China applies brakes to Africa lending

October 28 was a bad day for Ugandan finance minister Matia Kasaija. Hauled into parliament and grilled over the terms of a $200m Chinese loan for the expansion of Entebbe airport, which serves the capital Kampala, he apologised to the assembled lawmakers. “We shouldn’t have accepted some of the clauses,” he said. “But they told you . . . either you take it or leave it.”

At issue was a contract signed six years earlier with China Eximbank, one that some Ugandan lawmakers, officials and lawyers say undermines national sovereignty. A report by Ugandan newspaper Daily Monitor even suggested that Beijing could seize Entebbe airport, the country’s main international gateway — a claim that echoed accusations of Chinese “debt traps” and one forcefully denied by both governments.

The controversy highlights the challenges that African governments and Chinese banks face following a 20-year lending spree that has made Beijing the continent’s largest source of development finance.

From almost nothing, Chinese banks now make up about one-fifth of all lending to Africa, concentrated in a few strategic or resource-rich countries including Angola, Djibouti, Ethiopia, Kenya and Zambia. Annual lending peaked at a whopping $29.5bn in 2016, according to figures from the China-Africa Research Initiative at Johns Hopkins University, though it fell back in 2019 to a more modest, if still substantial, $7.6bn.

Having dived headlong into the world’s poorest continent, Chinese lenders have grown more cautious as some nations have reached the limit of their borrowing capacity and the prospect of default looms. The IMF lists more than 20 African countries as being in, or at high risk of, debt distress.

In response, lenders, including China Eximbank and China Development Bank, the country’s two main policy banks, have adopted increasingly hardline lending terms. Those conditions, some of which differ markedly from other official creditors, are starting to be tested as pandemic-related economic hardship puts a strain on more indebted African countries.

Xi Jinping reinforced that caution in a video speech to the triennial Forum of China-Africa Cooperation held in Senegal in November 2021. Over the next three years, China’s president said, the country would cut the headline amount of money it supplies to Africa by a third to $40bn and, he implied, redirect lending away from large infrastructure towards a new emphasis on SMEs, green projects and private investment flows.

“China is moving away from this high-volume, high-risk paradigm into one where deals are struck on their own merit, at a smaller and more manageable scale than before,” a forthcoming analysis of China’s lending to Africa by Chatham House, a UK think-tank, will say.

Despite such signs of caution from Beijing, the controversy over the Entebbe airport loan reflects a growing conviction in much of the west and among some academics and campaigners in Africa that Chinese lending is essentially predatory. They point to Chinese control of Sri Lanka’s Hambantota deepwater port through a 99-year lease as evidence of Beijing’s presumed designs on strategic assets in Africa. They also suggest that Chinese lending, including to prestige projects such as the $4bn railway linking Kenya’s port of Mombasa with Nairobi, benefit corrupt elites more than citizens.

“The volume of credit that some [African governments] have binged on makes them dependent beyond any sensible notion of sovereignty,” says Chidi Odinkalu of the Fletcher School of Law and Diplomacy at Tufts University, expressing common misgivings about the sheer volume of Chinese lending and the implied quid pro quos.

“You can’t blame China for looking to secure repayments from dissolute regimes who think money can be free,” he adds. “Africans are running from western conditionality. Now they are locked in a manner of speaking in a Chinese ‘financing wall’.”

‘Toxic’ contract clauses

At the heart of the Entebbe airport controversy are what have been called, by some analysts, “toxic clauses” in the loan contract that require Uganda’s Civil Aviation Authority to channel all revenues into special escrow accounts and submit budgets to China Eximbank for approval — arrangements that are meant to secure the loan. The entire contract is governed by Chinese law and disputes, if they arise, must be settled by arbitration in Beijing.

A detailed waiver of sovereign immunity led some commentators to worry that China could seize the airport if Uganda were to default on the loan. Those concerns echo similar controversies in Kenya and Zambia. Although Chinese loan critics have raised the prospect of strategic assets being seized due to default, in no case has this happened.

