Conditionality in Chinese bilateral lending

Abstract

China's long insistence on non-interference and sovereignty and frequent criticism of Western interventionism has contributed to a widely held impression that China lends and invests abroad without attaching policy conditions. This discussion paper surveys the general policy debate on conditionality in lending, as well as China's own debate on conditionality. We then examine bilateral loans provided by Chinese state-owned policy banks, notably China Exim Bank, arguing that the assumption of China's shunning conditionality is valid only if the term is taken narrowly to imply the specific set of policy conditions (e.g. privatisation and financial liberalisation) routinely called for by World Bank Group lenders. Based on a literature review and analysis of loan features along with tentative evidence from empirical cases of Chinese bilateral lending, we identify four hypothetical types of conditionality: political conditionality, embedded conditionality, cross-conditionality and emergent conditionality. In all likelihood the last three types of conditionality are not imposed by a unitary state actor, but emerge as an indirect consequence of the voluminous business activities of Chinese state-linked lenders and enterprises in developing countries. [PUBLICATION ABSTRACT]

Headnote

Abstract

China's long insistence on non-interference and sovereignty and frequent criticism of Western interventionism has contributed to a widely held impression that China lends and invests abroad without attaching policy conditions. This discussion paper surveys the general policy debate on conditionality in lending, as well as China's own debate on conditionality. We then examine bilateral loans provided by Chinese state-owned policy banks, notably China Exim Bank, arguing that the assumption of China's shunning conditionality is valid only if the term is taken narrowly to imply the specific set of policy conditions (e.g. privatisation and financial liberalisation) routinely called for by World Bank Group lenders. Based on a literature review and analysis of loan features along with tentative evidence from empirical cases of Chinese bilateral lending, we identify four hypothetical types of conditionality: political conditionality, embedded conditionality, cross-conditionality and emergent conditionality. In all likelihood the last three types of conditionality are not imposed by a unitary state actor, but emerge as an indirect consequence of the voluminous business activities of Chinese state-linked lenders and enterprises in developing countries.

JEL codes: F34, F36, F59

Keywords: China, bilateral lending, conditionality, policy banks

Headnote

Tiivistelmä

Yleisesti oletetaan, että koska Kiina on pitkän pitänyt kiinni puuttumattomuus- ja suverentiteettipe-riaatteista ja usein kritisoi Lännen interventionismia, Kiina myös lainaa ja sijoittaa ulkomaille ilman politiikkaehtoja. Tämä keskustelupaperi tarkastelee yleistä keskustelua lainojen ehdollistamisesta, sekä Kiinan sisällä käytyä ehdollistamiskeskustelua. Seuraavaksi tarkastelemme Kiinan valtio-omisteisten politiikkapankkien (policy banks) bilateraalisia lainoja, erityisesti Exim-pankin osalta. Keskustelupaperin argumentti on, että Kiinan oletettu vastahakoisuus ehdollistamista vastaan pätee lähinnä jos tämän käsitteen ymmärretän tarkoittavan niitä nimenomaisia politiikkaehtoja, joita Maailmanpankkiryhmän lainausinstituutiot tavanomaisesti ovat edellyttäneet, kuten yksityistämistä tai rahoitusmarkkinoiden avaamista. Kirjallisuuskatsauksen sekä lainojen piirteiden ja alustavien Kiinan bilateraalilainoituksen empiiristen tapausten analyysien pohjalta, identifioimme neljä hypo-teettista ehdollistamisen muotoa: poliittinen ehdollistaminen, upotettu ehdollistaminen, ristikkäinen ehdollistaminen sekä emergentti ehdollistaminen. Nämä ehdollistamisen muodot eivät, ensimmäistä lukuunottamatta, todennäköisesti ole yhtenäisen valtiotoimijan asettamia. Sen sijaan ne ilmaantuvat kiinalaisten valtiollisten lainaajien ja valtionyhtiöiden merkittävien kehitysmaapanostusten epäsuo-rana seurauksena.

JEL codes: F34, F36, F59

Asiasanat: Kiina, ulkomainen lainananto, ehdollisuus, politiikkapankit

(ProQuest: ... denotes non-US-ASCII text omitted.)

1 Introduction

China's long insistence on non-interference and sovereignty and frequent criticism of Western interventionism has created a widely held impression that China lends and invests abroad without attaching policy conditions. Under this view, Chinese financing institutions, unlike Western governments or Western-controlled institutions, grant loans without requiring the recipient government adhere to certain political standards (e.g. governance) or adjust their economic policies (Bosshard, 2007; ..., 2008: 125-126; Foster et al., 2008: 6; ..., 2008; Chin and Helleiner, 2008: 90; Farnsworth, 2011: 60; Brautigam, 2010: 37, 39-40; Dennison and Dworkin, 2010: 2).

Indeed, respect for state sovereignty and non-interference have been guiding principles of Chinese foreign policy for decades. Premier Zhou Enlai coined the Five Principles of Peaceful Coexistence during negotiations between China and India in 1954. 2 The purpose of the Five Principles policy was to ensure that the newly independent countries would avoid the aggressive relationship they earlier experienced with colonial powers.3 China's current leadership still rhetorically sticks to the principle of non-interference in foreign policy, but often couches it in a context of mutually beneficial cooperation or common development, illustrative of this is former Chinese Foreign Minister Li Zhaoxing's statement that "mutual respect and non-interference in each other's internal affairs between countries are the necessary conditions for building a harmonious world." (China Daily, 2007). Apart from obtaining United Nation's Security Council authorisation for any crisis management action, China's government regards host nation consent as a major distinguishing line that divides extensive Chinese involvement in Africa, for example, from Western intervention during the Kosovo crisis in 1999 (Bellamy and Williams, 2005; Van Hoeymissen, 2009). The Chinese government is thus able to claim that it does not intervene in other countries' sovereign affairs.

In Zhou Enlai's 1964 outlining of China's eight principles on aid to foreign countries, he stated that "the Chinese Government strictly respects the sovereignty of the recipient countries, and never attaches any conditions or asks for any privileges." (Brautigam, 2009: 29). Beijing has since consistently maintained that it does not impose political conditions to its lending and aid. For ex-ample, at the closing ceremony of the Forum on China-Africa Co-operation Ministerial Conference in October 2000, Chinese Premier Zhu Rongji said "China never attaches any political string to its assistance to Africa or seeks any political privilege in doing so." (PRC Foreign Ministry, 2000). Wary of foreign criticism of China?s tying financial aid to securing access to natural resources, the Chinese State Council recently released its first-ever White Paper on Chinese foreign aid. The White Paper stresses that China does not attach any political conditionalities whatsoever to its for-eign assistance, nor does it interfere in the domestic affairs of other countries or seek political privi-leges ...

In this paper, we challenge the view cherished in China and widely accepted internation-ally that Chinese bilateral lending is devoid of conditionality. We ask whether this "no-strings-attached" perception stems from a limited view of conditionality encompassing only the kinds of conditions attached by the IMF and World Bank that misses the conditionality inherent to Chinese lending. Our argument is that the assumption of China not attaching policy conditions in its lending is valid only in a narrow sense, understood as demanding adherence to certain governance and transparency standards or concrete changes to economic policy such as privatisation. In the broad sense, China is certainly not above attaching conditions to lending. However, most conditions are probably not imposed by a unitary state actor. They instead emerge from the voluminous business activities of Chinese state-linked lenders and enterprises in developing countries.

2 Data sources and caveats

Researching Chinese bilateral lending is fraught with data challenges. Comprehensive information on all bilateral loan frameworks and detailed numerical data related to policy-based lending are not publicly available. Specific loan covenants are confidential and the lending institutions in question are not particularly transparent or accessible. Unsurprisingly, relatively little is known about the terms of Chinese concessional loans (Foster et al., 2008: 40-44; Hubbard, 2007: 8-9).

In 2008, a team of World Bank economists attempted one of the most thorough quantifica-tions of Chinese-financed projects. They meticulously compiled a database of Chinese-financed in-frastructure projects in Africa covering the years 2001-2007, sifting through international and Chi-nese media reports, as well as Chinese official sources. Yet, even this studious attempt at quantify-ing Chinese-financed projects reported that as many as 41 % of all projects were unverifiable; formation on them was not available from any official Chinese sources (Foster et al., 2008: 12). This lack of comprehensive and solid data does not make the topic amenable to econometric analy-sis, so we have adopted an eclectic approach to data-gathering, using data from multiple sources.

First, we use information on loan deals available from publicly available Chinese sources (e.g. the Chinese Foreign Ministry and Ministry of Commerce, and the contract database of the Bei-jing University Faculty of Law). We also draw on scattered case-evidence and targeted anonymous interviews and discussions with people knowledgeable regarding various aspects of international lending. We have supplemented these sources with reviews of the Chinese policy debate, as well as drawn on secondary sources in the relevant literature.

The paper gauges China?s position towards attaching explicit policy conditions to lending by first surveying the general debate on conditionality in policy-based lending and the Chinese do-mestic debate on conditionality. For this purpose, we conducted an extensive review of the Chinese policy debate (academic journals, official statements, media columns, etc.) in the period 2007-2010. We then turn to examine China?s bilateral lending practices, focusing on one of China?s three major state-owned "policy banks," the China Exim Bank (Chexim). China?s two other policy banks are China Development Bank (CDB) and Agricultural Development Bank of China (ADBC).

Based on the analysis, we hypothesise four kinds of conditionality related to Chinese bilat-eral lending: political conditionality, embedded conditionality, cross-conditionality and emergent conditionality. A caveat regarding the empirical validity of these conditionality types needs to be mentioned here: our claims should be regarded only as tentative, suggesting perhaps the way for-ward for further empirical study. The first two of the conditionality forms we identify are relatively well grounded empirically and based on the general features of Chinese bilateral lending and inter-governmental agreements. The latter two, in contrast, are constructs arising mainly from scattered case-evidence, as well as our understandings of the nature and features of Chinese policy-based fi-nancing. Further empirical research obviously is required to validate their prevalence.

3 The debate on conditionality in policy-based lending

Attaching policy conditions to lending is by no means a new phenomenon. In the scholarly debate, especially the policy conditions attached by lending institutions of the World Bank Group have long been noted. 4 However, conditionality in policy-based lending subsequently also spread to regional development banks and bilateral donors (Koeberle et al., 2005: 5). In conjunction with IMF aid re-quests in the 1980s, the IMF typically demanded "structural reforms" as a condition for receiving financial aid.5

The IMF and the World Bank shy away from the overtly political conditions related to "democracy" or "human rights" individual countries may apply in their development lending. In fact, the Articles of Agreement of the World Bank?s lending institutions prohibit them from inter-fering in a country?s political affairs and making decisions based on the political character of the member country (see e.g. IBRD, 1989, Art. IV, section 10). Similar restrictions apply to the IMF (Bräutigam, 2010: 16, 44). In the self-understanding of these institutions, they have a non-political mandate, in comparison to "political" institutions such as the UN General Assembly. Nevertheless, the World Bank institutions have occasionally been criticised for pursuing political objectives (Swedberg 1986: 386; Bacha, 1987; Teivainen, 1994: 19-24; Marquette, 2004).

