4 THE LATECOMER’S CHALLENGE

Export Credit Agencies

Given that policy banks support the overseas business of Chinese firms, they are often juxtaposed with a set of PFAs that facilitate export finance. In OECD’s terminology, these PFAs are export credit agencies (ECAs)—that is, financial agencies through which governments provide state-backed credits and insurances in support of national exporters’ competition for overseas business.¹² For example, the Export-Import Bank of the United States (originally named the Export-Import Bank of Washington) has been financing American exporters since 1934, Germany’s Credit Institute for Reconstruction (better known as KfW) has supported the country’s export and international project finance since the 1940s, and the Export-Import Bank of Japan (now Japan Bank for International Cooperation) has taken charge of financing for Japanese firms’ overseas business since the 1950s.

Some ECAs are government departments, some are state-owned independent corporations, and others are private companies.¹³ They generally offer two kinds of financial support to firms: direct loans (also known as credits) and credit insurances and guarantees (also known as pure cover). In the first case, an ECA provides direct funding to firms, whereas in the second instance, a commercial bank provides the capital and the ECA insures and guarantees it. Clients of ECAs can be corporations—importers and exporters in home and host countries—as well as financial institutions and sovereign entities in host countries. While ECAs offer a variety of financial schemes tailored to the specific needs of different clients, the overall goal of offering these financial services is to facilitate the cross-border business development of the firms in the ECA’s home country.

Compared with commercial lenders that also support firms’ international business, ECAs are usually considered “creditors of last resort,” offering relatively longer-term, larger-volume, and lower-cost capital to industrial and infrastructure projects that have difficulties attracting commercial lenders. The reason ECAs are able to offer such finance is because they are backed by the state in one way or another—namely, by receiving budgetary revenue, by being subsidized by government funding, or by having their fundraising process guaranteed by sovereign credibility.

The OECD Export Credit Group (ECG) regulates the ECAs of most advanced industrial economies. Its main purpose is to prevent member countries from conducting vicious trade competition through excessive state subsidization. All OECD members except Chile, Costa Rica, and Iceland are ECG members.¹⁴ As of May 2023, 34 OECD member countries are in the ECG. All of them are high-income countries except for Türkiye, Mexico, and Colombia, which are upper-middle-income countries. Each member country has one or two official ECAs regulated by the ECG (table 4.2). Some of them are export-import banks offering direct credits, some are official insurers or guarantors, and some do both. For example, the United States has one ECA regulated by the ECG, the Export-Import Bank of the United States, which provides both direct credits and pure cover. Japan has two ECAs regulated by the ECG: Japan Bank for International Cooperation, which offers direct credits, and the Nippon Export and Investment Insurance, which offers pure cover. Germany’s only ECG-regulated ECA, Euler Hermes Aktiengesellschaft, offers pure cover only.

As introduced in chapter 3, China has two official ECAs: the China Exim and the China Export & Credit Insurance Corporation (Sinosure). The China Exim provides direct loans primarily, and Sinosure provides insurances and guarantees. The CDB is not an ECA by definition because its mandate is to finance infrastructure and industrial projects and because it still conducts the majority of its business at home. But it offers large volumes of credits that support Chinese firms’ export and cross-border investments, which has led to complaints from Western exporters about the CDB competing with them, according to a report the U.S. Exim generated in 2020.¹⁵ In other words, the CDB’s bulky overseas lending has made it a de facto ECA.

The U.S. Exim’s report and its “China and Transformational Exports” program may appear to indicate a large business overlap and competition between China’s PFAs and the OECD-regulated ECAs, but in fact, the lending destinations of the two groups of PFAs differ significantly. OECD-regulated ECAs finance projects occur primarily in better-off markets. Between 2009 and 2019, almost half of the official export credits of OECD member countries flowed to high-income countries, and roughly 30 percent of them flowed to upper-middle-income countries. Credits to lower-middle-income and low-income countries accounted for less than a fifth (figure 4.1). In those years, the top-ten destinations of OECD member countries’ official export credits were the United States, Russia, Turkey, the United Kingdom, the United Arab Emirates, Brazil, Saudi Arabia, India, Mexico, and China (figure 4.2).

TABLE 4.2. ECAs involved in the work of the OECD Export Credit Group, May 2023

China’s policy banks, by contrast, lend predominantly to developing regions. Since neither the CDB nor the China Exim publish official data on where they provide financing, in making this statement, I rely on secondary data collected by Boston University’s Global Development Policy Center (GDP Center), which has captured the geographical distributions of policy-bank lending. The GDP Center has two databases—China’s Overseas Development Finance Database and China’s Global Energy Finance Database—focused on the loans made by the CDB and the China Exim. The former records policy-bank loans to sovereign borrowers, excluding loans to corporate borrowers, between 2008 and 2019. The latter traces policy-bank loans to both government and corporate borrowers in the energy sector between 2000 and 2020.¹⁶ Neither database captures the full picture of policy-bank lending, which would include both government and corporate lending in multiple sectors, but they provide the most comprehensive information to date.

According to the overseas development finance database, top destinations for China’s policy-bank loans were low-income and middle-income countries: Venezuela, Pakistan, Russia, Angola, Brazil, Ecuador, Argentina, Iran, Indonesia, and Turkmenistan, among others (figure 4.3). According to the global energy finance database, top destinations for China’s policy-bank loans were Russia, Brazil, Pakistan, Angola, Nigeria, Indonesia, Vietnam, the United Kingdom, Venezuela, and India, among others. All of them were low-income and middle-income countries, except for the United Kingdom (figure 4.4). Both databases show that policy-bank lending in high-income countries took up a small portion (less than 7 percent) of total overseas lending, and the dominant share was in lower-middle-income, upper-middle-income, and low-income countries (figure 4.5).

Sinosure, China’s official insurer, offers short-term (less than two years) export credit insurance, medium- and long-term (more than two years) credit insurance, and overseas investment insurance to Chinese firms conducting business overseas. The latter two kinds of financial services are most relevant to infrastructure and industrial financing. Medium- and long-term insurance is primarily employed for capital equipment transactions and infrastructure projects.¹⁷ Overseas investment insurance is usually employed to finance more profitable projects and to support firms’ investments in the equity shares of these projects. The fact that Sinosure covers policy-bank loans indicates a business overlap between the insurer and the two policy banks. For example, a firm may borrow from the China Exim and purchase insurance from Sinosure. That said, given that Sinosure also collaborates with Chinese commercial banks and not just the policy banks, a presentation of the insurer’s global business distribution illustrates a more complete picture of China’s official export finance.

Sinosure has published aggregated data by continents in its annual reports.¹⁸ Between 2013 and 2018, the annual amounts of medium- and long-term export credit insurance in North America (less than 1 percent), Oceania (less than 1 percent), and Europe (less than 15 percent) took up only a small proportion of the company’s annual coverage as China’s official export insurer; insurance in Asia and Africa accounted for the largest proportions (figure 4.6). Similarly, Sinosure’s overseas investment insurance did not support the “richer regions” to a large extent but focused on Asia primarily (60–70 percent; figure 4.7). The two figures imply that Sinosure’s main clients covered by these two kinds of insurance, which are China’s international contractors and investors, do not focus on projects in regions with the highest income levels. Overall, the OECD-regulated ECAs conduct business in regions that are relatively more developed than the CDB, the China Exim, and Sinosure.

Aid Agencies

The significant difference in lending destinations of Chinese PFAs and OECD-regulated ECAs raises the question of whether the two sets of PFAs are actually comparable. Indeed, despite their large amount of financial support for Chinese firms, policy banks are often perceived as development-oriented “aid agencies” because the majority of their credits flow to developing regions. In advanced industrial economies, however, the main kind of PFAs that finance projects in those regions are official aid agencies instead of ECAs.

The OECD largely leads the international governance of bilateral aid-giving, and the main organization that regulates official aid agencies of advanced industrial economies is the OECD Development Assistance Committee (DAC). By defining what “development assistance” is, the DAC determines to what extent and under what conditions poor countries receive capital for development. To qualify as official development assistance (ODA), according to the OECD’s definition, a loan must meet three conditions: (1) it must be provided by a government organ (as opposed to a private investor), (2) it must serve the development purposes of the recipient countries (as opposed to commercial or political purposes of donor countries), and (3) it must have a grant element of at least 25 percent. “Grant element” is a measurement of the softness of loans. The higher the grant element is, the more favorable the loan is to the borrower. A minimum requirement regarding the grant element implies that a loan has to be sufficiently concessional to be calculated as ODA. Official credits that do not meet the third condition (that is, they are insufficiently concessional) are calculated as other official flows (OOF). Export credits that serve development purposes, thus, are calculated as OOF.¹⁹

In addition to defining what ODA is, the DAC also decides who receives ODA. The ODA recipient list consists of those countries the World Bank identifies as low- and middle-income (according to per capita gross national income) and those the United Nations identifies as the world’s least developed countries. The list is updated every three years, and the DAC removes those countries that have exceeded the high-income threshold for three consecutive years.²⁰ In other words, a country has to be sufficiently underdeveloped in order to receive ODA from the DAC.²¹ According to official data, the top ODA recipients between 2010 and 2019 were Afghanistan, India, Ethiopia, Vietnam, Iraq, Democratic Republic of the Congo, Pakistan, and Syria, among others (figure 4.8).

The reason that the DAC has become the most powerful international institution regulating foreign assistance is that its members are the major credit providers in the world. The DAC currently has 30 members, including the European Union. All of them are high-income countries. Member countries usually have a corresponding government ministry—in most cases, either an economic ministry or a foreign-affairs ministry—in charge of administering aid-giving, in addition to an official aid agency mandated to implement ODA disbursement (table 4.3). For example, in the United States, the State Department guides ODA policies, and the U.S. Agency for International Development manages the majority of ODA. In Germany, the Federal Ministry for Economic Cooperation and Development leads foreign aid-giving, and two other agencies implement such processes: the German Agency for International Cooperation (for technical cooperation) and the KfW (for financial cooperation). In Japan, the Ministry of Foreign Affairs supervises aid-giving, and the Japan International Cooperation Agency implements aid disbursements. In some countries such as the United Kingdom, a government office, not an independent public agency, implements foreign aid policies. The DAC holds high-level meetings attended by corresponding government ministers and senior-level meetings attended by the heads of aid agencies of the member countries.²²

Aid agencies usually receive budgetary funding from the donor country’s government. They are thus able to provide grants, interest-free loans, and long-term and low-interest rate concessional loans to public borrowers in underdeveloped regions. This implies that, unlike an ECA, an aid agency is less commercially driven and usually cannot keep a financial balance solely based on the revenues it generates from the projects it finances.

China is not a member of the DAC and therefore does not refer to its foreign aid as “official development assistance.” The Chinese equivalent of ODA is foreign aid/assistance (duiwai yuanzhu). As discussed in chapter 3, China’s policy banks are not aid agencies. The Ministry of Commerce managed the vast majority of China’s government foreign aid until 2018, when the China International Development Cooperation Agency was formed and partly took over that role. Nor does budgetary funding subsidize the loans that the policy banks make, except the China Exim’s small portion of government concessional loans, which are capitalized by the bank’s own funding and subsidized by fiscal revenue from China’s Ministry of Finance. This implies that policy banks resemble ECAs more than aid agencies in terms of how they lend. Yet, in terms of where they lend, policy banks seem to have more overlap with DAC-regulated aid agencies. All top-15 destinations of policy banks’ sovereign lending in the past decade (figure 4.3) were also on the DAC’s recipient list.

TABLE 4.3. Aid agencies and supervisory ministries of OECD member countries

That being said, the difference between China’s foreign assistance and policy-bank lending is not as significant as that between the ODA and export finance of OECD countries. As figure 4.2 and figure 4.8 suggest, export credits and development assistance disbursed by OECD member countries demonstrated starkly distinctive preferences—the former targeted high-income and upper-middle-income regions primarily, whereas the latter assisted low-income and middle-income regions. In China’s case, however, both foreign aid and policy-bank lending supported low- and middle-income regions mainly. In the 2013–2018 period, 45.73 percent of China’s foreign aid flowed to the least developed countries, 34.77 percent to lower-middle-income countries, 14.87 percent to upper-middle-income countries, and the rest to international organizations and others.²³ Policy-bank credits did not support low-income countries as much (less than 20 percent), but they mainly flowed to lower-middle-income and upper-middle-income countries as well (figure 4.5). To put it simply, advanced industrial economies finance relatively less developed regions with aid or concessional loans and relatively developed regions with commercially oriented export credits, whereas China does not distinguish the two as much. Both the CDB and the China Exim finance developing countries mainly, offering loans to both government borrowers that seek to capitalize their infrastructure projects and corporate borrowers that seek to explore overseas business opportunities.

Development Banks

The policy banks resemble business-serving ECAs in terms of how they finance and development-oriented aid agencies in terms of where they finance. As such, they are comparable to a third kind of PFA—development banks mandated to finance development-oriented projects. Compared with development assistance/aid, “development finance” is a broader concept. Development assistance has a connotation of concessional financing and involves a certain degree of state subsidization by donor countries, whereas development finance incorporates a wider range of financial activities that are either state-subsidized or purely commercial. That is to say, development banks and policy banks are alike both in terms of where they finance and how they finance.

