China's commodity-backed loans are less lopsided than thought, but Latin America should beware commodity-led growth
Eyebrows hit the ceiling last month when it was found Chinese development banks lend more to Latin American governments than the World Bank and Inter-American Development Bank. A large proportion of Chinese finance in Latin America is packaged with oil-sale contracts commonly referred to as "commodity-backed loans", whereby nations ship hundreds of thousands of barrels of oil to China to help repay their debts.
These commodity-backed loans have been scorned, because it is assumed that China forces Latin Americans to "lock-in" to low prices for oil. With oil prices having gone through the roof, China must be making windfall profits: such is the received wisdom. But a closer look suggests the deals are better for South Americans than most believe.
New research shows that between, 2005 and 2011, the China Development Bank and the Export-Import Bank of China 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 United States Export-Import bank combined.
The majority of the loans went to non-creditworthy governments such as Argentina, