China is upending how the international financial system handles debt crises in the developing world. Wall Street isn’t happy.
Large bond fund managers cried foul last month when China blocked their deal to salvage investments in defaulted Zambian debt. The smackdown came just weeks after Chinese officials brokered a private debt restructuring with Sri Lanka, outmaneuvering Western governments that were trying to do the same.
China can set its own rules because it has become the biggest lender to developing countries, outweighing Western powers that dominated such matters for more than 50 years. The new reality is rankling the old guard and making debt crises around the world longer and harder to predict.
“If you’re hoping for a quick restructuring at a reasonable pace, that’s not going to happen,” said Michael Cirami, a bond-fund manager for Boston-based Artisan Partners EMsights Capital Group.
Western governments, investment firms and the International Monetary Fund have long decided how emerging-market debt gets overhauled, using a mix of formal rules and backroom deals. But China lent $1 trillion to countries in Africa, Asia and Latin America to bolster its global influence over the past decade and now many of the loans are going bad.
Longer restructuring negotiations prolong economic pain for borrower countries and their citizens. They also lower recoveries for bond funds, which don’t collect interest payments while debt is in default.
So far, the restructurings have involved small countries, including Ghana and Ethiopia. Larger nations, with greater geopolitical import—such as Argentina and Pakistan—could be next.
“If we don’t manage the [restructuring] paradigm shift well, we can move onto very dangerous ground,” said Pierre Cailleteau, a managing director at Lazard, the investment bank advising Sri Lanka, Suriname, Zambia and others in negotiations with lenders.
Zambia, Africa’s second-largest producer of copper, stands at the center of the power shift.
Beijing lent around $4 billion to Zambia to build airports and power plants through Chinese contractors. Many projects didn’t meet targets and Zambian officials have said some money was siphoned off by corruption.
Zambia defaulted in 2020 and the IMF agreed in 2021 to a $1.4 billion bailout, contingent on other lenders restructuring. Officials including U.S. Treasury Secretary Janet Yellen began pressuring China to engage in talks with an organization of Western countries called the Paris Club. Beijing agreed, but negotiations dragged on for nearly two years, a delay critics blamed on Chinese stubbornness.
Another potential explanation is that Westerners designed the rules of the talks—called the common framework—without accounting for Chinese practices and goals, said Alexandra Zeitz, an assistant professor at Concordia University. “When you look at what’s actually in the common framework, it’s really just the Paris Club rules,” she said.
China expects bondholders to take greater losses than official creditors and for multilateral banks to forgo some of what they were owed—a reversal of the Paris Club norm, people familiar with the matter said. Beijing didn’t formally agree to a deal until this October.
Bondholders, including Amia Capital, Amundi, RBC BlueBay Asset Management, Farallon Capital Management and Greylock Capital Management, had been negotiating in parallel to restructure $3 billion of debt. They agreed in October to take losses of around 40%, roughly the same amount as official creditors. The bondholders publicized the deal after a few days, believing they had China’s support, the people familiar with the matter said.
Two weeks later, the official creditor group led by China vetoed the bondholder plan, saying that more debt relief was required. That contradicted analysis by the IMF and the Zambian government.
Zambia’s government tried to control the damage, convening a call with bondholders, but the meeting failed to produce a strategy, the people familiar with the matter said. Negotiations between the parties could resume this week, one of the people said.
“The onus was on the Paris Club members that had experience with this to manage China’s expectations and something went wrong,” said a spokesperson for the Zambian bondholder group.
Debt restructurings have historically followed a pattern. Countries in default typically asked the IMF how much debt reduction was needed to fix their economies, then haggled with lenders for the concessions.
Lenders generally split into two camps: governments in the Paris Club and bond-fund managers in committees. The two contingents bargained separately with countries in default but agreed that they would make comparable concessions, often communicating through back channels to reach consensus.
China, in contrast, mostly negotiated on its own with debtor countries. It differed in other ways, too. China offered debt extensions to borrowers, but not debt reductions that the Paris Club and bondholders sometimes agreed to. It also resumed lending faster after default than Western countries.
In Sri Lanka, China has refused to team up with other countries, cutting side deals with the government instead. The country’s restructuring has progressed much faster than Zambia’s.
Sri Lanka borrowed billions from China in the 2010s to build projects before the government defaulted and collapsed last year. The IMF has agreed to provide a $3 billion bailout as long as other lenders agreed to debt relief.
China sat in on several meetings of the committee of Sri Lanka’s official creditors, which includes Japan, India and France, but never joined the group. The committee spent months haggling with Sri Lanka and planned to announce a breakthrough deal on $6 billion of debt at IMF meetings this fall, according to people familiar with the matter.
The day before the planned announcement, Sri Lanka revealed that China had already negotiated its own restructuring of $4 billion of debt, without revealing the terms. The official committee canceled its scheduled announcement and sought to find out whether the Chinese deal was comparable to what Japan, India and their cohort had agreed to, the people familiar said.
Six days after Beijing’s announcement, the Sri Lankan government made another unexpected disclosure: two state-owned Chinese companies were investing $1.6 billion to help jump-start construction at the Port City Colombo, a project whose progress had stalled since the country defaulted.
“What the Chinese are offering is exactly what the Sri Lankan authorities want: new money and investment,” said Brad Parks, the executive director of William & Mary’s AidData research lab. “It might not be in the interest of the country in the long run, but in the short run, it’s almost too good to pass up on.”