In the contemporary era, development finance for most advanced industrial economies implies a sense of “otherness”—that is, the finance of underdeveloped economies, as the lending countries themselves have already undergone industrialization decades or hundreds of years ago and no longer need to finance as many domestic projects. But in China, the term “development finance” (kaifaxing jinrong) involves the financing of the country’s own development, as China is still going through urbanization and industrialization. Given the different developmental stages of their home countries, policy banks (especially the CDB, because it primarily finances domestic projects) and their Western counterparts are not necessarily comparable with respect to domestic finance in the same time period. Rather, policy banks are more comparable to PFAs of other countries when those countries were at the same developmental stage. As American economic historian Rondo Cameron wrote in 1953, “Continental Europe in the mid-nineteenth century was as much an underdeveloped area as India, South Africa, or any of the leading Latin-American countries today.” It was the long-term financial agency Crédit Mobilier, argued Cameron, that mobilized credits and capitalized railway constructions.²⁴ Like China’s policy banks in the twenty-first century, then the French agency expanded its business scope beyond its home country, exporting skills, institutions, and ideas across borders and contributing to industrial development in European countries such as Germany, Austria, Spain, and Switzerland.

More contemporary counterparts of China’s policy banks are national development banks (NDBs), especially Germany’s KfW and the Development Bank of Japan (DBJ), on which the CDB has intentionally modeled itself (see chapter 1). Both were established in the early postwar era (KfW in 1948 and DBJ in 1951).²⁵ In addition, both played a primary role in facilitating their respective countries’ economic reconstruction and continued industrialization.²⁶ Many developing countries, on gaining independence in the early postwar decades, also established NDBs to foster industrialization.²⁷ NDBs of developing economies are more comparable to Chinese policy banks, given the similar developmental stage of their respective economies.²⁸ However, these economies are not major decision makers of the existing international regimes, and their NDBs are therefore not discussed in detail here.

Nowadays, NDBs of advanced industrial economies no longer serve the goal of industrializing the national economy. Large industrial firms of these economies can raise capital from private investors rather than official creditors. Western NDBs or long-term financial agencies that used to contribute greatly to the industrialization of their respective countries have thus been dissolved, merged into other financial institutions, or if they still exist today, they have switched their main functions from financing large-scale industrial projects to supporting newly emerged areas such as small and medium enterprise (SME) finance, climate finance, and the financing of technological development.²⁹ The CDB resembles these Western NDBs in that it is also actively engaged in financing emergent areas and capitalizing SMEs, innovative technological companies, and climate-friendly projects. However, the majority of CDB credits have been flowing to the industrial and infrastructure sectors through loans to large national enterprises and local government financial vehicles (see chapter 2).

Policy banks are comparable to multilateral development banks (MDBs) rather than to NDBs in terms of their role in overseas development finance. MDBs include the World Bank, which is a major U.S.-led institution created at the end of the World War II to rebuild the global economic order, and the many regional development banks, namely, the European Investment Bank, Asian Development Bank, African Development Bank, and Inter-American Development Bank, among others. Peking University’s development finance institution dataset identified 38 regional MDBs in 2019.³⁰ Regional MDBs are not regulated under a specific international regime, but many of them are modeled on the World Bank and affected by the norms and rules that it set up.³¹

Policy banks resemble Western MDBs to a large extent in terms of how and where they finance. Both types of banks employ a wide range of financial instruments, including state-subsidized concessional finance and business-driven equity investments to finance the developing world. This can be seen from the internal structure of the World Bank. The World Bank consists of two institutions: the International Bank for Reconstruction and Development (IBRD), which lends to governments of middle-income and creditworthy low-income countries, and the International Development Association (IDA), which provides concessional loans and grants to the poorest countries. The IBRD raises most of its funds by issuing bonds on the international financial market, whereas capital contributions from the governments of its member countries primarily funded IDA. The United States has been the largest contributor to IDA.³² In addition to the IBRD and IDA, the World Bank Group includes more market-based institutions: the International Financial Corporation (IFC) and the Multilateral Investment Guarantee Agency (MIGA). The IFC seeks to facilitate development by incentivizing private investors to finance commercially viable projects, and it offers a more diverse set of financial services such as loans, equity, and blended finance; MIGA provides guarantees (political risk insurance and credit enhancement) to investors and lenders. That is to say, the World Bank Group employs financial instruments that are both state-subsidized and market-based to finance the developing world. While IDA loans are primarily government-funded, the IBRD, the IFC, and MIGA generally operate under a market logic.

Policy banks also employ a wide range of financial instruments. Their non-concessional lending, which takes up the majority of their total lending (see chapter 3), resembles IBRD lending to a large extent, as both the Chinese banks and the IBRD aim to finance development-oriented projects in a financially viable way, and both raise funds by issuing bonds to market investors. The China Exim’s small portion of concessional lending resembles IDA lending, which targets the least developed regions primarily and has the most favorable terms of all Chinese overseas bank loans. The CDB has also created subsidiaries that resemble the IFC—namely, the China-Africa Development Fund and the CDB Capital Co. Ltd., which conduct equity investment in commercially viable projects. Like MIGA, the China Exim offers guarantees to support trade finance.

Existing research has compared the global finance of policy banks and that of Western-led MDBs in terms of their volumes, terms, lending destinations, and impact on developing countries.³³ Yet the two are not the most comparable cases when it comes to international rulemaking because policy banks are national financial agencies whereas MDBs are intergovernmental institutions. The World Bank can be understood as the crystallization of an international regime, while the PFAs are regulated under international regimes.³⁴ More specifically, the World Bank is a decision-making body that determines important international rules of development financing, whereas national PFAs are among the agents those rules affect. Some scholarship has compared the Asian Infrastructure Investment Bank, a China-led MDB established in 2016, to the Work Bank when examining the impact of China’s rise on Western-led development finance rules.³⁵

In short, development banks (NDBs and MDBs) led by advanced industrial economies share many similarities with China’s policy banks; yet they are often not considered the most comparable “Western counterparts” of policy banks. NDBs in advanced industrial economies played important roles in capitalizing industrial development decades or hundreds of years ago, but nowadays their main financial mandates have gone beyond facilitating national industrial development. Chinese policy banks, by contrast, remain the main financiers of China’s industrialization. Western-led MDBs and Chinese policy banks finance similar kinds of overseas development projects. They also share similar financing rationales, employing both government-supported funding and business-driven investments to foster development. Yet, MDBs are intergovernmental institutions and therefore not perceived as the most comparable counterparts of the national policy banks when considering their respective impacts on international rulemaking.

To summarize, no category of Western PFAs can be considered the perfect analogue to policy banks. Given that they provide state-backed financial support for national firms’ global business, policy banks are comparable to official ECAs regulated by the OECD ECG; in terms of the regions they finance, policy banks are comparable to aid agencies regulated by the OECD DAC; considering both the kind of projects they finance and the financial instruments they employ, policy banks are comparable to development banks. Regardless of which PFAs the policy banks are compared with, however, there is no doubt that the Chinese banks have become the world’s leading development finance providers in terms of size (figure 4.9) and that they have been reshaping the international regimes that regulate the PFAs of advanced industrial economies.

China and the International Aid Regime

While most discussions contrast a state-directed development finance approach practiced by China with a market-based development finance approach practiced by the United States and other Western economies, a closer examination of the undergirding logic of the Western-led international aid regime shows the opposite. Throughout the postwar decades, advanced industrial economies primarily advocated and practiced a gift-like, state-led means of development assistance while catch-up economies practiced a business-oriented means of development finance. Further, the practices of policy banks and Western aid agencies have begun to converge since the 2008 global financial crisis, as advanced industrial economies have increasingly adopted a more self-interest-driven approach to development finance, incorporating commercially oriented business actors in facilitating global development.

When the Organization for European Economic Cooperation, the predecessor of OECD, was founded in 1948, it focused primarily on restoring the European economy. This soon began to change in the 1950s against the backdrop of decolonization and the Cold War. Former colonies gained independence and sought to reconnect with the international society, and the two superpowers, the United States and the Soviet Union, started to use development assistance as a foreign-policy tool to ally with an emerging Third World.³⁶ By providing capital, expertise, and their respective prescriptions to development, the two superpowers demonstrated their understanding of what development was and presented the “underdeveloped” countries pathways to prosperity. As stated in the World Bank’s official history, “Economic development emerged as a shared global enterprise, linking poor countries that had little in common but poverty, and tying rich and poor through the mutual need for security and a growing sense of moral obligation.”³⁷

In the early1960s, the OEEC restructured to become the OECD and revised its mandates from financing Europe to financing the newly emerged “developing world.” In the Resolution of the Common Aid Effort adopted in March 1961, the Development Assistance Group (predecessor of the OECD DAC) highlighted the necessity of using concessional credits to finance underdeveloped regions:

While private and public finance extended on commercial terms is valuable and should be encouraged, the needs of some of the less-developed countries at the present time are such that the common aid effort should provide for expanded assistance in the form of grants or loans on favorable terms, including long maturities where this is justified in order to prevent the burden of external debt from becoming too heavy.³⁸

This shift from “finance on commercial terms” to “assistance on favorable terms” highlighted a core rationale of DAC-led development assistance—that is, an association between “concessionality” and “underdeveloped-ness.” In other words, the poor need the assistance of the rich in order to develop. Behind this association is the role of the state in allocating and pricing capital: the concessional portion of an ODA loan—or more specifically, the margin between a DAC concessional loan and a market-based commercial loan—needs to be covered by the donor country’s government revenue. The DAC is thus a mechanism that transfers government revenue from donor to recipient countries.

Many scholarly works have pointed out the government-led nature of such a means of aid-giving and the hierarchical nature of the DAC-led international aid regime and questioned the efficacy of government-to-government foreign assistance.³⁹ Revenue-based aid is essentially a “gift” from donor countries that does not need to be repaid as much as loans on commercial terms. While it helps mitigate recipient countries’ pressure for repayment, it also disincentivizes them to use the capital in a profit-generating way. Furthermore, it transfers the repayment pressure to the taxpayers of the donor countries.

This traditional means of North–South development assistance has been challenged by emergent donors. Japan, for example, was accused by Western DAC donors for practicing “mercantilist” foreign assistance (that is, tied aid). In the immediate postwar decades, Japanese ODA was tied to the products and services of Japanese firms; in other words, a project financed by Japanese ODA must be contracted to Japanese companies. For Japan, development assistance was part of its industrial policy. The money not only assisted developing countries but also Japanese firms exploring overseas markets. There are both advantages and disadvantages of this means development assistance. On a positive side, it limited the use of ODA funding on given projects, preventing misallocation of capital; it also largely ensured the implementation of ODA projects by incorporating firms with business incentives to complete the projects.⁴⁰ On a negative side, as ODA loans were essentially state-subsidized credits, tying them with business activities may lead to violation of fair-trade principles. In the 1970s and the 1980s, as Japan’s economy grew and its firms became globally competitive, fellow OECD member states began to pressure Japan, urging it to untie ODA loans and practice more gift-like development assistance.⁴¹

Yet, since the 2008 global financial crisis, criticisms of “mercantilist” development assistance have waned drastically. In contrast, advanced industrial economies and the multilateral development finance institutions led by these economies have acknowledged and advocated for engaging business actors in development finance. For example, the OECD has developed the concept Total Official Support for Sustainable Development (TOSSD) over the past decade, bringing up a new measurement for development-oriented capital. Instead of requiring concessionality on development assistance, the TOSSD mechanism encourages the participation of profit-seeking business capital in facilitating development by incorporating the calculation of “private capital mobilized by government intervention.”⁴² Similarly, the World Bank Group initiated the IDA-IFC-MIGA Private Sector Window in 2017, aiming to mobilize private-sector investments in IDA-only countries.⁴³ In Europe, regional MDBs such as the European Investment Bank have begun to serve as a main financial channel to offset the constraints of fiscal austerity in the post–global financial crisis era, using public credits to support infrastructure finance and SME investments.⁴⁴ On a national level, advanced industrial economies, including the United Kingdom, Australia, New Zealand, Canada, the Netherlands, and Japan, have begun to (re)adopt mercantilist development policies, engaging private-sector actors in development projects and retying aid to national firms.⁴⁵ Even the United States, which used to criticize Japan’s mercantilist development assistance, established the U.S. International Development Finance Corporation (DFC) in 2020, aiming to mobilize private-sector investment to participate in economic development.

The reason for this huge policy turnaround is twofold. On the one hand, the 2008 global financial crisis impaired the fiscal capacity of traditional DAC donors. To alleviate fiscal burden, they need to seek alternative means of development finance, such as incorporating emergent donors into international cooperation frameworks and encouraging burden sharing with private-sector investments. On the other hand, China has contributed more and more capital to global development and made the unorthodox mercantilist approach mainstream.⁴⁶ A recipient of Japanese ODA since the late 1970s, China has emulated the way Japan had conducted ODA projects, using foreign assistance as a tool for facilitating trade and industrial policies. As chapter 3 illustrated, China’s government foreign assistance is almost completely tied and has supported the overseas business expansion of national firms alongside policy-bank loans. Advocating mutual benefits and economic connectivity instead of charitable gift-giving, China has promoted South–South development cooperation with other developing countries. To counter China’s increasing influence in the developing world, the United States adopted an “American” strategy—founding the DFC, creating the Build Back Better World initiative, and calling on the G7 countries to practice an “alternative” development finance approach based on business-driven investments.

Regardless of whether their goal is to engage China to share the fiscal burden for financing global development or to counter the rise of China as a major development player, advanced industrial economies have undoubtedly encouraged a more business-oriented development finance approach that differs starkly from the traditional state-led development assistance approach. Despite the fact that these new policies and practices are framed to be an alternative to the bulky Chinese development finance, the Western approach is in fact converging with the Chinese approach or, broadly speaking, the “Southern” approach. Scholars have conceptualized this change as the rise of “retroliberalism,” the emergence of a “development as de-risking paradigm,” or the “Southernization” of the international aid regime.⁴⁷

This, however, is not to say that emergent Southern development finance providers like China are crowding out DAC donors. Obtaining grants and loans from China does not prevent host countries from receiving them from others. As the funding gap for development is huge, Southern development partners and DAC donors can practice development finance or assistance simultaneously without necessarily competing with one another. Furthermore, compared with advanced industrial economies, late-developed economies like China have a comparative advantage in practicing business-oriented development finance because firms from these economies are more likely to participate in projects in lower-income countries than their Western counterparts do.

Throughout the postwar decades, Western-led financial institutions have in fact never given up the options of blended finance in which public funds are used to mobilize private investment in development projects. On a multilateral level, the World Bank’s IFC has played an important role in mobilizing private capital for development since its inception in 1956. Moreover, the IBRD and the IFC identified a network of development finance companies in various countries that, since the 1950s, have acted as intermediatory institutions to conduct industrial investments in developing and emerging markets.⁴⁸ On a national level, the United States founded the Overseas Private Investment Corporation (the predecessor of the DFC) in 1971 to conduct profit-generating investments in developing countries. Nevertheless, these market-based development finance instruments practiced by advanced industrial economies have their limitations. Theoretically, PFAs are expected to play a risk-sharing role, thereby incentivizing private investments in poor economies. But for decades, development finance institutions struggled to mobilize large amount of private capital, as many development-oriented projects in low- and middle-income countries were simply not suitable for private actors, even if official finance from the World Bank or other PFAs shared some of the risks.⁴⁹ The challenge persists today. According to estimates by the Overseas Development Institute, in 2019, $1 of public investment by MDBs and development finance institutions mobilizes only $0.37 of private finance in low-income countries, and $1.06 in lower-middle income countries and $0.65 in upper-middle income countries.⁵⁰ The Center for Global Development’s estimation also shows that private finance mobilized by multilateral development finance institutions in low-income economies has been rather limited.⁵¹

Advanced industrial economies practicing blended finance must determine who could be mobilized to partake in the projects that are not commercially appealing. Unlike firms of catch-up economies, which rely largely on credits from PFAs to conduct business overseas, firms of advanced industrial economies can raise capital from commercial investors and do not necessarily need to resort to official creditors. This also explains why many NDBs of advanced industrial economies have switched their main function from industrial finance to microfinance or SME finance—large industrial champions can borrow from commercial investors or buy insurance from ECAs instead of joining blended-finance projects initiated by development finance institutions. There are therefore doubts as to whether the DFC can achieve its foreign-policy objective and development objective—rivaling China with private investments and fostering international development primarily in low-income and lower-middle-income countries—at the same time. A commentary by the Center for Global Development points out that in 2020, its first year of operation, the DFC provided 40 percent of its total credits to upper-middle-income economies and almost 3 percent to high-income economies, financing projects that primarily reflected foreign-policy objectives rather than development needs. For example, the DFC announced a $300 million investment to finance energy projects in high-income countries across Eastern Europe, a $190 million investment to finance a 5G-enabled submarine fiber-optic cable to connect Singapore (high income) and the United States, and up to $3.5 billion of refinancing for Ecuador’s (upper-middle income) Chinese debt in exchange for excluding Huawei from its 5G network.⁵²

For Southern development partners like China, fostering global development can be achieved by supporting national firms’ overseas business. This is their advantage as late-developed economies. As chapter 3 shows, quite often, Chinese firms doing business in an underdeveloped region have played important roles in facilitating projects taking place there. For instance, contractors like China Harbor lobbied hard to bring about the first phase of the Hambantota Port project in Sri Lanka. For these contractors, conducting business in a foreign developing country may not differ as much from conducting business in China. But the difference is significantly larger if, say, an American firm were to move its business from the United States to an underdeveloped region. This is why, as figures 4.1 to 4.8 illustrate, the destinations of business-serving export credits and development-oriented aid of OECD-regulated countries diverge largely, whereas the destinations of China’s export credits and foreign assistance overlap significantly.

To summarize, the Western-led international aid regime has not functioned primarily on laissez-faire principles. On the contrary, since it emerged in the late 1950s and early 1960s, the undergirding rationale of this international regime has largely relied on the role of the state in allocating and pricing credits. Government subsidization from donor countries has been a crucial factor enabling concessional financing for recipient countries. In the post–global financial crisis era, such a state-based mechanism has begun to morph. Facing fiscal challenges, DAC donors adopted alternative means of development finance, mobilizing private capital and incorporating business actors to undertake projects in developing regions. This mercantilist approach was often associated with the industrial policies of catch-up economies and discouraged in mainstream development financing. The rise of China as well as other emerging Southern development partners has accelerated such a change, not because Chinese aid crowds out Western aid but because China’s increasing influence in the developing world has incentivized incumbent rulemakers to respond with an alternative. Against this backdrop, the development finance policy of China and of advanced industrial economies have begun to converge, as they both adopt a self-interest-driven, business-oriented rationale. However, compared with late-developed economies, advanced industrial economies do not have an advantage in financing development projects in a commercially oriented way. For decades, they have had difficulties mobilizing large amounts of profit-seeking private investments to undertake projects in the developing world, especially low-income and lower-middle-income economies. Whether the big turnaround in the years since the global financial crisis can yield the intended outcome requires further examination.

China and the International Export Credit Regime

Another way to interpret China’s business-oriented development finance and its relations with existing international regime is through the lens of export finance. In fact, it is difficult to draw a hard line between China’s bilateral development finance and export finance because both are state-backed finance that benefits firms’ overseas business. As discussed previously, the OECD regulates two sets of bilateral PFAs: aid agencies and ECAs. While the regulation of aid agencies falls under the international aid regime, the regulation of ECAs falls under the international export credit regime, or the international trade regime, broadly speaking.⁵³ The way the OECD disciplines these two sets of PFAs can be characterized as dichotomous—that is, development assistance is explicitly demarcated from export credits and prohibited from being used as an instrument for supporting export.⁵⁴

International cooperation on export finance can be dated back to 1934, when private and public credit insurers from France, Italy, Spain, and the United Kingdom formed a union, now known as the Berne Union, to exchange trade information and reduce commercial risks collectively. The OECD-led export credit regime, nonetheless, did not come into being until the 1970s against the backdrop of the oil crisis, when OECD member countries rivaled one another through export subsidization.⁵⁵ To prevent an export credit war, these industrial economies, especially the United States, sought collaboration to restrain excessive use of export credits. What symbolized the formation of the export credit regime was a “consensus” reached in 1976 and later crystalized in 1978 as the Arrangement on Guidelines for Officially Supported Export Credit, also known as the “gentlemen’s agreement.” The Arrangement placed limitations on the terms and conditions of export credits and required certain levels of information sharing among members.⁵⁶ Essentially, the formation of this regime was a solution to a collective action problem: without coordination, each member has the incentive to unilaterally increase its official export support, but as a result, everyone spends more budgetary revenue on export subsidization and no one is better off; with coordination, the group becomes better off as a whole. The rationale underlying this regime is starkly different from that of the international aid regime. While the aid regime relies on the role of the state in allocating and pricing credits, the export credit regime aims to limit the role of the state in intervening in market activities.

