China’s value to Latin America has long been clear. Trade between the two sides has soared in recent years, hitting €207bn ($225bn) in 2014, according to data from the European Commission. That makes China the second largest importer of Latin American goods (mostly raw soft and hard commodities) after the US, and the third largest exporter to the region after the US and the European bloc of nations.
But what is often overlooked is China’s increasingly crucial role as a provider of commercial and developmental funding.
It can be viably argued that the most important policy lender at work in Latin America, at least in terms of its sheer ability to rustle up vast amounts of long term financing for regional sovereigns and corporates, is no longer the International Monetary Fund or even the Inter-American Development Bank, but the China Development Bank and, to a lesser extent, the Export-Import Bank of China (Chexim).
And while China’s seemingly limitless ability to stump up cash to finance everything from hydroelectric dams to railroads to soybean processors may be gratefully received by cash-strapped governments, it does raise some serious questions. For instance: has Latin America become too addicted to Chinese financing? Are governments using capital to fund infrastructure projects or merely to plug gaps in budgets (or worse)? And what would happen if this easy new form of funding were to disappear if, say, China, struggling to rebalance its economy, were to suffer a full blown financial crisis of its own?
Others, conversely, have begun to ask whether mainland policy lenders, under orders to lend by their Chinese paymasters, have become too financially trigger-happy. Why are CDB and Chexim so willing to splash their cash in Latin America? Do they have a coherent financial strategy in place or are they simply keen to ingratiate themselves with any government, from true growth generators to pariah states? And what happens if a major borrower (say, an oil-rich but debt-laden nation like Venezuela) reneges on its debt repayments? Will China simply shake its head and continue to lend to its fragile-but-resource-rich friend?
First to the raw facts. China Development Bank and Chexim lent $29.1bn to Latin American governments and state-run enterprises in 2015, according to data from the Inter-American Dialogue (IAD), a Washington-based think tank. That was three times the previous year’s total and second only in annualised terms to 2010, at the height of China’s post-financial crisis stimulus spree. Together, the two policy lenders disbursed more capital to Latin America in 2015 than the IDB and the World Bank combined and nearly as much ($33.4bn) as the total raised last year by all regional governments on the international debt markets.
RECIPIENTS
The main beneficiaries over the past decade (China has only been lending to Latin American governments on a state-to-state basis since the mid-2000s) have typically been commodity-rich states burdened by a history of debt, defaults and bad planning.
Venezuela has received $65bn in funding since 2007, or around 52% of all regional funding by the two Chinese policy banks. That includes two loans in April and June 2015, each worth $5bn.
Ecuador has received $15.2bn over that period, including $7bn in 2015, most of which was directed into energy and transport infrastructure.
Argentina rounds out that trio of nations having secured $15.3bn from China, mostly to build dams and highways.
“Chinese finance has been critical for countries that have limited access to international credit markets,” says Margaret Myers, director of the IAD’s China and Latin America Programme. “Beijing is also clearly more comfortable about engaging with countries that are centrally run. It allows them to facilitate deals more quickly and it’s a model with which Chinese state-run firms are more comfortable.”
ENERGY AND INFRASTRUCTURE
Most Chinese policy lending has, so far at least, been directed into two key areas: energy and infrastructure. The former is a fairly simple process. China has, for instance, lent Venezuela more than $50bn since 2005, with Venezuela repaying its debts in the form of shipments of cheap crude oil.
Infrastructure is a different matter. Few would deny that Latin American infrastructure is in a lamentable state from its poor airlines to patchy power grids. A recent survey by a traffic app, Waze, found that seven of the world’s 10 worst countries to drive in, based on traffic density, road quality and accident frequency, are in Latin America. The largest economy, Brazil, ranked 120th out of 144 countries in terms of the quality of its overall infrastructure in a 2014 survey by the World Economic Forum, while the IMF estimates the region’s annual infrastructure deficit at between $170bn and $260bn.
THE BENEFITS FOR CHINA
China is not financing the region out of charity. Funding local infrastructure benefits the Asian country in three ways. First, it gives a crucial economic boost to a much needed trading partner. In the January 2016 update to its World Economic Outlook, the International Monetary Fund tipped Latin America’s economy to shrink by 0.3% in 2015 and 2016 and the multiplying effect of well-planned infrastructure offers a solution to these woes. Every one US dollar spent on new railways or highways generates a corresponding 1.6 dollars in economic growth, the IMF reckons. A stronger regional economy also means more buyers of Chinese made goods, which goes some way to explaining why in the nine years to end-2015, Chinese policy banks channeled $40.3bn into regional infrastructure projects.
