Productive Finance for the Belt and Road Initiative: Reexamining China’s Debt Sustainability Framework

China has committed over US$1 trillion in overseas financing, much of it directed toward productive public assets that have helped close infrastructure gaps and stimulate economic growth. Nevertheless, a series of external shocks—largely unrelated to Chinese financing—have left many countries struggling to pay external debts or borrow at affordable terms.

As the Belt and Road Initiative (BRI) enters its second decade, it is evident that risk assessment and debt management have become increasingly important for Chinese development finance institutions (DFIs).  Chinese authorities have begun putting in place a framework to assess the debt sustainability of China’s investment partners worldwide.

A new working paper by Yan Liang analyzes this debt sustainability framework (DSF) and identifies three areas where it falls short. The paper also suggests new indicators to help address these shortcomings.

Main findings:

• China’s DSF is based on the International Monetary Fund (IMF)’s framework and is fraught with similar drawbacks. These drawbacks loom even larger when the framework fails to adapt to the unique characteristics of BRI financing and the conditions and development stages of BRI countries.
• The current DSF for BRI market access countries (MACs) has three major flaws.
  • It includes the neglect of the asset side of the public balance sheet and its implications for debt-carrying capacity, the inability to account for fiscal multipliers resulting from transformative public investment enabled by BRI financing, and the conflation of domestic currency debt and foreign currency debt despite their distinct causes and management strategies.
• The DSA for BRI countries should incorporate meaningful revisions to account for the contributions of BRI financing to public asset formation, economic growth and the generation of foreign exchange revenues. This should take into account the need for Emerging Market and Developing Economies (EMDEs) to take on debt for development and climate financing.

The author concludes that a properly designed DSA would not only provide a more accurate assessment of solvency and liquidity risks but also help host governments develop sound policies for managing debt. Properly accounting for the implications of BRI financing on debt sustainability could also influence the terms and procedures of debt restructuring since, arguably, more productive debt should be prioritized over less productive debt to avoid interrupting the formation and operation of productive public assets.

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