One critique of World Bank and IMF policy conditionality is that the development financ-ing arms of these institutions place an unacceptably high number of detailed conditions on loan re-cipients, who are often among the world?s poorest countries. One report counted on average 67 conditions per World Bank loan (Eurodad report, 2006: 3). Many of these conditions promote pol-icy goals that may be politically controversial such as the privatisation of basic services or trade lib-eralisation. Most other bilateral and multilateral donors and creditors tie their development aid and debt relief to the existence of an IMF programme (ibid: 5), and international agencies may threaten to withdraw financial support if conditions are not met (Hunter and Brown, 2000: 117). The signifi-cance of World Bank and IMF conditionality then goes beyond the funding provided by these insti-tutions themselves.

A different strand of conditionality critique concerns the ineffectiveness of lending condi-tionality pursued by the World Bank Group institutions (e.g. Hunter and Brown, 2000; Weyland, 2003; Kaufman and Nelson, 2004). Financial aid affects policy reforms in complex ways, providing ample space for recipient governments to resist external pressures. Conditionality is often most ef-fective when it coincides with domestic policy priorities and development needs (Wigell, 2011; Pridham, 2010). This line of critique has been prominent among IMF and World Bank economists, with much of the conditionality discussion in recent years revolving around the concept of "country ownership" (see e.g. Koeberle et al., 2005).

IMF conditionality also arose in 2000 as an issue in the Chiang Mai Initiative (CMI) of swap arrangements between the central banks of Asean+3 countries (which includes China). Under the CMI, swap agreements are generally complementary to IMF assistance, although tying liquidity to the existence of an IMF programme and its conditionality requirements has been a perennial is-sue. The bilateral swap agreement set up between China and Japan in 2002 was exceptional in that it did not include the IMF link and used local currencies (Chin, 2010: 703; Henning, 2002: 19-20; Ranjan and Prakash, 2010: 12).

Chinese views on conditionality have to be understood against a backdrop of a highly criti-cal domestic policy debate revolving around American dominance of the World Bank Group insti-tutions and the US dollar?s dominance in the global economy. In keeping with this general mood, Chinese leaders are among the most vociferous critics of the current system of international eco-nomic governance. In March 2009, for example, Chinese central bank governor Zhou Xiaochuan argued in three articles ( , 2009a; 2009b; 2009c) that the world should gradually move away from dollar-centricity and pondered options that included more extensive use of IMF Special Drawing Rights (SDRs).

An often noted distinguishing feature of China?s foreign policy is its strong emphasis on principles (Zhang, 2008: 161). The policy conditionality of IMF and the World Bank seemingly clashes directly with the non-interference principle that supposedly guides much of China?s foreign policy. The Chinese government has recently toned down its insistence on absolute non-interference, e.g. expressing concern over the stituation in Sudan (e.g. Evans and Steinberg, 2007; 2010: 43) and shown a willingness to speak up when Chinese interests abroad are threatened. In February 2011, China surprised many by voting for a UN Security Council resolution on Libya (1970) that referred the situation to the International Criminal Court, a move that by some observers was interpreted as indicating a subtle change towards less intransigence on non-conference.

Nevertheless, in the domestic policy debate within China, the policy conditionality demands of multilateral organisations are frequently criticised.6 They are seen as a means of interference in other countries' domestic affairs. During the Asian financial crisis 1997-1998, conditionality came to be seen as a key part of the "Washington Consensus," a term originally used to describe a set of policy recommendations imposed on Latin American countries' economic, fiscal and financial policies in the 1980s (see Williamson, 1990 and 2004). More than a decade after the Asian financial crisis, the policy prescriptions and reforms required by the IMIF are still commonly regarded among Chinese experts as having failed to achieve their objectives and fit badly with East Asian societies, while causing considerable economic and social pain (e.g. ..., 2009a).

Many Chinese commentators argue that conditions imposed by the 11VIF such as forced free-floats of currencies, liberalisation of the capital account, privatisation and other, sometimes draconian, economic measures hurt more than help. In this debate, IMF conditionality is often seen as closely connected to the policy prescriptions favoured by the United States. Yu Yongding, an influential Chinese economist and former advisor to the Chinese central bank, bluntly states: "IMF conditionality should be totally reconsidered. The action taken by the US government in dealing with [sic] current financial crisis has totally discredited the prescriptions provided to and imposed on the crisis-affected countries during the Asian Financial Crisis." (Yu, 2009: 3-4).

Even as Chinese policy commentators have been critical in particular of the IMF conditionality, Chinese experts have gained influential positions in the institutions of the World Bank Goup, and following recent voting reforms, China has emerged as one of the biggest shareholders in the IMF and World Bank. The policy criticism of external commentators has not been reflected in China's actions within these organisations, where China has generally maintained a constructive role. Some people participating in the Chinese policy debate link the issues of China's increasing IMF voting power and conditionality. For example, one Chinese professor based in Shanghai argues that, once China's voting power becomes commensurate to the size of its economy, China can have a say in which countries can take money, how much they can take money and how they can use the money. Previously, it has been the United States that has used various aid packages to open up countries' financial markets for US companies. Naturally, notes the professor, China can also later consider diplomatic, political and other reasons in promoting conditions for aid that are beneficial for China (..., 2009b).

While occasionally flirting with the idea of China attaching its own conditions, Chinese commentators more commonly appear content with criticising the policy conditions attached by "Western-dominated" lending institutions and donors. Two Chinese experts even argue that foreign aid is never unconditional; it always furthers the commercial or political aims of the donor country. Astonishingly they then, practically in the same breath, maintain that China does not attach any po-litical conditions to its development aid (see. e.g. ... and ..., 2008: 123-126). Another prominent Chinese scholar has argued that the Chinese practice of providing aid primarily in the form of turn-key projects that require intensive Chinese involvement at all project phases, including post-construction management during handover, does not constitute interference in the recipient coun-tries domestic affairs; it merely teaches recipient countries to become self-reliant (..., 2008: 39). However, another Chinese commentator recently acknowledged that no country can entirely im-plement a policy of non-interference in other countries domestic politics (...2010: 43).

4 The scope and nature of Chinese bilateral lending

China has emerged as a major bilateral lender to developing countries in recent years. Chinese lead-ers frequently promise concessional loans amounting to billions of US dollars. For example, in 2005 both the Chinese president and foreign minister pledged US$10 billion in concessional loans to developing countries over the following three years. Two years later, the chairman of the Na-tional People?s Congress promised $5 billion in preferential loans to African countries. In 2009, Chinese premier Wen Jiabao pledged a further $10 billion in concessional loans to African coun-tries, plus an additional $1 billion loan for small and medium-sized African businesses. Although the realised concessional loan sums are often much less than what is stated in the media (Bräutigam, 2010: 19), they are, nonetheless, significant.

Most of China?s development lending is done by the Chexim and CDB. Administratively, Chexim is directly under the Chinese State Council. CDB is more focused on investments and is owned by Central Huijin Investment, which, in turn, is owned by China Investment Corporation. CIC sits administratively under the Ministry of Finance (Walter and Howie, 2011: 218). Given that Chexim is the sole government-authorized source of concessional loans and export credits in China, and that it incorporates a role that in many other countries is handled by designated bilateral donor institutions (Foster et al., 2008: 40-41), growth in the balance sheet of Chexim provides a proxy for China?s growing bilateral development lending. From a modest beginning in the mid-1990s, Chexim?s balance sheet has recently outpaced the balance sheet assets of the Asian Devel-opment Bank (see Figure 1). The compound annual growth rate for the bank?s balance sheet has been a staggering 47.0 % over the course of its existence, and a still-respectable 27.7 % in the dec-ade to 2009, with the last two years showing a clear jump in balance sheet assets.

Analysis by the Financial Times recently estimated that CDB and Chexim lent at least US$100 bil-lion to developing countries during 2009-2010, topping the loans provided by the World Bank?s main lending arm, the International Bank for Reconstruction and Development, and the Interna-tional Financial Corporation, the main private-sector lending vehicle of the World Bank Group for non-sovereign-backed lending ( Financial Times , 2011). In some cases, developing countries have apparently chosen to take Chinese bilateral funding in lieu of a funding package negotiated with the IMF or the World Bank (Chin and Helleiner, 2008: 90).

The April 2011 White Paper on Chinese foreign aid notes that as of end-2009 China had provided a total of 256.3 billion yuan in foreign aid (about US$40 billion at current exchange rates), of which 58.6 % was provided in the form of concessional or interest-free loans .... Although the report did not break down sums by country, this was apparently the first time the Chinese government had ever released overall figures for foreign aid. The large discrepancy between the figures of White Paper and the Financial Times appears to stem from the fact that only budgetary transfers were counted in the official aid figure, which includes interest on concessional loans but not principal (..., 2008: 40).

Chinese definitions and practices related to its fast-growing bilateral financing are somewhat vague; they do not follow standard conventions or the definitions used by the OECD and in other multilateral arrangements. China also frequently invokes the catch-all term "external assistance" (...), a broad concept that embraces grants, interest-free loans, preferential loans, cooperative and joint venture funds for aid projects, science and technology cooperation and medical assistance (SchUller et al., 2010: 2-3; ... 2011). Unlike direct aid and interest-free loans funded by budgetary means, concessional loans and preferential buyer credits provided by Chexim are funded by issuing debt on the financial markets. Only the interest differential on concessional loans is paid from the aid budget of the Ministry of Commerce; the difference between the interest on preferential buyer's credits and Chexim' s funding costs are covered by the Ministry of Finance (... and ..., 2008: 132-133).

Much of the debate about Chinese foreign aid practices relates to this ambiguity in what constitues proper development aid, what is to be considered pure export promotion, and what, perhaps, should even be regarded as foreign direct investment. Adding to the confusion, Chinese concessional loans are often bundled with market-rate loans. A fairly typical feature of Chinese bilateral lending is the financing package. Pioneered by Chexim in 2006, the package combines concessional loans with export buyer and export seller credits (Brautigam, 2010: 38). These packages have been compared to OECD "mixed credits" (ibid: 20), but the Chinese financing packages may be more relaxed on environmental and anti-bribery requirements (OECD countries customarily set environmental and anti-bribery requirements on the projects they support with official development assistance). Furthermore, Chinese financing packages do not need to be reported to other countries, so they evade external review.8

The emergence of the Chinese policy banks as major players on the international develop-ment lending scene has had a significant impact on efforts to erect and maintain common standards and practices in bilateral development lending. China has taken an ambivalent attitude towards ef-forts at setting lending standards coordinated under the auspices of the OECD. According to the agreement among OECD members concessional loans can be offered with longer repayment terms and lower interest rates than might otherwise be offered by the market. China observes the OECD work undertaken on officially supported export credits and tied-aid credits, but does not endorse OECD guidelines on lending that take the form of "gentleman?s agreements" (OECD, 2010).9 China, however, frequently uses the term "concessional" to denote loans it provides to developing countries. As a result, there has been substantial debate over how "concessional" Chinese conces-sional loans are in practice. The case-evidence (Bräutigam, 2010: 22-23), and the terms of publicly available concessional loan framework agreements suggest Chinese concessional loans are not par-ticularly concessional when it comes to maturities or interest rates.10

Foster et al. applied the standardised calculation formula used by the World Bank?s Inter-national Development Association to assess the grant element of Chinese concessional loans to Sub-Saharan Africa during the period 2002-2006. On average, these loans had a grant element of 36 %, which was well above the 25 % threshold used by the World Bank and the IMF as an official development assistance (ODA) definition, but far below the 60 % grant element of IDA credits. On average, the assessed Chinese loans offered an interest rate of 3.6 %, a grace period of four years and a maturity of twelve years. There is, however, much variation in the financing terms of Chinese financing institutions, depending on the recipient country. Overall, the assessed Chinese conces-sional loans offered a moderate level of concessionality which was well above private creditors but lower than other official creditors (Foster et al., 2008: 46-47).