Still, writing about the Entebbe airport agreement on Facebook on November 30, Joel Ssenyonyi, head of Uganda’s parliamentary public accounts committee, said: “Given the experience of Zambia with their airport and national broadcaster after a Chinese loan, and recently Kenya with their port, it’s no wonder that Ugandans are concerned.”

Those comments reflect sentiment in much of the continent that China will eventually exert a price for what has, until now at least, been seen as easy lending. The $200m Entebbe airport loan, which carries just a 2 per cent interest rate repayable over 27 years, is cheap by most standards.

Some draw a parallel with western financial institutions, including the IMF and World Bank, which lent generously to African governments in the post-independence period only to impose harsh structural adjustment programmes on them from the 1980s after governments struggled to repay.

“The Chinese will dispense loans fairly quickly and will not ask pesky questions if you mow down protesters in the street, but they need to make sure you pay back their money,” says Daniel Kalinaki, Uganda’s head of editorial at the Nation Media Group, whose Daily Monitor newspaper first revealed the details of the Entebbe contract.

Kalinaki says the “problematic clauses” in the Entebbe contract allow China Eximbank in effect to put the airport under administration, though he also criticises western lenders for what he sees as equally dubious practices including funnelling loans back to their own companies and consultancies. “Africa is being caught in the middle,” he adds, “it has to decide which is the least worst path to take.”

Experts say that some of the concerns over clauses in Chinese contracts are overblown. An immunity waiver, for example, is a standard component of comparable loans made by western governments and agencies. Most experts also dismiss as a myth accusations about China’s supposed intention to entrap borrowers in order to gain control of ports or airports.

“We did not find much evidence of physical infrastructure assets being put up as collateral,” says Bradley Parks, executive director of AidData, a research unit at William & Mary University and co-author of two recent studies on Chinese lending.

However, some of the other legal conditions that rang alarm bells in Kampala — trademark clauses employed by Chinese lenders — may be cause for legitimate concern, experts say. A study published last year found that Chinese state-owned banks use liens, escrow and special accounts to collect revenue from the borrower as a repayment security far more extensively than their international counterparts.

While almost 30 per cent of the 100 Chinese loan contracts examined by the study featured such clauses, only 7 per cent of bilateral creditors from OECD countries in a comparison sample employed them. Moreover, nearly three-quarters of Chinese loan contracts that use special accounts require the borrower to deposit all revenues from the associated project, a particularly draconian requirement.

Although details of the Entebbe airport contract have not been made public, two other China Eximbank loan agreements for infrastructure projects signed with the Ugandan government just months before the airport deal contained escrow account provisions. In both cases, all project revenue was to be funnelled into a debt repayment reserve account, in effect giving Chinese lenders first dibs on revenue if a borrower becomes distressed.

Such debt service reserve accounts, known as DSRAs, are not unusual, bankers and legal experts say. “We do DSRAs all the time,” says a senior official at a European development finance agency. However, while such arrangements are common in limited-recourse project finance, where the lender has only a partial claim on the underlying asset, they are very rare in agreements such as a state-owned international airport, where the borrower is backed by a sovereign state.

‘The Chinese go straight to the president’

As well as escrow accounts, Chinese lenders often include clauses that explicitly exclude the debt owed to them from being included in restructuring arrangements by officials in the Paris Club of bilateral creditors.

Not everyone agrees that escrow accounts and greater monitoring are a bad thing. Chinese banks used to be criticised for lending too easily to governments, allowing them to divert a portion of loans to election campaign coffers or to personal accounts.

Viewed through this lens, management scrutiny and the use of escrow accounts in the Entebbe airport contract could be regarded as positive. “Some African governments feel it is quite useful,” says Hannah Ryder, chief executive of Development Reimagined, an Africa-focused consultancy with its headquarters in China. “It creates some accountability.”

However, lawyers familiar with China Eximbank and China Development Bank say such oversight can be taken too far. “When the amounts to be held in these [escrow] accounts are on the high side, the borrower is right to be complaining,” says one lawyer who has advised China Eximbank on loan documentation. “The same applies when the contract gives the bank wide-ranging powers.”

Legal experts also caution that the use of Chinese law to govern cross-border loans could become a problem if disputes arise.