Right now, it’s also hard to see who, other than China, will provide the funding that Latin America so clearly needs. The private sector is unlikely to help, given the state of the economy: in 2015, for the first time in 17 years, more capital left than entered the region. Nor are the World Bank or the IDB likely to offer much succour. The two multilaterals cut regional lending by 5% and 14% respectively last year, according to internal data. By contrast, says Kevin Gallagher, co-director of the Global Economic Governance Initiative (GEGI) at Boston University, Chinese financing “is helping to get Latin America through a pretty dire time. This is the worst economic period facing local policymakers since the 1990s so any investment in infrastructure is a good thing.”
Second, better infrastructure is an indirect boon for China’s resource hungry economy. Many of the big projects funded by Chinese banks are big, multi-year efforts. China is part funding a $10bn railway project that, if completed, will link the Brazilian port of Acu overland with the Peruvian capital Lima. Other floated ideas include: tunnelling through the Andes to connect Argentina and Chile by rail; an oil pipeline linking Venezuela and Colombia; and the expensive and controversial Nicaraguan Canal.
The future of all these outsized projects remain in doubt but any that get the nod will likely have two factors in common. They will source at least a share of their funding from one of the two big Chinese policy lenders. And they will be designed with 1.3bn end users in mind: China’s increasingly wealthy and demanding populace.
FIGHTING INSECURITY
While all of these projects will improve local infrastructure, they will also, notes GEGI’s Gallagher, alleviate the Chinese government’s ingrained fear of “food and resource insecurity”, key factors that in times past led to the toppling of emperors and dynasties. With that in mind, China is building new supply routes across Latin America that cut out the costly Panama Canal, the dark waters around Cape Horn and the bandit-infested Strait of Malacca.
And finally, better infrastructure should — or at least this is China’s intent — permanently embed mainland firms wholesale into Latin America’s superstructure and supply chains. China’s economy expanded last year at its slowest pace in a quarter century. Indebted state-owned enterprises are being hit hard by wafer-thin margins, rising domestic competition and falling orders at home and abroad. In February, activity in the nation’s factory and services sector fell to their lowest level in seven years, prompting the central bank to inject more cash into the banking sector.
Yet if anything, such domestic frailties actually serve to increase Latin America’s allure. The region may be in deep strife, a result of the inevitable unwinding of a 10 year commodities supercycle and the legacy of missed opportunities by timid and reform-averse politicians. But to Chinese SOEs, the region is bursting with potential, from the glaring need for new infrastructure to the opportunity to educate a new generation of consumers about the benefits of low cost Chinese brands, from Geely sedans to Lenovo laptops to Xiaomi-badged smartphones.
“China’s markets are saturated so it makes sense to seek new customers abroad,” says GEGI’s Gallagher. “Beijing is brimming with reserves and it wants to use its surplus capital to give its leading banks and firms truly global standing. This is all part of China’s overall foreign policy.”
Adds the IAD’s Myers: “The real aim is to allow Chinese corporates to insert themselves into entire supply chains, which is already happening in Argentina and Venezuela but which will increasingly happen in the likes of Brazil. Better infrastructure, funded by China and using Chinese firms and labour, allows Beijing to export excess industrial and human capacity while boosting its soft-power status in the region.”
Myers sees similarities here with the ‘One Belt, One Road’ model unveiled in 2013 by President Xi Jinping, a development strategy that aims to globalise leading SOEs, enable China to export surplus cash, capital and workers and international China’s currency, the renminbi. Ilan Berman, vice-president at the Washington-based American Foreign Policy Council, says China’s ultimate aim here is to use hard cash as a bargaining tool in order to make Latin America dependent on mainland lenders, brands and industrial giants. As American influence in the region wanes, China is rushing to fill the void, he adds.
So for all the valid concern surrounding China’s economy, few expect Latin America’s precious new flow of funding to dry up any time soon. “I see no reason to expect state-to-state financing from China to lessen in 2016,” says Myers. “If anything, we are likely to see even more lending take place this year.”
FUNDING THE WEAKEST
China is likely to target economies under the greatest economic and fiscal strain, experts say, including the likes of Barbados, Costa Rica and Bolivia. Then there is Brazil, the region’s big beast, which is likely to remain mired in recession in 2016 for a second straight year. In February, China Development Bank made its ambitions for the country clear, announcing plans to lend $10bn to the scandal-hit energy firm Petrobras in exchange for petroleum, a transaction that mirrors deals previously thrashed out between China and Venezuela and Ecuador.