In providing a concessional loan, a framework agreement is first drawn up between the governments of China and the recipient country. No complete set of concluded agreements is pub-lished, and even the details of the reported framework agreements are often sketchy. As a result, compiling an exhaustive list of such agreements is challenging. Appendix 1 shows framework agreements that can be found by searching on the Chinese Foreign Ministry and Commerce Minis-try websites and the contract database of the Beijing University Faculty of Law. We further sup-plement our list with agreements identified in an earlier study that relied on the Foreign Ministry website. Through these sources, we identify 90 framework agreements signed with 50 different countries. Obviously, these represent a fraction of all agreements. Chexim itself refers to having signed 78 concessional loan projects in the period 2001-2005 alone (Foster et al., 2008: 40-41). Probably the most comprehensive assessment, the recent State Council White Paper on Chinese aid, claims 325 concessional-loan-financed projects in 76 countries (... , 2011: 4).

Concessional loans are always denominated in yuan, while preferential export credits are denominated in other currencies. In practice, however, Chinese development lending almost never involves direct transfers of money to the target country through loans and only rarely takes the form of cash grants (Foster et al., 2008: 43; Bräutigam, 2010: 19). When a Chinese policy bank makes a concessional loan, the money typically never leaves China. Chexim, for instance, pays the Chinese contractors or suppliers in yuan and the recipient pays off in dollar installments to Chexim. One condition for such a loan is that the project has a Chinese lead contractor so that the loan can be transferred directly from the lender?s account to the lead contractor?s account in a Chinese bank. The borrower then repays in installments to the Chinese policy bank in an agreed currency or form . The practice is common in bilateral development lending and export credit financing in general.

This lending practice forms a natural springboard for increasing international use of the yuan. In December 2010, Chexim announced that in the coming five years it would use its position to promote internationalisation of the yuan in cross-border trade and investment (China Radio In-ternational, 2010). This is in line with the policy objectives of the Chinese government. The re-cently released 12th five-year plan endorses gradual increase of the yuan in international trade and promoting its greater international use ( ,... 2010: 28, 30). China?s central bank has also announced measures to this effect. Earlier, China has already concluded a number of bilateral swap agreements using the yuan (see Appendix 2). Requir-ing the use of the Chinese currency in bilateral lending and how the Chinese policy banks will put the policy objectives of the 12th five-year plan into practice are evolving issues.

5 Lending with Chinese conditions

Below we describe and explain the four types of conditionality we have identified by examining specific cases and the general literature on Chinese lending.

Political conditionality. Political conditionality refers to the recipient country needing to meet basic diplomatic and political preconditions prior to receiving any funding. These include diplomatic rela-tions and toeing the line on Chinese political sensitivities. This political conditionality inherent in Chinese diplomatic dealings is akin to the political conditionality applied by the European Union. The EU routinely demands the inclusion of a "democracy and human rights clause" when signing partnership agreements with non-EU governments.

While the policy conditionality of international financing institutions is often criticised in the Chinese debate and Chinese foreign policy supposedly is guided by the non-interference princi-ple, Beijing itself has often attached broad political conditions for reaching diplomatic agreements (Zhang, 2008: 162). Most obviously, Beijing regularly demands that its interlocutors reaffirm their commitment to the One-China principle and the People?s Republic of China?s as the legitimate gov-ernment of China, before cooperation can ensue.

Chinese state-owned lenders contend they do not apply political conditionality to their lending, even advertising this to non-Chinese customers as a key advantage of taking a Chinese loan (China Exim Bank, 2007). If we do not accept this statement at face value, we may ask what politi-cal conditions are applied in Chinese development lending? The diplomatic precondition is the first hurdle. In Chinese lending to developing countries, diplomatic relations with the PRC are a stated condition for receiving e.g. a Chexim concessional loan (China Exim Bank, 2009). Indeed, all the African countries to which Chinese policy banks have lent money have diplomatic relations with the PRC (with the exception of Swaziland). As a rule then, Chinese aid and bank credits are given to countries with which China has diplomatic ties (Bräutigam, 2010: 7, 29-30). This has larger trade implications as China is known to have asked its trading partners to support the diplomatic isolation of Taiwan (Farnsworth, 2011: 56), and has restricted and punished countries that do not obey Bei-jing?s wishes to isolate Taiwan from multilateral international organisations and venues where membership or attendance is based on sovereignty. As an example, Beijing pressured Hanoi to ex-clude Taiwan from the APEC summit in Vietnam in 2006. When Hanoi refused, Beijing temporar-ily halted aid to Vietnam (Mitton, 2006).

The political condition of adhering to the One-China policy may be enshrined in diplo-matic agreements that incorporate the framework agreement for concessional loans. For example, China and Belarus signed a joint communiqué in 2007 after a meeting during which a framework agreement for the first Chinese concessional loan to Belarus was signed. The joint communiqué contains pledges by Belarus to adhere to a One-China policy; reaffirm the PRC as the legitimate government of all of China; resist Taiwanese independence, including all kinds of measures aimed at legitimising Taiwanese independence such as referenda on Taiwan?s re-joining the UN; resisting Taiwan?s participation in all international and regional organisations where membership is reserved for sovereign countries; and promising not to engage in any interaction with Taiwan of an official nature. Belarus also expressed its support for PRC efforts to reunify with Taiwan and stated that the Taiwan issue is a Chinese domestic matter. On Tibet, Belarus stated that it is an inseparable part of China and firmly resisted attempts by any country to interfere in China?s domestic matters. In re-turn, China pledged its opposition to any efforts to use "human rights" to interfere in the internal matters of Belarus (..., 2007).

