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Are we heading for a Southeast Asian debt crisis?

  • Published at 12:36 am August 27th, 2018
We don’t have to sink
We don’t have to sink Bigstock

We can avoid a debt crisis if we play our cards right. This is the complete part of yesterday’s op-ed

In the span of two years, two South Asian countries, Sri Lanka and Pakistan, are defaulting on their external debt -- all thanks to Chinese infrastructure initiative flurries in the region. 

Sri Lankan Prime Minister RanilWickremesinghe, in 2016, delivered the world a shocking statement: “We still don’t know the exact total debt number,” drawing on the ineluctable fiscal catastrophe. 

The estimate stood at a sweeping $64.9 billion -- $8bn of which is owned by China. Neighbouring country Pakistan, on the brink of seeking an IMF bailout, has a $91.8bn external debt. China’s $62bn infrastructure building program in Pakistan heralded the out of hand spendthrift.

It all started with China’s $8tn Belt and Road Initiative in 68 countries, jousting for regional hegemony, to build railroads, harbours, airports, energy plants in swaths of Asia, Europe, and Africa

At first glance, the plan looks similar to post World War II Marshall Plan, albeit China’s contribution is limited to loans and investment where the US extended grants. China’s initiative is causing consternation primarily because the loans are often offered for opaque deals to countries already battling bureaucratic corruption and political calamity but trying to flourish despite all that, as emerging economies. 

Aside from the fact that China is on a mission to expand global influence, the project is also an effort to prove that Chinese model of development works. Chinese officials considered a plan for Pakistan, known as China Pakistan Economic Corridor (CPEC) as a flagship for their Belt and Road project and went on touting it as a game changer. Three years into China’s plan, Pakistan is grappling with debt crisis, making it a shameful blemish of China’s BRI. 

One might find it surprising to see Chinese President Xi Jinping’s photo alongside with Shehbaz Sharif, the chief minister of Punjab, in Pakistan’s National Election’s campaign banner -- implicates the magnitude of influence China poses in another sovereign state’s domestic matter. 

Among many infrastructure plans, Orange Line, Pakistan’s first metro, epitomizes the problems that surrounds the CPEC. To mention a few, the metro disproportionately serves the populace of Punjab, a Sharif brothers’ stronghold, to bait votes. And, public subsidies are used to operate this $2 million air-conditioned metro.

Critiques of the project identifies most of these deals as contingent on using Chinese contractors. Another ambitious project of China is the Gwadar port. Built by Chinese contractors, its development already spread flares of protest when local fishermen were displaced. 

“91% of revenue at the port will go to China, and only 9% to Pakistani authorities,” predicts the former economic advisor to the Chief Minister of Balochistan Kaiser Bengali. 

What spurred the discontentment among local businessmen are the discriminatory incentives, such as exemption from income tax, sales tax, and import duties which Chinese contractors received. 

Thus, not only are some localities disproportionately being ignored from development on mere political whim, businesses are set up to fail against unfair competition. Although President Xi Jinping promulgated the BRI projects as a formula to “advance the process of common development and regional integration,” it only meant more business for China, and demented debt spiral for the recipients. 

As far as the eyes can see, regional development is not the only motivation. Questionable geo-political interest loomed after China proposed a debt-for-equity swap in Sri-Lanka. A Chinese state-run company now has a 99-year lease of a port in Hambantota city. 

Historically, China is known for pushing failed projects and injecting more money in it. Ostensibly, they took “ghost city” ventures well beyond China’s geographic territory by literally creating a city in the middle of the jungle at Hambantota, Sri Lanka. 

Their adventure ranged from making the most expensive highway to spending $42 million just to remove a rock from a lake. What does Hambantota not have? Deep sea port, a large industrial zone, an LNG plant, an international airport, a tourism zone, conference center, a world-class cricket stadium, some of the best highways in the country -- you name it. 