While the Arrangement placed restrictions on export credits, it did not discipline aid-giving. OECD ECG members thus could use tied aid as a way to circumvent the restrictions of the Arrangement. As discussed above, Japan had been tying ODA to national exporters throughout the first three postwar decades. European countries also practiced tied aid. Consequently, aid loans that were supposed to be supporting low-income and lower-middle-income countries were relocated to upper-middle-income and even high-income countries, as they were used as export credits to serve firms’ business pursuits.⁵⁷ Facing these challenges, the United States initiated new rounds of negotiations to revise the agreement and discipline tied aid, which resulted in the Wallén Package in 1987 and the Helsinki Package in 1991. The former raised the minimum concessionality level for tied aid and revised the way of calculating softness, and the latter prohibited the use of tied aid on richer developing economies and projects that should be financed commercially.⁵⁸ These disciplines further demarcated development-oriented aid from business-oriented export credits.

The emergence of gigantic volumes of Chinese credits since the twenty-first century has nonetheless contested the OECD-led international export credit regime. Like Japan, China challenged the U.S.-led international rules by supporting national firms, both state-owned and privately owned. China’s commercial bank loans, policy-bank loans, as well as foreign assistance (almost entirely tied) assisted Chinese exporters, investors, contractors, and suppliers in obtaining business opportunities overseas (see chapter 3 for more details). However, China differs from most of its industrial precursors in that it is not a member of the OECD. While the United States could discipline the export finance of Japan, France, and other industrial competitors by renegotiating OECD arrangements, it could not place the same restriction on China.

Yet the export credit regime is inefficient if it does not include China, which is now the world’s largest export credit provider. The United States thus intended to drag China into the game led by advanced industrial economies, despite China’s reluctance. In 2012, Washington and Beijing agreed to establish an international working group (IWG) on export credit management that was said to be an outcome of the United States’ failed attempt to persuade China to join the OECD ECG.⁵⁹ The IWG consisted of 18 members, including nine ECG members (Australia, Canada, the European Union, Japan, South Korea, New Zealand, Norway, Switzerland, and the United States) and nine non-ECG members (Brazil, China, India, Indonesia, Israel, Malaysia, Russia, South Africa, and Turkey). It was China that insisted on the incorporation of the latter eight members for the purpose of increasing the representativeness of emerging economies.⁶⁰ The first IWG meeting was held in February 2012, attended by the ECAs of China and the United States (U.S. Exim, China Exim, and Sinosure) and their fiscal departments (U.S. Department of the Treasury and China’s Ministry of Finance). The two sides sought to reach an agreement on substantial matters by 2014.⁶¹ However, the negotiation was unsuccessful in the ensuing years. China and many other emergent economies saw joining this collaborative mechanism as bringing more restraints than benefits, because they needed state-backed export credits to facilitate industrial development. After eight years of consultation, the IWG was suspended, as the positions of its members remained “significantly divergent with respect to commitments on core issues, transparency in particular,” according to a joint statement by the IWG in 2020.⁶²

Not only has cooperation been suspended, but the United States has switched to adopting an antagonistic approach in response to China’s reluctance to collaborate on export credits through a multilateral framework. In 2020, the U.S. Exim established the “China and Transformational Exports” program, which the president of the bank referred as “one of the most significant initiatives in Exim’s 86-year history.” Employing export credits with terms and conditions that are “fully competitive with rates, terms, and other conditions established by the People’s Republic of China or by other covered countries,” the program seeks to support U.S. cutting-edge industries such as artificial intelligence, biotechnology, biomedical sciences, wireless communications equipment, quantum computing, renewable energy, semiconductor and semiconductor machinery manufacturing, emerging financial technologies, water treatment and sanitation, and high-performance computing.⁶³

The intensifying rivalry seems to illustrate a typical story of a late-developed economy using state-backed preferential credits with favorable terms and conditions to catch up with earlier industrialized economies. However, the interplay between China’s rise and the U.S.-led export credit regime is more than just a “clash.” Two things add peculiarity to the Chinese version of catch-up. First, unlike what conventional literature has captured, loans offered by policy banks, as chapters 1-3 show, are not necessarily cheap. The policy banks’ costly bond-based funding mechanism does not allow them to finance projects with an average interest rate below the bond yields. The interest rates of policy-bank loans, therefore, are often no lower than that offered in the international capital market. What is more, since many DAC members use official aid as opposed to export credits to finance projects in developing countries, the policy banks—which are not aid agencies—often do not have a price advantage when competing with DAC-regulated aid agencies. For example, China competed fiercely with Japan in bidding for Indonesia’s Jakarta-Bandung High-Speed Railway project; the CDB offered its cheapest possible option—a loan of 2 percent interest rate—but even such a condition was much less concessional than the loans that the Japan International Cooperation Agency (Japan’s official aid agency) offered, which had an interest rate close to zero.⁶⁴

In fact, not all Chinese firms choose to borrow from policy banks because of the cost of such loans. As illustrated in chapter 3, Chinese investors like Tsingshan Iron & Steel borrowed from policy banks because they were the first financial agencies willing to offer support in an emerging market to be explored (see chapter 3). By the same token, Chinese contractors suggested that the governments of developing countries seek loans from the policy banks not necessarily as a way to increase the contractors’ competitiveness in bidding by obtaining the cheapest possible funding but because other financiers had little interest in the types of projects they were pursuing. In many cases, Chinese contractors and suppliers were able to provide products and services that were already cheaper than that of their competitors, and they did not have to rely on the official “cheap credits” to create a price advantage for the Chinese consortium. The comparative advantage that the policy banks created for Chinese firms was that they supported the host governments, especially those of low-income and lower-middle-income economies, in jump-starting projects in the first place.

This leads to the second peculiar feature of China’s challenge to the existing international export credit regime. As figures 4.1 to 4.5 show, China’s policy-bank loans cover developing regions (low income, lower-middle income, and upper-middle income) primarily, whereas OECD countries’ export credits target high-income and upper-middle-income countries. In other words, the two business scopes do not always overlap. While they support China’s industrial champions’ competition with their Western counterparts, policy banks also assist national firms in obtaining contracts in lower-income countries, which firms and investors from advanced industrial economies are not necessarily interested in competing for (see chapter 3).