Some scholars argue that China?s conditionality when it comes to aid is almost entirely political; requiring recipient countries to support China?s positions on various global issues (Bergsten, 2008). There is relative certainty regarding the fact that the positions on human rights and global governance issues of China and other developing countries are increasingly aligned (Holslag, 2010: 8). A harder-to-answer question is whether receiving ample Chinese funding and endorsing such general political statements commonly incorporated into bilateral communiqués and agreements actually results in other countries aligning their political positions with China or complying with China?s wishes. Some even argue that it is China which is aligning its position with developing countries (Bräutigam, 2010: 38).

An interesting case of how Chinese financing may have political consequences is the December 2009 visit of Chinese vice-president Xi Jinping to Cambodia, where he announced US$1.2 billion in aid and loans. Only one day before his visit, Cambodian authorities forcibly deported 20 Uighur asylum-seekers to China. Before the repatriation, the UN High Commissioner for Human Rights had expressed concern to the Cambodian government regarding deportations to China. China and Cambodia are both signatories to the 1951 UN Convention on the Status of Refugees. The Convention obligates parties to cooperate with the UN High Commissioner for Human Rights (USCC, 2010: 122).

Embedded conditionality. Embedded conditionality refers to the recipient country needing to ad-here to a number or project-related demands regarding, for example, the use of Chinese-sourced contractors, sub-contractors, technology, equipment suppliers, management and training, as well as a Chinese workforce. Scholars have long identified the purchase of donor country exports, or "cap-tive demand," as a condition of foreign aid (Richardson, 1978: 56). Chinese experts also recognise that making aid conditional on the purchase of donor country products and technologies is one of the main economic aims of foreign aid (... and ..., 2008: 123-124).

Whereas the proportion of untied aid of all bilateral aid has risen to 82 % for Development Assistance Committee (DAC) donor countries (Clay et al., 2009: 12), Chinese external assistance still consists entirely of "tied aid" (Chin and Frolic, 2007: 11, 14). Tied aid refers to an international practice whereby the borrower is tied to purchase the required technology or equipment from the lender country. In a tied-aid arrangement, the loan interest rate is low and eligibility is limited, ac-cording to OECD rules regulating ODA, to low- and lower-middle-income countries. As men-tioned, China is not a party to the OECD agreement, so it does not adhere to this convention. Natu-rally, China also does not need to report its ODA to those countries that are party to the OECD agreement.11

China provides concessional loans to upper-middle-income countries for which ODA nor-mally is not an important part of the national economy. China?s White Paper on aid mentions that 11 % of Chinese foreign assistance has gone to upper-middle income countries (... , 2011: 9). In Table 1, we have extracted those concessional loan framework agreements from Appendix 1 that China has concluded with upper-middle-income countries. China also directs some of its foreign aid, especially concessional loans, into economically viable sectors, such as telecom-munications, mining, and other industrial projects (... , 2008: 40), i.e. activities forbidden to parties to the OECD agreement. According to the guidelines agreed within the OECD, countries can only provide tied-aid loans to commercially non-viable projects.12

It seems that concessional loans and preferential buyer?s export credits have become central com-ponents in financing Chinese business operations abroad. According to the Chexim, such loans are directed into manufacturing projects, infrastructure construction projects and social welfare projects in the borrowing country that will generate promising economic returns or good social benefits (China Exim Bank, 2009). In a typical case of Chinese policy bank financing, Chexim provides a loan denominated in the Chinese currency for a recipient company, local or central government. A central condition to qualify for the loan is that the recipient uses a Chinese contractor in engineer-ing, procurement and construction (EPC) phases, as well as import essential technologies and equipment from China and allow the contractor and subcontractors to use a Chinese workforce (Bräutigam, 2010: 29-30). In many cases, this model excludes local businesses and restricts utilisa-tion of local labour. In October 2010, a member of the Vietnamese National Assembly?s Finance and Budget Committee claimed that 30 Chinese companies were participating in 42 key strategic projects in Vietnam. Apparently, the Chinese contractors used no Vietnamese materials, equipment or labour ( VietNamNet , 2010). The White Paper notes that the most important form of Chinese for-eign assistance is the provision of complete projects (... ). Such turnkey projects currently account for about 40 % of all Chinese budgetary expenditure on foreign assistance (... , 2011: 5; see also , 2008: 39).

Repayment of the loan is sometimes backed with proceeds from the recipient country?s main export commodity. The proceeds are either put in an escrow account with Chexim (e.g. Ghana uses cocoa revenues to pay for a Chinese loan for the Bui Dam), or the resource itself can be ac-cepted as payment as in the case of Angolan oil. A number of African countries have used such re-source-backed credit lines: Nigeria, Congo-Brazzaville, Equatorial Guinea, Ghana, D.R. Congo, Sudan, Angola and Gabon and possibly Zimbabwe. This model is sometimes referred to as "Angola mode." In the Angolan case, Chexim has provided Angola since 2002 with several billion dollars in loans, building a vast number of infrastructure projects.13 According to the agreements, the money could only be used for infrastructure building and 70 % of the projects would be awarded to Chi-nese state-owned enterprises approved by the Chinese government that brought over their own la-bour from China. Loan repayments are made in oil, making Angola the largest source of crude oil imports for China (Foster et al., 2008: 20-21, 42-43; Bräutigam, 2010: 20-21; Michel and Beuret, 2009: 214-215). The large role played by state-owned enterprises in implementing Chinese devel-opment projects has been noted even by Chinese scholars as a peculiar feature of Chinese foreign aid (... and ..., 2008: 132).

