The Limits of China’s Debt Trap

By Phillip Orchard


Summary

This month marks five years since Chinese President Xi Jinping laid out his vision for the Belt and Road Initiative, Beijing’s sprawling infrastructure push spanning dozens of countries, during a pair of visits to Kazakhstan and Indonesia. BRI is less a concrete, well-defined plan and more an umbrella term for a jumble of China-backed projects involving myriad goals, many of them purely commercial. China has an oversize industrial base to keep humming, plus a vast labor pool to keep busy, at a time when it’s entering a prolonged phase of slowing growth. And it has proved adept at combining diplomatic influence with the lending power of its state-owned banks to pry open new opportunities for its firms abroad.

However, a large number of prominent BRI projects appear commercially dubious, at best. Indeed, Chinese firms have been able to win so many contracts so easily in part because BRI is littered with projects that were unable to attract investment from other sources. China has outsize tolerance for risky “white elephants” with poor prospects for ever turning a profit not because it has money to burn. Rather, there are broader economic and strategic dimensions at play. For example, some projects are intended to open up trade routes that bypass maritime chokepoints, while also helping integrate less developed interior Chinese provinces into the global economy to reduce the steep wealth imbalances between the coast and the interior.

What has outside powers on edge, though, is the suspicion that Beijing is using BRI as a sort of Trojan horse to, at minimum, cultivate political influence with which it can tightly align weaker states to China’s strategic interests and weaken the established Western-led liberal order. Powers like India and Australia, which have reason to fear a Chinese encroachment into their traditional spheres of influence, think an overriding goal of BRI is to dramatically expand China’s military footprint as well.

Such concerns manifest most acutely in the series of deepwater ports China is building in strategically valuable locations throughout the Indo-Pacific along what it calls its “Maritime Silk Road,” also commonly referred to as China’s “String of Pearls.” Of course, merely building deepwater ports isn’t the same as building a naval base. Host countries have a vote over how a port is used, and they have their own strategic and political pressures to consider, not to mention the need to balance relations with neighboring powers that have no desire to see a People’s Liberation Army base on their doorstep. But rival governments claim that some BRI projects are set up to snare host countries in “debt traps” and essentially strip them of that vote.

With its international economic and strategic interests expanding, China has good reason to want to develop the military capabilities to protect them. And this requires a network of naval and air bases beyond mainland China. The question is: Can BRI really be the means toward this end? This Deep Dive examines the strategic potential of China’s String of Pearls and the viability of “debtbook diplomacy” as a way to pursue Beijing’s broader aims, with a particular focus on China’s effort to expand its military footprint abroad. It concludes that China’s success or failure will hinge less on economic leverage and more on its ability to convince regional states that their best bets – strategically, militarily and economically – are with Beijing.

The Strategy Behind the String of Pearls

All told, China now has ownership stakes in nearly two-thirds of the world’s major deepwater ports, including long-term leases over ports in strategically valuable locations from Greece to Tanzania to Argentina – and across the Indo-Pacific. Again, most of these are merely commercial ventures, no different from U.S. port terminals operated by firms from Singapore, South Korea and Denmark. The Chinese navy has minimal use for the China-backed Greek port of Piraeus, and minimal hope of ever gaining full-time access to it.

But it’s not hard to see why China’s rivals are wary of certain projects. India sees Chinese port projects in Pakistan, Sri Lanka, Bangladesh, Myanmar and the Maldives as encirclement. Australia sees Chinese projects from Vanuatu to Fiji as an attempt to project power in the same area where the Japanese tried to cut off Australian supply routes in World War II. Japan sees China-backed ports in Malaysia, Thailand and Cambodia as boosting China’s ability to threaten critical flows of natural resources to the home islands.


These ports would certainly have considerable value to the Chinese navy as it seeks to build out its bluewater capabilities. To prevent the U.S. and its allies from being able to close off maritime chokepoints in the Strait of Malacca and what’s known as the first island chain, it needs the ability to take the fight to the enemy deeper into the Pacific. To secure Chinese shipping traffic farther afield and protect its growing investments, it needs to be able to maintain a full-time presence in the Indian Ocean and around the Horn of Africa. To come to the aid of the ever-growing Chinese diaspora and prove to regional states that it can carry the common security burdens currently shouldered primarily by the U.S., it needs to be able to respond quickly and decisively far from Chinese shores. It can’t do any of this without a bluewater navy, and a bluewater navy requires, at minimum, a far-flung network of logistics and support facilities. In other words, BRI’s military dimensions are a logical outgrowth of China’s comprehensive pursuit of national power.

Indeed, Chinese military planners have been fairly open about the navy’s need for a network of bases – and fairly transparent about their support for the String of Pearls to take on dual-use functions – calling for a dozen or more available ports across the globe. Already, Chinese law requires Chinese transportation firms working in ports abroad to provide replenishment services for Chinese naval vessels. Such activities have been taking place since at least 2016, including in Thailand, according to a report by the Center for Advanced Defense Studies.

While China’s overriding interests are clear, though, the notion that Beijing is intentionally trying to snare weaker states in debt traps as a means to military ends is harder to prove. It’s not hard to understand why China’s rivals are concerned about this tactic. There’s a long history of countries mixing commercial and military power for strategic gain, after all. China should know: This is how the U.K. ended up with Hong Kong. And the logic behind such concerns is fairly straightforward. As the Pentagon put it in its latest report on Chinese military power: “Some countries participating in BRI could develop economic dependencies on China, often from over-relying on Chinese capital. Some BRI investments could create potential military advantages for China, should China require access to selected foreign ports to pre-position the necessary logistics support to sustain naval deployments in waters as distant as the Indian Ocean, Mediterranean Sea, and Atlantic Ocean to protect its growing interests.”


 
Yet, such a coercive strategy would carry myriad risks that may needlessly undermine China’s long-term strategic aims. China needs friends, and it’s not yet powerful enough to win allies simply by dictating terms – particularly in a crowded region where multiple other powers hold considerable sway. It’s not 19th-century Britain.

The Anatomy of a Debt Trap: Sri Lanka

The case of how Sri Lanka ended up ceding control – and an unclear degree of sovereignty – over 15,000 acres of land around a deepwater port to a Chinese state-owned firm for 99 years is held up as a cautionary tale about BRI’s harder edges and the attendant risks for Beijing.

No one else would touch the deepwater port Sri Lanka’s former president, Mahinda Rajapaksa, wanted to build in his hometown of Hambantota on the island nation’s southeastern coast. There was some logic to the project. Sri Lanka sits astride the world’s busiest shipping lane; a steady stream of traffic heading between East Asia, the Middle East and Europe is visible from on shore. And Sri Lanka has long been keen to emulate Singapore’s success as a shipping and logistics hub. But the country’s primary existing deepwater port just 150 miles (240 kilometers) away in the capital, Colombo, had slack capacity and was set to undergo its own China-funded expansion, so outside investors saw the Hambantota port as an unviable vanity project by a strongman who had turned the government into a family enterprise.

Beijing had grown cozy with Colombo throughout the first decade of the 2000s, thanks in large part to security assistance that had helped bring about the end of Sri Lanka’s 26-year civil war against the Tamil Tigers and other militant groups – a war that had isolated Rajapaksa’s government from the West over alleged human rights abuses against civilians caught in the crossfire. In 2007, Beijing offered to finance the port with some $307 million provided by its Export-Import Bank at around market rates, but with some conditions. According to leaked diplomatic cables, for example, Beijing demanded that the state-owned China Harbor Engineering Co. be the one to build the port and be allowed to import thousands of Chinese laborers to do it. According to The New York Times, Sri Lankan officials say China also demanded an intel-sharing arrangement regarding activities around the port. An international airport and a cricket stadium were to be built as well, for good measure. The port was completed by 2010 but quickly proved a commercial disaster, berthing just a few dozen ships in its first three years. (The airport lost its only daily commercial flight earlier this year.) In 2012, to make the port more attractive to business, Rajapaksa turned to the Chinese again to finance a $757 million expansion. China agreed, but at much steeper terms, with all outstanding loans to be repaid at a fixed rate of 6.3 percent.