To summarize, the rise of China as a major development finance provider does not simply yield a rivalry between the challenger and the incumbent powers. The impacts of policy-bank loans on the international aid regime and the international export credit regime are different, as the underlying rationale of these two Western-led regimes are quite the opposite. In response to China’s growing influence, traditional DAC donors have increasingly advocated and adopted a market-based, business-oriented means of development finance. Thus, the Chinese and the Western approach are converging. The ECG-regulated export credit regime is to some extent undermined by China’s state-backed export finance supporting its national firms, implying increasing contestation between the rising and incumbent powers. Yet, China’s export credits have, to a large extent, supported projects in developing countries, which firms of advanced industrial economies are not interested in undertaking. In this way, China has filled a funding gap in underdeveloped regions insufficiently covered by either development assistance or export finance from advanced industrial economies.

China and the International Sovereign Debt Regime

Yet the filling of the funding gap by China’s policy banks has led to controversies in the global governance of sovereign debt relief, an issue area that has drawn growing attention. As discussed previously, most Western-led official bilateral finance in underdeveloped regions has been government-funded grants or loans with a high degree of concessionality, disbursed through the OECD DAC-regulated aid agencies; business-driven export finance by OECD ECG-regulated ECAs favors more developed markets and has limited presence in lower-income regions (figure 4.1). Chinese bilateral finance in underdeveloped regions, on the other hand, has been both state-supported and commercially oriented, because loans are backed up by the state’s credibility and driven by the business incentives of Chinese firms and banks. Such a difference has resulted in a contestation between China and the international sovereign debt regime governed by the IMF and the Paris Club.

The IMF is an international institution mandated to monitor global financial stability and a Bretton Woods institution of the U.S.-led postwar economic order. The Paris Club is an informal group of official bilateral creditors that aims to coordinate debt resolution. There are 22 permanent members of the Paris Club, most of which are OECD countries. Like the OECD ECG, the Paris Club is a solution to a collective action problem. Through information sharing and coordination, the mechanism restrains member countries (creditors) from free-riding on one another’s debt relief, avoiding the scenario in which a debtor uses capital obtained from debt relief by some countries to repay debts owed to other countries. The IMF and the Paris Club have developed a set process in resolving debts, which generally consists of two parts. First, the debtor country would discuss with the IMF to obtain financial assistance upon adopting a package of IMF-suggested macroeconomic policies that aim to restore the debtor’s creditworthiness; second, after receiving an IMF arrangement, the debtor country would discuss with the Paris Club to receive measures for alleviating its debt burden.

The rise of China as a major bilateral creditor to the developing world challenges the Western-led sovereign debt regime. Some Chinese banks’ contracts include “no Paris Club clauses,” which explicitly state that debts owed to China should be managed separately from debts owed to other creditors, such as Paris Club members, and should not be included in debt restructuring plans conducted by multilateral institutions such as the IMF.⁶⁵ Traditional creditors have tried to engage China in collective debt relief frameworks, but China has not officially joined the Paris Club and has kept a cautious attitude towards debt restructuring led by the West.

There are three main disparities between the ways China and the IMF/Paris Club resolve debt issues. A first disparity centers on the “conditionality principle” of the Paris Club. That is, the implementation of a policy reform program supported by the IMF is a prior condition for receiving debt relief from the Paris Club. The goal of this principle is to ensure that the debtor country is taking necessary steps, such as making adjustments in fiscal and monetary policies, to restore its economic and financial situation. China, however, does not link the debt relief of a single project to the macroeconomic conditions of the debtor country. When making lending decisions, policy banks usually request ex ante guarantees and collaterals from the public borrower if the project being appraised does not seem to be generating sufficient revenue for repayment (see chapter 3). Furthermore, the Chinese government has been practicing a noninterference principle as one of its fundamental foreign-policy principles since the 1950s and prefers not to interfere in the domestic economic policymaking of the debtor countries.

A second disparity relates to the “comparability of treatment principle” of the Paris Club, which states that a debtor country that signs a debt relief agreement with a Paris Club creditor should not provide better terms to bilateral creditors who are not members of the Paris Club (for example, China), including commercial and official creditors. This principle prevents debtor countries from using capital made available from restructuring debts owed to Paris Club creditors to repay debts owed to non–Paris Club creditors. An issue relating to the comparability of treatment principle is the seniority of creditors—the order through which creditors are repaid by the same debtor. Usually, multilateral financial institutions (the IMF, the World Bank, and other MDBs) have the highest priority, meaning that if a debtor has money to make a repayment, these institutions are the first ones to be repaid, followed by official bilateral creditors, bond holders, and private creditors.⁶⁶

The way policy banks resolve debts, nonetheless, contests these existing rules and practices. First, policy banks do not disclose the details of their loans. Paris Club creditors therefore are not able to know through open channels what debtor countries have promised to the Chinese banks in the event of default. Second, as chapter 3 points out, policy banks in some cases financialize borrowing government’s credibility to hedge against potential risks—for example, by requesting sovereign guarantees or collateralizing export revenues to ensure repayments. The banks’ ex ante bilateral contracts may give them priority over other creditors in the queue of debt collection, including the most senior creditors such as the World Bank. The World Bank’s Negative Pledge Clause, in fact, aims to prohibit borrowers from using public assets to repay other creditors before itself.⁶⁷

A third disparity lies in debt relief measures. Western creditors employ a variety of measures, including write-offs (reduction and cancellation of principals), reducing interest rates, rescheduling repayments, and refinancing with extended credit lines. While China has been practicing all these measures, it is reluctant to reduce or cancel policy-bank loans. Thus far, it has only canceled some of the interest-free loans capitalized by the Chinese government’s revenue and not involving funding from the policy banks.⁶⁸ In 2020, China joined the Debt Service Suspension Initiative (DSSI) led by the Group of 20 (G20), which suspended the debt repayments of 73 poorest countries to official bilateral creditors. This was seen as a significant step China has made toward managing debt issues through a multilateral framework.⁶⁹ Despite that, China has not made attempts to write off debts owed to policy banks. In a public speech at the Boao Forum for Asia in April 2021, Hu Xiaolian, then president of the China Exim, highlighted that the interests of both creditors and debtors should be considered: “Debt suspension is neither debt reduction nor debt cancellation. It is an adjustment made to tackle difficulties at specific times. One should not take this opportunity to harm China’s interests or take advantage of China. [Debt reduction and cancellation] is impossible and weakens financial sustainability.”⁷⁰ The CDB, which China identifies as a commercial lender as opposed to an “official bilateral creditor,” is not included in the DSSI, despite the fact that it has been a major creditor to many of the DSSI debtors.

