The Chinese are rapidly becoming the largest source of sovereign credit for a number of Latin American countries, particularly those with weak access to global capital markets. In a new study I co-authored – The new banks in town: Chinese finance in Latin America – we estimate that between 2005 and 2011, state-led Chinese banks provided upwards of $75bn in loan commitments to Latin American governments. The Chinese committed $37bn to the region in 2010 alone, more than the World Bank, Inter-American Development Bank and the US Export-Import bank combined.
Two Chinese development banks – the Chinese Development Bank (CDB) and the Export-Import Bank of China – account for the vast majority of these loan commitments. And most of the loans go to Argentina, Brazil, Ecuador and Venezuela for mining, energy, commodity and infrastructure projects.
Growing presence
These lines are no 'sweetheart' deals. Chinese banks charge market rates, and sometimes more. Indeed, we found that the CDB charges higher interest rates than its Western counterparts in the World Bank, Inter-American Development Bank and the US Export-Import Bank. This is why US academic Deborah Brautigam refers to the CDB as the “development bank that doesn’t give aid”.
A $10bn 2009 line of credit from the CDB to Brazil would have been priced at Libor plus 280 basis points (bps), whereas the equivalent from the World Bank would have been Libor plus 55bps. A $10bn 2010 CDB credit line to Argentina for a rail system was priced at Libor plus 600bps, whereas recent World Bank loans to Argentina loans have been about Libor plus 85bps.
With the exception of Brazil, these countries have credit profiles that preclude most private investment and the majority of the international financial institutions. Brazil enjoys a BBB rating from Standard & Poor's and an Emerging Market Bond Index spread of 219bps. Argentina (B rating with a spread of 935bps), Ecuador (B- rating with a spread of 838bps) and Venezuela (B+ rating with a spread of 1220bps) are a different story.
Why would China provide massive loans to countries with such shaky credit profiles? There are a number of reasons. China is looking to diversify its investments away from low-yielding US debt securities, internationalise the renminbi, provide opportunities for its ‘national champion’ firms (many loans are tied to Chinese equipment purchases, etc...), and gain access to key commodities that Latin America has and China needs.
To hedge the risk, many of these loans are commodity backed – $46bn of the $75bn in loan commitments to Latin America. The misconception is that Brazil, Ecuador, and Venezuela (the countries that have such agreements) have to send barrels of oil to China at an agreed price before the recent price spikes. China buys a pre-specified number of barrels of oil per day and pays spot prices on the day of shipment. The Chinese then deposit a portion of the revenue into the borrower's CDB account and then withdraw the funds from that account for loan repayment.
Not only does it hedge risk, but it provides China with about 19% of its oil supply. The seven commodity backed loans in Latin America bring in approximately 1.5 million barrels of oil per day – or six-and-a-half months worth of oil.
Perfect match?
On many levels this is a win-win scenario. Latin American countries can fill serious trade and infrastructure gaps and enter capital markets sooner. Ecuador, which defaulted on its debt in 2008-09, has received billions of dollars from China, and is now attracting private investment again. China gets to diversify its investment portfolio, secure oil, and build markets for its products.
However, the picture is not all rosy. This investment accentuates Latin America’s century-old problem of commodity dependence, and the environmental ramifications of these massive projects will take a bite out of their economic benefits. The region would do well to reinvest some of the capital into innovation, industrial diversification and environmental protection. At China’s end it is wait and see what happens if (and when) one of these countries defaults on its China loan. At the time of writing, it seems clear that Chinese finance in Latin America presents some real opportunities, but also some real challenges.
Kevin P Gallagher is associate professor of international relations at Boston University, co-author of 'The new banks in town: Chinese finance in Latin America', commissioned by the Inter-American Dialogue, and co-author of the book 'The dragon in the room: China and the future of Latin American industrialization'.