In the 2015 elections, Sri Lanka’s growing dependence on China became a campaign issue. Despite China Harbor reportedly funneling millions of dollars into his campaign to protect its investments, Rajapaksa was swept from office. The new government promptly canceled an order to purchase Chinese fighter jets and launched a slew of investigations into China-fueled corruption. But it inherited the same debts – including, to China, an amount equivalent to more than 8 percent of the country’s gross domestic product – and couldn’t find enough support from other outside sources, forcing it to turn to China almost immediately for another $1 billion to make ends meet. In mid-2017, to wipe its share of the project’s debts from the books, Sri Lanka agreed to a debt-for-equity swap that gave another Chinese state-owned firm, China Merchants Port, 85 percent ownership over the port, plus another 15,000 acres of adjacent land for an industrial zone, for the next century. The Chinese flag was raised over the port amid mass protests in December.

The final agreement includes a stipulation barring foreign navies from accessing the port without Colombo’s permission, and the Sri Lankan government has repeatedly insisted this will be enforced. But it’s not hard to imagine Beijing dangling any number of sticks and carrots to push for naval access. Nor is it hard to imagine Beijing trying to exploit the murky state of sovereignty over the port to force the issue. In 2014, for example, during a state visit by Japanese Prime Minister Shinzo Abe, China put the Rajapaksa government in a diplomatic fix when it quietly docked a nuclear submarine at a part of the Colombo port considered a “Chinese enclave” – rather than a part controlled by the Sri Lankan military that normally hosts visiting warships – reportedly in violation of bilateral protocol. (The new Sri Lankan government managed to turn down a Chinese request for a submarine visit last year without incident.) Yet, there’s only so much military value China can extract from Hambantota without Colombo’s explicit consent. Moreover, in July, Colombo announced that it would move its southern naval headquarters to the Hambantota port, partially as a show of Sri Lankan sovereignty. Meanwhile, India is reportedly in advanced talks to buy a majority stake in the empty airport at Hambantota – a move that would greatly diminish the port’s naval value for China. If a clandestine naval base was ever Beijing’s goal in Hambantota, it appears to have been one that was rather easy to thwart.

There’s also nothing to suggest that China is on the road to securing a green light from Colombo to transform the port into a full-fledged base anytime soon. To push Sri Lanka too far on the point at present would risk making it politically infeasible for Colombo to concede. It would also sow further wariness in other regional capitals over taking on Chinese debt. Hambantota isn’t important enough to jeopardize the whole of BRI. China is playing a long game, though. Its bet on Rajapaksa may have backfired, but governments come and go, and its port holdings in Sri Lanka give it untold influence that will outlast many more. China will have ample opportunities to try to cement a military foothold the old-fashioned way: by coaxing Sri Lanka into more lasting strategic alignment.

Takeaways

Ultimately, the Sri Lanka case tells us several things. One, Chinese leverage from Chinese credit is real. It’s notable that Sri Lanka’s new government took the course that it did. In theory, Colombo could have just defaulted on what it owed to China and moved on. The downside of being a creditor nation is that, if you really need the money back – or if you really need the project you’re financing to be completed and (in China’s case) serve fundamental strategic imperatives – the debtor holds quite a bit of leverage in its own right. But Colombo’s fear of the reputational costs of default, its lack of alternative sources of outside lending, its hope that BRI will eventually pay off for the Sri Lankan economy, and its unwillingness to burn bridges with China suggest that Beijing may be able to reap at least some concessions of strategic value in similar situations elsewhere. But such tactics inevitably have a short shelf life. As China gains a reputation for predatory lending (irrespective of how much it deserves this reputation), and as countries balk increasingly at Chinese funding for dubious projects, Beijing will be left competing for economic influence via investments where it’s not the only one bidding.