What it does not have is the crowd to keep it running. This is a trouble authorities often run into with large-scale top-down projects. 

And therein lies the ultimate question:Is China propelling these countries into debt abyss to acquire foreign asset? The series of debt crisis prompted by ambitious projects is putting China in a credibility check regarding geo-political integrity.

Pakistan now has two doors to open to get out of this immediate debt crisis. Either they can take bailout from IMF, or follow Sri Lanka’s lead and sell SOEs to China. 

If the new government does take the bailout from IMF, it would prompt a moral hazard problem in the region. US Secretary of State Mike Pompeo already signalled the unwillingness to use tax dollars to bail out these infrastructure adventures that China has embarked on.

Southeast Asian countries are not looking so good either. Laos is walking headstrong into public debt crisis. Kyrgyzstan, the Maldives, Mongolia, and Tajikistan are teetering on financial instability as well. Cambodia and Afghanistan will owe more than half of their debt to China. 

Malaysia recently made news regarding the same issue, as Prime Minister Mahathir Mohamad proposed to put all the Chinese deals under review with a simple but pragmatic question: “But you must think, how do I repay?”

Amid all the instability, India appears as the oasis in a desert. Being another seasoned player in the region, India has been one of the very first to condemn Chinese large-scale projects across the sub-continent. 

Be that their quest for domination or securing national sovereignty, Pakistan and Sri Lanka’s fate proves they were on the right side of this debate since the inception. Despite the trade war between China and the US, surging debt crisis in the region, the countries’ main stock exchange Sensex is trading all time high. For the time being, India has shielded itself from the financial tremors and showed no signs of going south.

The Hasina administration has dealt commendably with China’s long tradition of reneging. The mounting $10 billion loan came mostly through soft loan at a 2% interest rate

Being an ideal prey for China with small scale economy with potential to grow and comparatively benign economic condition, Bangladesh has done surprisingly well on putting the national interest first. Despite the occasional political fallouts, leaders did not make the sudden injection of Chinese investment a tool to gain political capital, unlike Pakistan. 

The Hasina administration, which is typically reluctant to act on dire needs of social reforms, has dealt commendably with China’s long tradition of reneging. During president Xi Jinpings’s visit in 2016, the two countries signed on nearly 30 projects. The mounting $10 billion loan came mostly through soft loan at a 2% interest rate. 

Later, China tried to renegotiate to convert them into commercial credit, but failed as the administration resisted. Bangladesh’s external debt now stands at about $25bn with a debt-to-GDP ratio of about 27%. Which is not so bad given Bangladesh’s status as middle-income emerging economy. 

Although there is no clear threshold, crossing 40% debt-to-GDP ratio can limit the avenue for growth in developing or emerging economy. Typically, countries of emerging economies make the mistake of betting on their cutting-edge growth, thinking they can service their debt with the projected growth rate. 

In Bangladesh’s case, the government may undertake more ambitious projects counting on booming sectors such as remittance and ready-made garments (RMG), but it must be cautious. For instance, remittance slowdown was a blip in an otherwise booming stretch of GDP. 

It’s not that every country needs to create irretrievable fiscal chaos to push the economy to debt crisis. Historically, when a country in a developing region has failed to service their debt, it prompted creditors to renegotiate loan terms in neighbouring states, often by curtailing payment periods. 

At least that’s how Mexico’s sovereign default rippled through the region’s economy, creating a financial catastrophe, and the world underwent the Latin American debt crisis. It wouldn’t be a brand new surprise if that happens in South/Southeast Asia too. 

There is no doubt that foreign investment can help these countries ease infrastructure and energy bottlenecks. However, they must be cautious to avoid repeating history. 

To alter their debt trajectory, most countries would have to overhaul their tax administration and take austerity measures. South and Southeast Asian countries have potential of becoming emerging economies, and this is not the time to “lose a decade” into debt instability. 

Revana Sharfuddin studies Economics at George Mason University.

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