Apart from the few political conditions described above, Chinese policy-based lenders do not demand explicit policy conditions up-front like many other lenders. This facilitates the speed with which Chinese loans can be granted - a crucial competitive advantage in export financing. On the other hand, it stands clear that on a project level, Chinese sovereign-backed financing com-monly comes with a number of conditions attached. This is not unusual per se as, for example, tied aid of other countries includes similar provisions. However, Chinese requirements regarding use of Chinese inputs (labour, contractors, etc.) appear to be generally higher than in most cases. What makes Chinese financing somewhat more sui generis is the fact that, unlike most bilateral lenders, all Chinese policy-based financing follows the tied-aid model, including financing for higher in-come countries. Conditionality here does not refer to demands for outright changes of a country?s economic policy, rather conditionality is embedded in the project financing requirements.

Cross-conditionality. In the literature, cross-conditionality (sometimes referred to as implicit condi-tionality) indicates a situation where the conditions established by other creditors may de facto be-come conditions for loan disbursement of a new creditor (IMF, 2002: 40; Koeberle, 2005: 11). In the Chinese case, we contend that cross-conditionality refers to a situation whereby using funding provided by Chinese policy banks provides a lever to demand actions from the recipient country in some other context before loan disbursement.

An apparent case of cross-conditionality occurred in Indonesia, where China agreed to fi-nance most of the estimated US$8 billion budget for construction of a dozen coal-fired power plants with a total capacity of 10,000 MW to be operated by Indonesian state-owned electricity company PLN. The financing was provided by Chexim, CDB and Bank of China. In January 2009, after pro-viding an initial $2 billion loan tranche, the Chinese financiers suddenly suspended the release of further disbursements to all power plant projects. Separately, the CDB also pulled out of financing another power project in South Sulawesi Province, leading to the project?s postponement. Accord-ing to Indonesian sources, the Chinese financiers provided different explanations for their actions; they were either demanding higher interest rates than agreed in the original contract, or arguing, as the CDB, that they were "having problems" financing the project (PSIREN, 2009; Jakarta Globe , 2009a; 2009b).

In February 2009, Indonesian officials were informed that their Chinese investors were demanding the Indonesian government settle a contentious commercial dispute involving a much smaller deal between Indonesian PT Merpati Nusantara Airline and Xi?an Aircraft Industry, which had been financed with a $232 million Chexim concessional loan. The Merpati dispute began when the company aborted its purchase of 15 civilian aircraft from the Chinese manufacturer after run-ning into money problems. The Indonesians were told that the Chinese are willing to release the disbursements of power plant financing as soon as the Merpati dispute was settled. It is notable that the original financing for the Merpati deal was provided by Chexim, but the CDB and the Bank of China joined Chexim in an orchestrated suspension of all financing of power-plant projects in In-donesia. Suspending of financing for the power plants undermined the Indonesian government?s political credentials; the government had promised to implement fast-track the construction of much-needed electricity capacity and was relying on Chinese financing to meet that goal. Suspen-sion of Chinese financing threatened to dump the massive power construction project on Indonesian banks (Jakarta Globe, 2009c; Jakarta Post, 2009a; 2009b).

According to the Indonesian Minister of Energy, the situation had put them in a "hostage situation" that could only be solved if the Indonesian government caved to Chinese demands to first settle the Merpati dispute. The Chinese financiers also demanded higher interest rates in the PLN loans than originally agreed. In response, the Indonesian government sent a high-level delegation, led by its ministers for finance and trade, to China to seek clarification regarding Beijing?s inten-tions and to de-link the disputed aicraft deal from power-plant financing. The dispute was eventu-ally resolved after the ministers? trip. The Indonesian Finance Minister later requested that Chinese yuan, instead of US dollars, would be used for the procurement of project facilities from China (PSIREN, 2009; Jakarta Post, 2009a; 2009b; Jakarta Globe, 2009b).

Caution needs to be exercised in generalising on this case and the possible linkages be-tween separate financing deals as the information is based on second-hand sources. Nevertheless, the case suggests that large-scale Chinese financing in developing countries can confer leverage on Chinese state-linked financial institutions that extends across projects in the same recipient country. Emergent conditionality.

Emergent conditionality refers to the structural effects a history of Chi-nese funding and investment might create in the future. We stress that the existence of such condi-tionality is merely hypothetical as we have yet to see solid empirical validation.

Major infrastructure projects (e.g. power plants, railway networks, telecom networks) funded by Chinese policy banks usually involve transfer of complex technology, hardware, software and managerial know-how from China. The large size of these projects and high concentration of sourcing and management in Chinese hands at all stages of the project (design, construction, instal-lation, testing, training, and post-construction management) create technological, financial, manage-rial and educational dependencies that over time could create political dependency between the host country and China ( , 2008: 39). We are referring here to a situation where the recipient country's manoeuvrability is restricted by the accumulated weight of the "sunken costs" of relying exten-sively on China for critical aspects of major infrastructure projects.