The policy banks’ aversion to debt reduction can be understood through a historical lens. As discussed in chapters 1 and 2, policy banks were created to resolve problems of centrally planned fiscal and financial systems, and they have endeavored throughout their course of development to transform from the state’s bookkeepers to real banks functioning on their own funding and lending decisions. They are indeed official financiers backed by the state’s sovereign credibility in their fundraising, but they receive limited direct budgetary funding from the central government. Similarly, the Chinese government is unlikely to bail out the state banks’ losses. Since the 1980s, the state has conducted rounds of institutional reforms, adopting various financial means such as creating asset management companies and practicing debt-equity swaps to downsize the large volumes of nonperforming loans owed by state-owned enterprises to state-owned financial institutions. When facing the domestic challenge that a large number of local government financial vehicles (LGFVs) could not repay their loans owed to Chinese banks, the central government has insisted on using market tools rather than fiscal bailouts to resolve debt issues, advocating loan-bond conversions and public-private partnerships to (re-)finance existing projects (see chapter 2). To ask Chinese banks to wipe out debts or to ask the Chinese government to make up the losses for the banks would mean pushing China back to the “past,” which it has struggled to move away from through decades of market-oriented reforms.

In fact, China’s aversion to write-offs was not peculiar. The Paris Club also resisted the practice of debt reduction in its first few decades of existence, from 1956 through the late 1980s. During that period, the Paris Club practiced debt rescheduling, restructuring, and refinancing, or what it still calls the “classic terms” only. For example, when dealing with Argentina’s debt problem in the 1950s and 1960s, the IMF/Paris Club offered refinancing packages: the IMF provided a standby arrangement, the U.S. Exim and other American banks extended new credit lines, the U.S. Treasury offered a repurchase agreement, and the terms of the refinancing arrangements were extended twice in the 1960s.⁷¹ These debt measures were gradually replaced by more concessional measures in the 1980s, when excessive debts owed to commercial banks, in addition to official bilateral creditors and multilateral financial institutions, yielded the Latin America debt crisis. Continued debt suspension and new money did not resolve the crisis but incentivized the debtor governments to overspend, exacerbating the situation. By the end of the 1980s, the Paris Club creditors began to realize that it was impossible to find a way out of the vicious debt cycle without write-offs.⁷²

The mainstream practice of developing country sovereign debt relief thus began to change. In 1988, the Paris Club for the first time offered partial debt reduction under the “Toronto terms.”⁷³ In the subsequent years, the Paris Club put forward various other terms, increasingly offering more generous debt treatments to developing countries. Commercial creditors also agreed to reduce debts to middle-income countries under the U.S.-initiated Brady Plan in 1989, indicating a significant change in private banks’ debt relief measures. The plan allowed debtor governments to convert existing loans into “Brady bonds” with discounted face value or yields, which was essentially a reduction. The Brady bonds were guaranteed by the U.S. Treasury’s zero-coupon bonds, and the IMF offered financial support for the debtor governments to purchase these zero-coupon bonds.⁷⁴ After private and official bilateral creditors, multilateral institutions—the most senior creditors—also started to forgive debts. In 1996, the Bretton Woods institutions, namely the IMF and the World Bank, launched the Heavily Indebted Poor Countries Initiative, offering over 30 IDA-only countries debt reduction. In 2005, the IMF, the World Bank, and the African Development Fund started to provide more debt reduction through the Multilateral Debt Relief Initiative.

Yet debt reduction by public creditors (bilateral or multilateral) is controversial, because it may involve the use of budgetary revenue of creditor governments (through fiscal allocation or contributors’ donation) to bail out commercial financing in developing countries. Furthermore, it may incentivize commercial creditors to free-ride on such relief, thereby increasing the debt burden of the borrowers. The multilateral institutions have thus developed a debt surveillance mechanism to constrain unsustainable financing.⁷⁵ In 2005, the IMF and the World Bank created a debt sustainability framework, which set debt-burden thresholds to assess low-income countries’ debt sustainability and limit their imprudent borrowing. The next year, the World Bank announced its non-concessional borrowing policy, which disciplined IDA countries’ commercial borrowing by determining the volumes and terms of IDA loans to these countries.⁷⁶ These rules have disincentivized business-oriented, non-concessional lending in debtor countries, further demarcating export finance from development assistance by advanced industrial economies; in addition, these rules have reinforced the role of the Bretton Woods institutions in governing sovereign debt relief. Through the lens of Western institutions, China’s bilateral development finance, which has been mostly non-concessional, would therefore not improve the situation but raise the debt levels of debtor countries. Furthermore, it would weaken the debt surveillance mechanism because Chinese banks do not require policy adjustment by debtor governments to receive their loans.

China, however, sets policy based on the belief that time and continued financing can solve debt problems. As chapter 2 illustrates, China’s debt-generated “virtuous circle” of development is built on the assumption that loans for infrastructure and industrial projects would eventually (though the process may take long) lead to urban and industrial development, which would raise fiscal and land revenue and allow local public borrowers to repay their loans in the long run. When subnational governments and their corresponding LGFVs fail to repay loans, policy banks and other domestic financiers would refinance, restructure, and reschedule existing debts using various market instruments, because the central government will not bail them out. China’s response to the round of global debt relief during and after the COVID-19 pandemic has reflected such a view. In resolving Sri Lanka’s debt issues, for example, China offered new loans and moratoriums. In 2020, the CDB signed a financial facility agreement of $500 million with Sri Lanka’s finance ministry.⁷⁷ In 2021, the bank signed another 2-billion-renminbi credit agreement.⁷⁸ In 2023, the China Exim Bank offered Sri Lanka an extension on its debts due in 2022 and 2023.⁷⁹

The distinction between the Western approach and the Chinese approach raises the question as to which approach is more effective: debt forgiveness or continued rescheduling, refinancing, and restructuring. It also raises the question of whether the policy banks will keep practicing the latter approach or become more accepting of debt forgiveness, as traditional creditors did in the late 1980s, thereby aligning with the current Western approach. Emergent evidence suggests that such a change is unlikely anytime soon. While China has shown an increasingly positive attitude to working jointly with traditional creditors—for instance, it has joined the Common Framework for Debt Treatments initiated by the G20, cochaired Paris Club meetings on restructuring Zambia’s debts, and suspended the largest amount of debt service payment among all G20 members—it has not made an effort to write off bank loans. Instead, China has urged Western multilaterals and commercial creditors to take part in debt reduction and suspension.⁸⁰ Two of China’s top think tanks, the Finance Research Institute of China’s central bank and the Chinese Academy of Social Sciences, have put forward debt relief proposals based on a “state-supported, market-based” rationale. That is, debtor governments buy zero-yield bonds issued by the Chinese government or the policy banks; using these bonds as guarantees, debtor governments can issue offshore renminbi bonds on the international market and convert existing loans into offshore bonds.⁸¹ Essentially, the proposed solution was an emulation of the Brady Plan, and yet the Chinese version explicitly excluded the debt reduction part, as both proposals highlighted that debt reduction would create a moral hazard and should not be practiced.

Are Chinese policy banks truly going to resolve debt issues through continued rescheduling, restructuring, and refinancing, without requiring macroeconomic policy adjustments in the debtor countries? Even if we assume that China is going to resolve its domestic debt issues through continued financialization, is the same approach applicable to other countries, given the starkly different domestic institutions between China and the debtor countries? While exploring the answers to these questions, China itself has come to a turning point, as chapter 5 will describe.