Chinese president Xi pledged last year to invest $250bn in the region over the next decade and to boost bilateral trade by an extra $50bn a year.
In 2015, China set up the $20bn China-LAC Industrial Cooperation Investment Fund and the $10bn China-Latin America Infrastructure Fund while pumping a further $5bn into the existing China-Latin America Cooperation Programme. All that cash, notes the GEGI’s Gallagher, is “sitting in reserve at the CDB waiting to be dispersed”. Then there is the Asian Infrastructure Investment Bank, a new China-backed multilateral, which has yet to kick into gear but which will be turning its attention to Latin America in due course. The message from China to regional policymakers is clear: if you need to fund a new road, soybean processor or power station, we are here to help.
CHINA OR THE WORLD
Perhaps the biggest unknown is how much further China is willing to go to help its new friends. A rare public debate bubbled to the surface last year in China when a group of academics including Yu Yongding, director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, queried China’s willingness to continue to support risky sovereign borrowers. Focus fell immediately on Venezuela, which remains plagued by hyperinflation and beleaguered by low growth as a result of the low global price of oil, which accounts for 96% of the country’s export earnings.
Venezuela made a full payment on a $1.5bn bond in the final week of February. Yet with $10bn in debt repayments due in 2016 and foreign currency reserves at a 17 year low, it is now more a matter of how the country defaults rather than when. In that event, all eyes will be on the government of President Nicolás Maduro to see whom he repays first: China or the world. “It’s a very considerable question and one that we have no visibility on at the moment,” says the IAD’s Myers. “It’s unclear exactly how much Venezuela still owes China as some of its debts to Beijing have already been paid off in the form of oil.”
In the first week of February, Barclays published a research note suggesting that Venezuela would seek to restructure its oil-linked Chinese debt first before dealing with its obligations to international bondholders. Others are less sure, not least because Venezuela would need to nearly quadruple its daily oil shipments to China, to 800,000 from 228,000 barrels, in order to satisfy its loan repayments. “The Chinese government realises that it stands to lose some money” in the months ahead, says Myers. “But it’s making the calculation that its substantial foothold in a key sovereign energy provider is far more important, from a strategic point of view, than a few unpaid debts.”
But the truth is that no one knows how China will act (not even, perhaps, the government itself) if and when Venezuela defaults on its international debt. “What will China do if countries fail to repay their debts, given that [Beijing] lacks a sovereign debt restructuring mechanism?” asks Gallagher at the Global Economic Governance Initiative. “Some country will default sooner or later, whether it is in Africa or Latin America, and it will be instructive to see what they do. Will they react like any international banker by expecting their money back, or will they see the loan as a political tool and allow borrowers to roll it over?”
THE ECUADOR QUESTION
Venezuela’s impending default has rightly grabbed international attention. Yet it has also served to divert the world’s eyes away from Ecuador, another troubled economy highly fiscally dependent on oil exports. The tiny Pacific state has also borrowed heavily from China: its total debt to the country amounts to more than 15% of total economic output. The question now, says Gallagher, is “how long it will be, with the dollar cost of a barrel of oil in the 30s, until Ecuador has a debt problem with the Chinese. Ecuador is without doubt overly exposed to Chinese financing.”
In time, Ecuador’s willingness to borrow so heavily for so long from its new paymasters may come to be seen as a defining moment in the budding relationship between cash-rich China and resource-rich Latin America. On the one hand, China’s largesse has been of incalculable help to Ecuador, which has used the capital to build critical infrastructure and boost economic growth. Ecuador’s ability in December 2015 to repay a foreign loan for the first time since 1832 can be, analysts say, attributed directly to the country’s ability to borrow from Peter (China) to pay Paul (its international bondholders).
Yet, says the IAD’s Myers: “Given how much Ecuador owes China, it has also left the government considerably less fiscal room to manoeuvre. Were China to stop investing or financing so heavily in these countries with their higher levels of perceived risk, they would have to radically change the way they operate.”
For now at least that outcome seems unlikely — barring, say, a financial calamity of apocalyptic proportions in China. For now, China seems content to continue to lend to struggling Latin American governments, who in turn are more than grateful for the financial aid.
In the long term the question for governments from Brasília to Buenos Aires and Quito to Caracas is if this relationship is sound or whether it is unhealthily one-sided or co-dependent. Are troubled and struggling Latin American states using their new wealth to assemble critical infrastructure and build a better future for their people, or are they indebting themselves and future generations, this time not to the West’s wily bankers but to China’s shrewd mandarins? Only time will tell.