While Chinese lending and investments are distributed around the globe, many of China?s largest financial and infrastructure commitments are concentrated in a few countries. In sub-Saharan Africa, for example, 70 % of Chinese financing commitments during 2001-2007 went to Nigeria, Angola, Ethiopia and Sudan (with Nigeria and Angola accounting for more than half of the total) (Foster et al., 2008: 19-20). In Asia, major Chinese commitments are similarly concen-trated in certain countries. By some accounts, Chinese contractors have attained approximately a 90 % share of the EPC projects in Vietnam ( VBN , 2010). They are also the general contractors or retain key roles in 80 % of the 40 coal-fired power plant projects in the country?s development plan. Most of these projects are in strategic sectors such as oil, gas, power, chemicals and labour-intensive textile industries. According to Nguyen Van Thu, chairman of the Vietnam Association of Mechanical Engineering, "Ten thermal power plants each with a capacity of 300MW are being built by Chinese contractors, because Vietnamese firms were denied a level playing field." ( VietNamNet , 2010). Similar complaints have emerged recently in other recipient countries. Interestingly, one Chinese commentator suggests China needs to apply more conditions to its bilateral lending to quell the growing chorus of criticism (..., 2010: 42-43). In any case, Chinese lending and investments to date have generally been positively received in developing countries with few projects inciting ma-jor local resistance (see e.g. Parameswaran, 2010: 45).

Chinese-funded investments in strategic sectors have handed Chinese state-owned banks and enterprises collectively a highly influential position, for example, in the Angolan and Vietnam-ese economies. It can reasonably be argued that the Chinese policy banks, state-owned enterprises and state-owned commercial banks responsible for most functions in bilateral projects are not equivalent to the Chinese government. Nevertheless, the Chinese policy banks are state-owned lenders and strategic investors with stated goals of carrying out the policy objectives of the Chinese government. It may well be assumed that they, at the very least, are not indifferent to the state?s broader political objectives even if it means benign goals such as promoting strong commercial and political ties with host countries.

6 Conclusions

This paper has tried to debunk the notion that Chinese bilateral lending is devoid of conditionality as is often claimed. We argued that the assumption that China shuns conditionality only holds when conditionality is narrowly understood as implying the policy conditions associated with the lending institutions of the World Bank Group. In this light, a good case could also be made for Western lending being much less conditional than is generally assumed (Bräutigam, 2011: 3). Reality often comes in shades of grey. The conditionality of China?s lending activities may simply take different forms from the ones that traditionally have been the subject of academic and policy discussion.

Importantly, the conditionalities that we have identified are not imposed by the Chinese state as explicit policy conditions that require changes to national economic policies. While there are some broad demands regarding diplomatic relations and political bottom lines, much of the con-ditionality seems to emerge as possibly unintended consequences of the plethora of activities that various Chinese state-linked lenders and enterprises engage in. There is an affinity in this idea to Ann-Marie Slaughter?s point of a disaggregated state - the network logic of globalisation having transformed interactions from intergovernmental negotiations between sovereigns to direct interac-tions between sectoral specialists (Slaughter, 2004: 12).

Our argument here relates to a broader and highly topical issue: To what extent does China use its growing financial power to gain commercial or political leverage? Concern has recently been raised that China may use e.g. its promises of Southern European bond purchases to gain political and commercial advantages. In early 2008, the manager of China?s foreign currency reserves, SAFE, allegedly invested in Costa Rican government bonds as part of a bilateral agreement that called for Costa Rica to cut its ties with Taiwan and recognise the People?s Republic (Chin and Helleiner, 2008: 91). Recently, American diplomatic cables obtained by Wikileaks also alleged that China used its massive U.S. Treasury holdings to pressure U.S. Treasury Secretary Timothy Geith-ner to lean on Federal Reserve regulators and speed up approval of an investment by China Invest-ment Corporation ( Reuters , 2011).

Many of these suspicions are undoubtedly overblown, stemming partly from a lack of transparency on the part of Chinese state-controlled investors and lending institutions. Nonetheless, the fact is that China's role as a global financial power is rapidly growing at a time when we still have relatively little solid research on what kind of conditions, if any, Chinese lending institutions attach to their lending.

Footnote

2 The Five Principles are 1) mutual respect for each other's sovereignty and territorial integrity ... 2) mutual non-aggmssion (...) mutual non-interference in each other's internal affairs (...) equality and mutual benefit (...); and 5) peaceful co-existence (`~fl3Fit4h).

3 The principle of non-interference is alluded to in Article 2, parts (4) and (7), of the first chapter of the Charter of the United Nations. While not explicitly stated, non-interference is also implicit in many provisions and a well-established guiding rule of international conduct (Chatham House, 2007). Since its suggestion in 2001, a lively debate has gone on within the UN system on modifying the non-interference principle to include "responsibility to protect" (see e.g. ICISS, 2001).

Footnote

4 The World Bank?s International Development Assistance (IDA) and the IMF Poverty Reduction and Growth Facility (Eurodad report, 2006: 5).

5 The IMF Executive Board determines the broad parameters of conditionality, with IMF staff taking care of the details of particular stabilisation and adjustment programmes.

Footnote

6 This claim is based on an extensive review by the authors of China?s policy debate on reforming the global financial system.

Footnote

7 The Foreign Ministry chooses priority countries and the Ministry of Commerce is mainly responsible for direct aid. The Ministry of Finance determines the overall development aid budget (... and ... , 2008: 130).

Footnote

8 Anonymous interview with two persons involved in development lending; April 1, 2011.

9 Anonymous interview with two persons involved in development lending; February 3, 2011.

10 The authors surveyed six agreements made with Turkmenistan, Tanzania, Vietnam, Zambia, Venezuela and Tonga in the period 2001-2003. Beijing University Faculty of Law database.

Footnote

11 There are two committees in OECD that deal with aid: the Export Credit Committee is responsible for tied aid and the Development Aid Committee for untied aid.

12 Anonymous interview with two persons involved in development lending; April 1, 2011.

Footnote

13 A private company called China International Fund, established into Hong Kong in 2003, also has major investment commitments in sub-Saharan Africa, especially Angola. The ownership and source of its capital are unclear.

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