How Afghanistan snags China in a $282 billion creditor trap

The hurried withdrawal of the US from Afghanistan — the 1975 fall of Saigon déjà vu — has been heralded as a win for China and an opportunity for Beijing to extend its influence across the region. It's even been raised as a lesson for Taiwan not to rely on American protection, in the eyes of the Global Times, a state-run tabloid. 

However, the ironic truth for China is that the only thing worse than US soldiers near its borders is not having them there at all. Afghanistan is now a big headache for Beijing, which fears chaos there will spill over not just to its restive region of Xinjiang but to Pakistan. The People's Republic has invested huge infrastructure projects as well as extended huge loans to Islamabad as part of the Belt and Road Initiative, one of President Xi Jinping's signature policies.

Since the BRI's inception in 2013, the country has splashed billions of dollars abroad: building roads, dams and power plants. Its two main policy banks — the China Development Bank and the Export-Import Bank of China — lent an estimated $282 billion to countries throughout Asia, Africa, Latin America and Europe. So much so that in 2020, China's capital account recorded a deficit for the first time. Pakistan, which neighbors China and Afghanistan, is the biggest beneficiary of Beijing's overseas infrastructure drive. The so-called China Pakistan Economic Corridor alone is reportedly worth $62 billion. The country is potentially a key link between China's interests in Central Asia and the shipping lanes in the Indian Ocean.

But lately, Beijing has begun to worry about its assets there. On July 14, a blast on a Chinese shuttle bus in northern Pakistan killed nine Chinese engineers working on the $4 billion Dasu hydroelectric dam. The project, led by state-owned China Gezhouba Group Co., is not even part of the more controversial Corridor, and is financed by the World Bank. This attack followed another incident in April, when the Pakistani Taliban carried out a suicide bombing at a hotel where the Chinese ambassador was staying. 

One month on, no one has claimed responsibility for the Dasu attack. Pakistan last week placed blame on the Taliban across the border, saying, "Afghan soil was used for this incident." 

So far, the Chinese are being diplomatic. When asked about the connection between the Dasu attack and the Taliban, the foreign ministry in July countered with an intriguing distinction: Which Taliban? Beijing portrays the Afghan Taliban as "a pivotal military and political force," but sees the Pakistani Taliban as a terrorist group. In late July, during an Afghan Taliban diplomatic charm offensive visit, Beijing managed to extract a public pledge that the group would not allow fighters to use Afghan soil as a base to attack China. 

That promise alone showcases how uneasy China is with Afghanistan's new rulers. While China has not invested much in Afghanistan, it can't afford it to destabilize Pakistan. Beijing still has very vivid memories of its last creditor's trap, which it stumbled into with Venezuela six years ago. One more failed bet on a failed state will cut to the heart of Xi's BRI dreams.

Once upon a time, Venezuela was the Chinese policy banks' favorite destination. With loan-for-oil deals, China wagered that the country's petroleum production was enough collateral for debt repayments. By the beginning of President Nicolás Maduro's 2013 term, China had provided Venezuela with a $40 billion credit line, with about $30 billion of that amount still outstanding. 

That was a miscalculation. During the 2014 to 2015 commodities downturn, Brent crude went from $100 per barrel to half that; and China had to renew $9 billion of previous loan tranches just to help the Venezuelans navigate through the crisis and boost oil production capacity. China still hasn't got a big chunk of its money back. Last year, the Venezuelan government reportedly received a grace period on loans worth some $19 billion.

That creditor trap has dented confidence. China's policy banks have not delivered fresh funding to Venezuela since 2013. On top of that, their total development loans abroad peaked in 2016, shortly after the debt extensions in Venezuela. Failure to protect its interests in Pakistan will raise even more questions about Xi's nation-building model.

Much of Beijing's troubles comes from the way it approaches loan-making. Where the World Bank funds projects based on concrete metrics such as country risk premium and required rate of return, China seems to operate on instinct. Instead of looking backward into a country's credit history, Beijing tries to project what the debtor might look like if it got enough investment and infrastructure — a pie-in-the-sky approach.

There may be domestic blowback to a failure of the BRI. The Chinese people may not be all that generous about Beijing's largesse abroad if it amounts to little. Indeed, the policy banks were set up to execute fiscal stimulus and give out business loans at home, not to fund failed states. China Development Bank, the most muscular one, is already under-capitalized compared to its global peers. Why should China's banks get mired in distressed nations? Even with Beijing's help, Pakistan is a basket case. It has taken 13 bailouts in 30 years from the International Monetary Fund. 

The US's hurried exit from Afghanistan was certainly bad publicity, but America's debacle is not a win for China. One superpower wants its soldiers to return home. And the other? China just wants some positive internal rates of return to justify its dream of a new Silk Road. 

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement