Beyond “Debt-Trap Diplomacy”: The Dissemination of PRC State Capitalism

The narrative of PRC “debt-trap diplomacy” has gained increasing traction in some parts of the international media and US foreign policy-making communities. While useful in highlighting the adverse consequences of PRC-financed projects in developing countries, this narrative simultaneously overlooks the agency of the borrowing states and the sophistication of PRC corporate actors in implementing the economic strategy of the PRC party-state.

Close examination of the case of Sri Lanka, the most widely cited example in discussion of “debt-trap diplomacy,” suggests that the “debt-trap” narrative does not capture the nature of the sweeping change underway. By fixating on the debtor-creditor relationship, the “debt-trap diplomacy” narrative misses the bigger picture — namely, the penetration of the global economy by PRC “national champion” state-owned enterprises (SOEs), which will serve to entrench and legitimize the PRC development model.

The availability of PRC loans is merely one component in the package of state capitalism, which includes technically competent PRC SOEs that can deliver upon promises in a timely manner (ahead of an election, for example) and secure funding from the PRC when no alternative funding is available; as well as a business plan to bring in additional PRC investors, backed by a PRC party-state with enormous power to mobilize investment. This, rather than debts, will have the most profound implications for PRC relations with its supposed “debt-trap” counterparts, as the importance of loans to the PRC’s overall strategy will likely shrink moving forward. The PRC SOEs’ engagement in Sri Lanka, currently underway, provides an excellent case study through which to understand this process.

PRC SOEs’ Long Game

Their access to deep, patient pools of state-backed capital gives PRC central SOEs the ability to build ties with other countries over long time periods, and through projects that other actors might find unprofitable. This sustained engagement allows them to shape the perceptions and incentives of local decision makers in powerful ways that go beyond mere “debt traps”.

China Harbor Engineering Company (中国港湾), the company contracted to build the Hambantota port in 2007, first entered Sri Lanka in 1998 to deliver a foreign aid project provided by the Chinese government. As in many other developing countries, the aid project opened the door for the Chinese company to enter the local market. Despite the ongoing civil war, China Harbor took the long view, building unprofitable roads to build rapport with decision makers. One of the roads, known as A5, is now on Sri Lanka’s 1,000-rupee bill. When a tsunami hit Sri Lanka in 2004, China Harbor volunteered to help rebuild three fishing ports, and invited then-prime minister Mahinda Rajapaksa to cut the ribbon for each of them (Asia Pacific Daily, November 24, 2014; 21st Business Herald, September 18, 2015).

After Rajapaksa became president in 2005, he spared no time in pursuing his dream project—turning Hambantota, his home district, into an international shipping hub. After two feasibility studies conducted by Canadian and Danish consultants failed to launch the project, Rajapaksa approached China Harbor, which gladly agreed to move forward. An MOU was signed in October 2006 (SLPA, October 16, 2006; SLPA, November 8, 2010). By contrast, the Indian companies that Rajapaksa had approached earlier declined to invest, unconvinced that a Hambantota port would be a viable business proposition (The Island, May 13, 2014).

With China Harbor’s involvement, Rajapaksa was also able to secure Chinese government’s promise of funding when he visited China in 2007 (People’s Daily, March 4, 2007). Construction commenced promptly in October 2007. When a Chinese Deputy Minister of Transportation visited Hambantota in 2009, he praised China Harbor’s “perseverance and tenacity” (坚忍不拔) in opening up the Lankan market and implementing China’s “Going Out” strategy (CHEC, June 16, 2009) [1]. China Harbor’s “tenacity” was paid off with two contracts totaling $1.3 billion for the Hambantota Port project, of which about $1.1 billion was financed by China Exim Bank [2].

While China Harbor was building the Hambantota Port, the Chinese SOE that would take over the port in 2017, China Merchants Port Holdings Company (招商局港口), also made its first foray into Sri Lanka in 2009, as the country was emerging from civil war [3]. A China Merchants-led consortium won the tender to expand Colombo Port, the country’s main port, and invested over $500 million to build the Colombo South Container Terminal (CSCT). It was not only Sri Lanka’s largest foreign investment at the time, but also a milestone for China Merchants, marking its very first greenfield investment in overseas ports. The company would go on to invest in dozens of ports in 18 foreign countries (CMG), backed by its parent company China Merchants Group (CMG), China’s largest SOE by assets (CMG).