Two, political opposition may always be an obstacle for China in BRI countries, particularly with military projects that inflame nationalist concerns about sovereignty. China is struggling to navigate similar political currents in Malaysia, Myanmar, Pakistan and Vietnam, among others. Of course, political pitfalls are inherent to any attempt to establish a military foothold overseas and not automatically insurmountable. Just ask the U.S., which has managed to hold onto bases across the Middle East despite withering and often violent opposition. The U.S. military has even been booted from treaty allies like the Philippines. On Sept. 9, a party in Okinawa opposed to the critical U.S. bases on the island swept local elections. Still, Chinese predatory lending, bribery, reliance on Chinese labor and so forth are probably making Beijing’s political problems particularly vexing. And anti-ethnic Chinese sentiments in a number of BRI states will further complicate things. The cases of Sri Lanka and Malaysia, in particular, cast doubt on China’s ability to win long-term allies in other deeply divided countries like the Maldives, where Beijing is likewise seen as putting its thumb on the scale for one particular party.

Three, to withstand the vagaries of local politics and make sense from one government to the next, a lasting partnership must be anchored in mutual strategic interest. Short-term political interest compelled Manila to expel the U.S. Navy from Subic Bay in 1991. But the two countries’ strategic alignment never really weakened, and within two decades, Manila and Washington were inking a new deal to provide U.S. forces rotational access to five bases. China’s success or failure in Sri Lanka and other BRI states was always going to hinge on its ability to persuade partner states that bringing in the Chinese navy would bring with it tangible and lasting security benefits that work directly in their strategic interest. Money can buy only short-term influence, and debt only short-term leverage.

Take China’s deepening military ties with Pakistan, for example. The future of China-Pakistan relations is by no means smooth sailing, and the debts from its massive BRI project, the China-Pakistan Economic Corridor, have put the new government in Islamabad in a bind. Accordingly, on Sept. 10, the Financial Times reported that Islamabad is seeking to renegotiate the terms of the project. But the bilateral security relationship is rooted in ample common interest – from containing upland militants to counterbalancing against India. As a result, China, which has already been sending warships to the deepwater port it’s building at Gwadar, appears primed to secure the right to build a dedicated naval and air base farther to the west in Jiwani.

In some ways, the prospects for strategic partnerships appear best in countries farthest from Chinese shores – away from the territorial disputes, historical animosities and modern sources of potential conflict that continue to bedevil China’s relations with its closest neighbors. In the same way, U.S. remoteness can at once be a strategic weakness (since countries doubt U.S. willingness to intervene on their behalf) and a strength (since countries have little to fear of a direct U.S. attack).

But the problem for China is that, in pushing out, it’s encroaching on other powers’ traditional spheres of influence, and it’s not yet powerful enough to do so without spurring rival states into action. India won’t let China use BRI to tie Sri Lanka, the Maldives, Bangladesh and so forth without a fight. The same goes for Australia and island nations across the South Pacific, and for Japan and the Philippines, Thailand and Malaysia. Indeed, Japan is deepening involvement as far as Sri Lanka as well; for example, a Japanese warship made a quick visit to Hambantota in April, and the country’s defense minister toured the port last month. In fact, Japan is reportedly coordinating with India and Singapore to develop the deepwater port at Trincomalee farther north. Where China makes a play, other emerging powers are making counters (while learning to coordinate with one another, and the U.S., in the process).

In other words, China is facing stormy seas ahead. To win over the strategically located allies whose ports it needs, China has to prove capable of delivering the security benefits everyone else won’t or can’t – it has to give them ample reason to take on the political risks at home, shrug off pressure from China’s rivals, stop hedging their bets and throw their lot in with Beijing. But China cannot easily prove this capability until it has access to their ports. The U.S. network of friends and friendly ports came about through epochal shifts in the geopolitical landscape that left it as the sole guarantor of security on the global seas. Debt traps alone will do little to help China skip to the front of the line.

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