“The absence of case precedent in Chinese law means there would be a wide degree of discretion for courts to rule in a dispute,” says a lawyer with extensive experience of working with the country’s policy banks. “You also have to consider that English law, New York law or even Hong Kong law, which are more commonly used in cross-border finance, [have been] developed in jurisdictions that are international financial hubs, Chinese law lacks that.”

Chinese lenders have occasionally shown flexibility on loan terms for projects seen as politically important for Beijing, including loans to Djibouti, a small but highly strategic nation on the Red Sea coast that has borrowed heavily from Chinese banks. But most African governments have been given little leeway to alter terms.

Tom Ogwang, a researcher at Mbarara University of Science & Technology who has written about Chinese-financed infrastructure projects in Uganda, says that the technocrats negotiating loans are often not empowered to push back against onerous clauses. “Technically, we have very good people who have the knowledge. The challenge is there’s a lot of politics in all these agreements,” he says. “The Chinese go straight to the president. What they discuss there we don’t know.”

Although Uganda’s parliament has to sign off on loans, Ogwang says, lawmakers are often shown only a preliminary agreement. “Some clauses will be smuggled in by the Chinese, and then, once the loan approaches the repayment schedule, officials want to renegotiate.”

Rising African debt

That is what happened with the Entebbe loan, he says. In March 2019, the Ugandan government sent a delegation to Beijing to renegotiate terms it deemed “very unsuitable”, according to a letter, written by Kasaija, the finance minister and seen by the Financial Times. China Eximbank had already suspended loan disbursements after Kampala failed to implement parts of the contract — delaying construction for a year.

Although China Eximbank refused to amend the agreement, it did try to assuage the concerns of the Ugandan delegation. The bank promised to “make flexible” the condition that all airport revenues be deposited into the escrow account and resumed disbursements after the borrower proved that the repayment reserve account had the required minimum balance. It further “clarified” that its demand to see Ugandan Civil Aviation Authority budgets was for the purpose of review rather than approval, according to the Kasaija letter.

China Eximbank did not respond to a request for comment.

Analysts say the Chinese response reflects a focus on relationships rather than the letter of the contract.

“What gets put on paper and what happens in practice can be very different,” says Yunnan Chen, an expert on Chinese overseas development finance at ODI, a UK-based think-tank. “It is a very bad thing to default on a Chinese lender, but it lies in the nature of Chinese finance to help the borrower to not default,” she says.

Chinese banks have learnt many lessons over two decades of lending to African governments. In the 2000s, they experimented with financing infrastructure in resource-rich countries, such as Angola and Republic of the Congo, by securing loans against oil or mineral shipments or future resource-derived revenues. Chinese policy banks’ penchant for revenue collection accounts is a version of the same model in countries such as Uganda, Kenya and Ethiopia that do not have the natural resources to back loan repayments, experts say.

For Tang Xiaoyang, a professor at Tsinghua University in Beijing, the distinct lending models of Chinese banks are related to the country’s specific circumstances. “Western lenders can get profits from elsewhere, but for Chinese lenders to compete in advanced economies is difficult. So they have to establish new, riskier markets,” he says.

“They also see more similarities with China itself in African countries,” Tang says. “China grew out of poverty very quickly in the last 40 years, and infrastructure played a key role. We combined infrastructure with industrialisation, urbanisation and general growth, so we have experience and confidence in commercialising infrastructure.”

Rising African debt and the economic fallout from the pandemic may force China’s banks to adjust their lending practices yet again. Bankers and lawyers caution that a systemic crisis could overwhelm Chinese banks’ attempts to protect their interests through escrow accounts and exemption from global debt restructuring deals.

“China’s practice of collateralising their loans to sovereigns makes sense if you are thinking in terms of maximising your repayment prospects,” says Parks of AidData. But if debt stress deepens, he adds, this may not be enough.

After issuing 15- to 20-year loans with seven-year grace periods, it is only now that many loans are approaching their critical phase and borrowers are being put to the test. “They have dealt with problems with individual borrowers, but they haven’t undergone a global sovereign debt crisis,” says Parks. “So they will learn; they will adapt again.”

Source: Economy - ft.com