Barrister Muhammad Ali Talib is a practicing advocate of the High Court of Pakistan, specializing in corporate, finance, and commercial litigation. Previously, he has worked at various international law firms, namely CMS, Dentons LLP, and Bryan Clave Leighton Paisner.
On October 6th, 2021, Pakistan’s Planning and Development Minister Asad Umar was asked a very tough question, whether Pakistan has a “China-debt” problem? Asad Umar, maintaining his calm and assertive candor, brushed away all the concerns and stressed that “we do not have China debt problem”. Yet, this, certainly, is not the case since Pakistan is already entangled in the Chinese debt trap.
Pakistan, China, & the Belt and Road Initiative
The tale of Pakistan, China, and the Belt and Road Initiative (BRI) can be best described using the methodology that Japanese Film Maker Akira Kurosawa used in his 1950’s film “Rashomon”. The film starts with a straightforward murder case of a samurai and the rape of his wife by a bandit, and during the opening scenes, everything looks black and white.
However, the film then progresses by telling the account of three witnesses (the bride, the samurai’s ghost, and a woodcutter); each one of them tells a different story of the incident and a wholly different ending. All of the witnesses’ accounts agree that there was a body in the woods, but as the film unfolds, one begins to question the evidence to support the initial story.
The story of Pakistan, China, and BRI is similar to the story of Rashomon. The initiatives Pakistan branch was given the name of “China-Pakistan Economic Corridor (CPEC)”. CPEC, when it began, was hailed as a game-changer for Pakistan. It promised to create millions of employment opportunities, and construct essential infrastructure and energy projects which can breathe life into the ailing economy of Pakistan. China granted Pakistan $3.4 billion as development finance between 2000 and 2017. As per the Ministry of Finance report, 71 projects worth $27.3 billion are currently underway.
This article highlights the intricate mechanics of Chinese financing and analyses the clauses used in the Chinese debt contracts that generally do not form a part of public discussion. More importantly, the article questions whether CPEC really is a blessing for the economy of Pakistan or a well-hidden nuisance caused by the Chinese debt trap.
AidData Report and the Chinese Loans to Countries
The first and the most apparent issue, concerning the Chinese loans to countries, is the interest rate. According to the recent AidData report—How China Lends—Chinese loans have an average interest rate of 2-3%. In comparison, a typical loan by an OECD (Organisation for Economic Cooperation and Development) lender, like Germany or France, has an average interest rate of less than 1%.
Secondly, the AidData report highlights that the confidentiality clauses in the Chinese loan agreements prevent the borrower from disclosing any details about the loan. It is important to note that London’s Loan Market Association (LMA) loan agreements, which are widely used all around the world, also contain confidentiality clauses.
However, the clauses in the Chinese loan agreements are far broader in scope and cover all the terms and even the existence of the loan itself. This, perhaps, explains all the mystery surrounding the Chinese loans to countries, as confidentiality clauses bind the borrowing governments like Pakistan to not reveal any details of the agreement to the general public.
Thirdly, there are several security clauses in Chinese loan agreements; the two most important ones are the cross-default clause and the stabilization clause. The AidData study reveals that all of the 100 Chinese loan agreements of China Development Bank (CDB) and the Exim Bank of China—the two leading lending banks of China—taken as a sample, contained a cross-default clause.
A cross-default clause operates by automatically defaulting a borrower from Agreement A when the borrower defaults under Agreement B. This means that if Pakistan defaults on its IMF or World Bank loan, it will trigger an event of default for the Chinese loan, giving the Chinese lending authority a right to demand immediate repayment of the loan. Cross-default provisions, therefore, have a domino effect. Similarly, most CDB and Exim Bank agreements contain cancellation clauses to protect the lender from the legal and regulatory changes in the borrowing countries.
A stabilization clause can make new laws inapplicable to the investment project, or they can require the borrowing country to compensate the lender for the cost of complying with the new regulations. However, while cross-default clauses are more narrow and less common in multilateral loans, the stabilization clauses are widely included in every debt contract. However, it’s noteworthy to mention that these security clauses can give China lending authority and tremendous bargaining power over a developing country like Pakistan. They can also give Chinese lenders sway over the policies in the borrowing country.
No Paris Club Clause
By far, the strangest clause the Chinese debt contracts contain is the “No Paris Club” clause. To understand the effects of the clause, it’s essential to know what a “Paris Club” is. Club de Paris or the Paris Club is a group of major creditor countries whose role is to help and restructure the loans of debtor countries experiencing payment difficulties. Recently, the Paris Club extended Pakistan’s deadline to service its debt in light of the COVID-19 pandemic.
Alternatively, the AidData report reveals that Chinese loan agreements have a clause that commits the borrower to exclude the debt from any restructuring process, such as the Paris Club, and from any comparable treatment that the Paris Club might require the borrower to seek from its creditors. Having such restrictions can drastically impact Pakistan as it can limit its debt restructuring options, Moreover, as per another argument, it can also result in losing the Paris Club relief and multilateral financing.
What the Chinese Debt Trap Means for Pakistan
In light of the above discussion, it can be concluded that the Chinese foreign loan agreements are drafted with considerable bias and ingenuity. They also use multiple contractual tools to secure their interest in the borrowing country. They suffer from a lack of transparency by inculcating broad confidentiality clauses and hiding the liabilities from ordinary taxpayers.
Furthermore, the cross-default and stabilization clauses give the Chinese lending institutions the power to influence the policy of the borrowing country, with considerable discretion to cancel the loan altogether. Lastly, the use of the “No Paris Club” clauses, which prohibit the borrower from restructuring their outstanding loans to China, evinces that the Chinese banks make efforts to position themselves as “preferred creditors”.
With such stringent terms, for a country like Pakistan, with a debt of $233.64 billion, 98.7% of its gross domestic product is definitely in deep waters. At this stage, one should ponder whether CPEC is a blessing or a curse. It can be either, but one thing is certain, through their debt contracts, China has Pakistan on a tight leash with its significant bargaining power and policy influence. What’s important now is how China will use this bargaining power and to what extent; for now, it’s a game of wait and watch.
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