Reserve, said in an interview about his recently published Globalizing Patient Capital: The Political Economy of Chinese Finance in the Americas. 

Kaplan, who is now an associate professor at George Washington University, estimates China’s two major state policy banks had nearly US$67 billion of outstanding loans to Latin American governments by 2017, up from just US$5 billion a decade earlier.

Washington sees China’s lending as part of strategic competition in the region, labeling it a “debt trap.” Kaplan argues that, to extend its influence, Beijing has been reluctant to impose political conditions – such as demand for fiscal austerity – on its lenders, sometimes making it more vulnerable to defaults, such as in Venezuela. 

President Xi Jinping was faced with two difficult cases on the sidelines of the Winter Olympics in Beijing this month when the leaders of Ecuador and Argentina visited. Ecuador’s Guillermo Lasso obtained Xi’s support for a renegotiation of close to US$4.6 billion in debt, while Argentina’s Alberto Fernández secured US$23.7 billion in Chinese financing, mainly for infrastructure projects, amid talks with the International Monetary Fund to avoid default.

Here are extracts of the interview with Kaplan, which has been lightly edited for clarity.

What’s your view of Beijing’s motivation for lending in Latin America?

I see them as strategically trying to maximise their market internationally. Chinese development banks tend to look at how to expand China’s commercial presence in an entire sector, often a key sector like nuclear power or renewables. When you look at the content of these deals, you have a lot of capital inputs – machinery and turbines – coming in from China. In order to expand commerce, they are willing to take more risk compared to a World Bank loan. 

What I argue is that China is moving up a learning curve as a creditor, that’s why I term it a “creditor trap” at times. Effectively, they are trying to figure out ways of interacting as a financier internationally, and also adhere to longstanding foreign policy principles like non-interference in internal affairs. They want to avoid policy conditionality on their loans. So they need to have other ways of hedging their risk and so the argument I make is that they are hedging the risk more with commercial conditionality. The way they hedge risks are with natural resources either as collateral for loans, or as a means of repayment in the event of a default.

Your data analysis found that China’s state lending to Latin America is a form of “patient capital” – less likely to exit the region in times of economic turbulence than Western finance. Why does that matter?

As countries become more reliant on Chinese financing, the findings show that countries have more fiscal space, as proxied by higher fiscal deficits.  

There are lots of examples. In the five years after the global financial crisis, Bolivia was slow to tap Chinese financing, so we still saw initially budgetary surpluses. But then with the commodity downturn, Bolivia sourced about US$2 billion from China, a fifth of their overall external debt, and we started to see more deficit financing. In Costa Rica you see when western financing exits, China agrees to purchase bonds from Costa Rica, allowing them to have an inflow of financing that covers counter-cyclical spending.

You argue China’s lending could reinforce natural resource dependency and slow industrial development in developing countries. How have Latin American governments tried to avoid that?

In Argentina, we did see them make requests for greater local content. Brazil didn’t want to enter Chinese deals because of local content requirements. A country that is more dependent on China for financing has found that more difficult to do. Ecuador had a peak of two fifths of external financing coming from China. So they had less flexibility in terms of demanding local content compared to Brazil.

China’s lending to Latin America paused during the first year of the pandemic, yet deals continue, such as US$8.3 billion for a Chinese-designed nuclear power plant in Argentina. What’s the outlook?

That deal falls into the patient capital, market maximisation approach. Argentina will get below market-rate financing, and China’s trying to build market share in a sector. State-to-state financing is still very good for breaking into new markets, that’s why I think that this kind of financing is still likely to be in China’s toolkit. There’s probably more risk aversion with big state-to-state lending than there was historically because of Covid and the previous commodity downturn, US rates moving up and trade war uncertainty. That might make Chinese bankers more hesitant to commit. 

Following the pandemic shock to their economies, the prospect of restructuring and default looms for several countries in the region. How will Beijing engage with that process?

The big question is how much bilateral restructuring China is willing to do, and how much they will work through multilateral frameworks. In some cases it might make more sense to allow the IMF to come in as it has done in Ecuador. The China Development Bank (CDB) is one of Latin America’s main creditors, and they tend to renegotiate bilaterally. When we saw the [Lenín] Moreno administration come in in Ecuador, the CDB was fairly willing to restructure that debt. 

The CDB and China’s Export-Import Bank committed US$1 billion of new loans to Ecuador, about one percent of GDP, and said it was one of the lowest rates. Why such a low rate? In Ecuador we were seeing less favourable views among the public toward China. In the wake of the issues surrounding Venezuela’s debt moratorium, if you start to see multiple countries having debt problems that’s not great for soft power, so there was a real incentive for China to restructure. Domestically, there’s a tendency for Chinese banks to roll over loans and wait for better times.