Chinese lending - hidden risks

I still need to go back to PNJ’s valuation, but this NBER paper on Chinese funding was very interesting and something that might become more important if this COVID-19 crisis extends for more and more months.

The thrust of the paper is that much of China’s external lending has been hidden from the world (this paper came out in 2019 with data that ends in 2017), and because of that, the risks of the financial systems of a number of countries may be understated.

An important thing to know about Chinese loans is that the lenders in China (mostly the state) are looking for something different from what most Western capital is looking for. The majority of Western capital wants yield above all else. Chinese loans have multiple goals: yield, influence, securing commodities, commercial interests, or all of the above.

I found some of the historical analogies interesting, like this one:

“China’s overseas loans share many features with French, German and British 19th century foreign lending, which also tended to be market based, partially collateralized by commodity income, and characterized by a close link of political and commercial interests.” [Italics mine.]

And then looking at how it could play out, lending in the 1970s:

“With a view to financial stability, another relevant historical analogue is the lending boom of the 1970s, when resource-rich, low-income countries received large amounts of syndicated bank loans while commodity prices boomed. The Chinese lending flows during 2008 to 2015 share similarities with the 1970s lending cycle, which did not end happily once commodity prices, export revenues, and economic growth slumped across many of the countries that had gone on a borrowing spree.” [Italics mine.]

Quick aside: One of China’s goals, I would imagine, would be to help internationalization the RMB, the Chinese currency. The US has massive influence and gains a lot of rewards (seigniorage, lower capital costs, ability to punish actors) from being the reserve currency. There are some downsides too, namely that the dollar becomes the safe haven in times of global turmoil, hurting exports. China has wanted to make its own currency more global, but it has largely failed. And it doesn’t seem to be using its lending to accomplish this. The majority of its lending (about 70%) is in USD.

Back to the data: Of course, the first thing that I looked at was Vietnam, and it turns out that they don’t have that much debt. The bigger worries are Cambodia and Laos.

Source: Horn, Rainhart & Trebesch data, chart by Vietecon.com

Source: Horn, Rainhart & Trebesch data, chart by Vietecon.com

Source: Horn, Rainhart & Trebesch data, chart by Vietecon.com

As of the end of 2017, the data shows Vietnam with just $7bn in debt to China, or 3.2% of GDP. The trend was down (for Vietnam and in aggregate). Cambodia is much much more exposed with about the same absolute level of debt ($6.5bn), but that’s 30% of GDP. Laos has much less debt at $4.4bn, but that’s a high percentage of GDP at 26%.

Thailand, Indonesia and the Philippines have Chinese debt that equates to less than 1% of GDP. Malaysia saw a bit pick up in 2016, when it jumped from $0.7bn in debt to $11.9bn, and went up again in 2017. This is about 4% of GDP. I wonder if 1MDB is any part of this uptick.

A point that I want to make again is that much of this has been hidden - about 50% according to the article. For Laos, total “official” external indebtedness goes up from a little over $2bn in 2016 to over $8bn!

Vietnam is intricately linked to China: imports, exports, FDI, and debt. They have competing interests (South China sea) but also similar interests (free trade). It is much like Mexico and the US, or the EU and its smaller non-EU neighbors. But it has mostly stayed away from adding too much debt to this, at least in large figures. It could easily pay down this debt through reserves.

What makes me so nervous is that Vietnam’s neighbors are so closely tied to China, and this new debt data shows that it is even worse than feared. ASEAN is supposed to be, in part, a counterbalance to China, but Laos and Cambodia, two (albeit small) members, have little flexibility when it comes to China, especially in times of crisis. Worst case: Laos and Cambodia can’t pay the debt, then China could take over assets (if these are collateralized) or force other demands in exchange for forgiveness. It could also make it difficult to get funding from Western institutions, like the IMF and World Bank.

And I doubt that Vietnam wants China to have even more influence in its two closest neighbors.