Info Service on Finance and Development (Mar12/01)
A new report on the rise of Chinese finance in Latin America, titled “The New Banks in Town: Chinese Finance in Latin America,” reveals that Chinese loans to Latin American countries in 2010 exceeded that of the World Bank, Inter-American Development Bank, and the U.S. Export-Import Bank combined for that year.
The report is authored by researchers at the Global Development and Environment Institute in Tufts University, Kevin P. Gallagher, Amos Irwin and Katherine Koleski and published by the Inter-American Dialogue in Washington D.C.
Party in response to the global crisis creating significant financing gaps and a credit squeeze from traditional Western financing sources, China’s financial role in Latin America has grown at a record speed. Chinese loans to the region grew from under $1 billion before 2008 to over $36 billion by the end of 2010. Loans to the Latin American region account for over half of Beijing’s international lending, and China has now overtaken the U.S. as the largest trade partner for Brazil and Chile.
The report finds that China is an especially valuable source of credit for defaulted sovereign borrowers that cannot access international capital markets, such as Argentina and Ecuador.
The report demystifies some of the common claims about Chinese finance, in that China reaps advantages over Western financing because it offers cheaper credit at a lower premium, imposes no policy conditions, and has less stringent environmental guidelines that the loans of international financial institution and western governments.
However, the report clarifies that Latin American countries actually pay higher interest rates for Chinese loans. For example, the China Development Bank extended a $10 billion credit to Argentina in 2010 at the London Interbank Offered Rate (Libor) plus 600 basis points, whereas the World Bank, in the same year, lent Argentina $30 million at the Libor rate plus 85 basis points.
The authors also find that Chinese loans do not come with the often controversial policy conditionalities that are tied to loans of international financial institutions (IFI) and Western lenders. Chinese finance may also provide Latin American nations greater opportunity to carry out infrastructure and industrial projects to enhance long-run development, rather than for the latest Western development fads. While Chinese banks impose no policy conditions, they do require equipment purchases and, at times, oil sale agreements.
With regard to environmental guidelines, Chinese financiers do have a set of environmental principles. However, the authors of the report find that these guidelines are not on par with those of their Western counterparts. China and the U.S. agreed recently to begin talks on setting guidelines for export-credit financing which could bring Beijing into similar rules as those used by member countries of the Organisation for Economic Cooperation and Development (OECD).
The report also addresses widespread perceptions that Chinese finance is risky because it is motivated by a desire to secure long-term commodity supplies and lacks transparency. The authors detail how securing commodity supplies through long-term credit and technological support is nothing new. Japan cut similar deals with China in the 1970s, and now the Chinese are replicating the old Japanese format in Latin America.
Some claim that China’s expanding presence in Latin America is driven by an ideological desire to boost political South-South ties, while others say that Chinese finance is directed exclusively by national commercial interests. However, the report states that while Chinese finance is officially blessed by Beijing, it is executed by commercially oriented state banks.
The executive summary of the report is provided below.
The New Banks in Town: Chinese Finance in Latin America
By Kevin P. Gallagher, Amos Irwin and Katherine Koleski
We estimate that since 2005, China has provided loan commitments upwards of $75 billion to Latin American countries. China’s loan commitments of $37 billion in 2010 were more than those of the World Bank, Inter-American Development Bank, and United States Export-Import Bank combined for that year.
After providing estimates of Chinese finance, we also examine the common claims that Chinese loans to Latin America have more favorable terms, impose no policy conditions, and have less stringent environmental guidelines than the loans of international financial institutions (IFIs) and Western governments.
We find that:
• China Development Bank (CDB) loans carry more stringent terms than World Bank loans.
• The Export-Import Bank of China (China Ex-Im Bank), by contrast, generally offers lower interest rates than the US Ex-Im Bank—though this difference stems from the fact that the World Bank offers concessional interest rates as a form of aid, while China offers concessional rates not through CDB but rather through China Ex-Im.
• Chinese banks provide financing to a significantly different set of countries than the IFIs and Western banks, namely Argentina, Ecuador, and Venezuela, which are not able to borrow as easily in global capital markets.
• Chinese and IFI/Western banks do not overlap significantly in Latin America: They give different size loans to different sectors in different countries. Chinese banks have largely focused on loans to natural resource-based and infrastructure sectors.
• Chinese banks impose no policy conditions on borrower governments but do require equipment purchases and sometimes oil sale agreements.
• The financing terms in oil sale agreements seem to be better for the South Americans than most people believe.
• Chinese finance does operate under a set of environmental guidelines, but those guidelines are not on par with those of its Western counterparts.
It is our hope that this report will provide a more empirical-based foundation for research on Chinese finance in Latin America and the Caribbean (LAC). Our investigation lends credence to some claims about China in Latin America, but less so to others.
On the positive side, China is a new and growing source of finance for LAC, especially for the nations having trouble gaining access to global capital markets. Chinese loans do not come with the policy conditionalities that are tied to IFI and Western loans. Finally, LAC nations can get more financing for infrastructure and industrial projects to enhance long-run development rather than for the latest Western development fads.
However, contrary to much of the commentary on the subject, LAC nations generally pay a higher premium for loans from China. That higher premium comes in the form of interest rates, not loans-for-oil. It is commonly thought that LAC simply sends barrels of oil to China in return for financing and, thus, may lose out given the rising price of oil. Our analysis shows that this misreads the evidence: the majority of Chinese loans-for-oil in Latin America are linked to market prices, not quantities of oil.
Another cost of Chinese finance can be tied to working with Chinese contractors and businesses. This reduces “spillover” effects in LAC in terms of local contracting related to the loans.
And finally, the composition and volume of Chinese loans are potentially more environmentally degrading than Western banks’ loan portfolios in LAC. Although the IFI/Western banks’ environmental record is far from perfect, Chinese banks require less demanding environmental standards.