China Merchants’s eventual takeover of Hambantota Port in 2017 was unsurprising, as the company had already been tracking the port’s development for a number of years. Senior CMG leadership visited Hambantota as early as 2011, escorted by the Sri Lankan Air Force (CMG, November 23, 2011). China Merchants understood that once Hambantota Port was completed, it would directly compete with Colombo South Container Terminal in the cargo handling business—at the latter port, CMG enjoyed a 35-year concession. As part of China Merchants’ agreement with the Sri Lanka Port Authority (SLPA) concerning the Colombo terminal, the SLPA guaranteed to withhold container handling from Hambantota before Colombo reached a target volume, which contributed to the idleness of Hambantota Port in the first years of its operation (Daily FT, November 16, 2016).

Foreshadowing its final takeover of Hambantota Port in 2017, in 2014 China Merchants contemplated a $391 million co-investment with China Harbor in Hambantota Phase II, which would give the two PRC companies 35 years of concession for four berths. The signing of the agreement was witnessed by the two countries’ presidents, Rajapaksa and Xi Jinping (CMPort, September 18, 2014). This agreement later became invalid due to failure to meet agreed conditions (Daily News, January 28, 2017).

The election to the presidency of Maithripala Sirisena, who defeated Rajapaksa in the 2015, prompted greater scrutiny of the PRC mega-projects. The Sirisena government suspended a real estate complex tied to the Colombo Port in which China Harbor had invested $1.4 billion, citing the company’s failure to obtain relevant approvals. The Chinese government apparently intervened, with Xi Jinping calling for the Sri Lankan side to “protect the legal rights of Chinese enterprises” when meeting with Sirisena in 2015 (Xinhuanet, March 26, 2015). A year later, the suspension was lifted. Having to handle this controversy, the Sri Lankan government was unlikely to have much leeway when it came time to negotiate with the PRC regarding a debt-equity swap for Hambantota Port, whose idleness—partially the result of CMG’s agreement with the Sri Lankan Port Authority—had put the project deep into the red.

Sri Lanka finally reached an agreement with China Merchants in 2017, in which the latter was to inject $1.12 billion (including paying off Sri Lanka’s debt to the PRC) in exchange for a 99-year concession (People’s Daily, July 26, 2017). Despite all the criticism of Rajapaksa’s Hambantota plan, the Sirisena administration had little choice but to continue to work with the PRC; the cost was already sunk, and no other parties were coming to the rescue. But, where the Sri Lankan government was concerned, perhaps even more important than the “push” of its debts to the PRC was the “pull” of the PRC’s promise that it could help deliver Sri Lanka a more prosperous future, one based on the PRC’s own experience of state-backed capitalism.

The Lure of State Capitalism

China Merchants’ vision for Hambantota goes beyond shipping, embracing a “port-park-city” model similar to Shekou Port in Shenzhen, China Merchant’s signature project to date. The project plans to pair the port with an industrial park for export processing, to “create” additional traffic to the port, rather than relying on the existing transshipment flows Hambantota had struggled to attract. This industrial development would then drive urbanization in the area. China Merchants appeared to successfully sell this story to Sri Lanka’s then-Prime Minister Ranil Wickremesinghe, who was “impressed” when he visited Shenzhen in 2016 (ChinaMerchants1872, August 16, 2016). The two sides are going ahead with the vision: the PRC and Sri Lanka jointly launched a 50-sqkm “Logistics and Industrial Zone” in Hambantota in 2017, which they claim will draw $5 billion of Chinese investment over the next five years (Embassy of the People’s Republic of China in Sri Lanka, November 15, 2018).

The Wickremesinghe government’s decision to hand over Hambantota to China Merchants represented more than the imperative to shed debt; it also represented Sri Lanka’s buying into a vision of state-led capitalism. From the PRC’s perspective, the situation is very much a “win-win”: having enabled Hambantota Port’s loss-making, it could now offer a solution, one which Sri Lanka’s lack of better options left it little choice but to accept.

Establishing Hambantota’s place in the global maritime economy will require an enormous infrastructure and industrialization push, one which Sri Lanka alone will not have the capacity to carry out any time soon. The PRC party-state, on the other hand, has the necessary capacity. It can mobilize SOEs to invest in Sri Lanka, direct manufacturers to set up factories in Hambantota’s export processing zone, and integrate Hambantota into the networks of ports, shipping lines, and railways under the control of its SOEs. Countries like Sri Lanka might find it difficult to resist such a ready-made economic development strategy, particularly one that can quickly deliver the kind of gains that elected politicians like tout to their constituencies: In 2016 and 2017, for example, the China Merchants-managed Colombo International Container Terminals (CICT) saw 28% and 18.5% increases in volumes of containers handled, thanks to the transshipment attracted by China Merchants’ global network (World Maritime News, January 17; JOC, January 3, 2017; SLPA). Port of Colombo was ranked the fastest growing port in the world in the first half of 2018 (SLPA, September 10).

At the center of the state capitalism package is the Chinese SOEs. Less than two decades since the PRC embarked upon its “Going Out” strategy, the country’s state-owned enterprises have come of age as globally important players. China Merchants vowed in 2014 to attain “capabilities of global resource allocation and global management,” and to “occupy a privileged position in the global value chain.” (China Financial Weekly, September 14). It has made good on that promise, buying stakes in a network of 53 ports across six continents, and building numerous industrial and logistic parks (China Transport News, November 2). The “port-park-city” model is being promoted not just in Sri Lanka, but also in Djibouti—another country where PRC control of a port has raised eyebrows—as well as Belarus, Togo, and Tanzania (Economic Observer, October 30).

This push to tie host countries into a global network of PRC-directed state capitalism may make loans a less important tool of PRC foreign policy. PRC SOEs are graduating from the old model of relying on China’s policy bank loans to win infrastructure contracts abroad, as the margin in the contracting sector is thinning. Instead, they are looking to move up the value chain and take on the role of developer and direct investor, in order to have greater influence in project initiation and design. As this evolution continues, the relationships between the PRC and countries like Sri Lanka may become less “creditor-debtor”, and more “originator-host”, opening up new questions of how the PRC will interact with the other countries in the context of protecting its overseas investments.

The “debt-trap diplomacy” narrative therefore fails to capture the critical, changing role played by China’s SOEs, the driving force of China’s global economic expansion. It also underestimates the appeal of China’s state capitalism for political elites in developing countries. The right response to these phenomena, therefore, should move beyond a simplistic understanding of “debt-trap,” and instead address the consequences of state capitalism as a top-down model of development. Policy responses need to go beyond providing alternative sources of infrastructure finance, as the US, Japan, and Australia formed a trilateral partnership to do (OPIC, July 30), and look as well at ways to foster local capacity for enabling home-grown, bottom-up development solutions that promote local ownership.

Hong Zhang is a PhD candidate at Schar School of Policy and Government, George Mason University. Her research interests include the political impact of China’s overseas development assistance and the global expansion of Chinese SOEs. She previously worked for five years as an overseas correspondent with China’s Caixin Media in London and Washington DC.

Notes

[1] China Harbor also allegedly funneled money into Rajapaksa’s campaign in the 2015 presidential election (New York Times, June 25)

[2] The cost of Hambantota Phase I was $508 million, up from $361 million as in the original contract (Daily News, January 28, 2017). Phase II cost $808 million. China Exim Bank financed 85 percent of Hambantota Phase I and the entirety of Phase II (21st Business Herald, September 18, 2015). Phase I was a commercial loan with 6.3-percent interest rate, 15 years in duration including a four-year grace period. Phase II was preferential loan with interest rate of 2 percent (Xinhuanet, June 4, 2015; China Focus, July 30).

[3] According to Fu Yuning, a former chairman of CMG, the company had originally sought to invest in India but then discovered Sri Lanka as a promising location to support international trade in South Asia. Initially hesitant to invest in Sri Lanka due to the civil war, CMG decided to go forward with the investment when Rajapaksa assured him that the war would end within three months (CMG, April 2014).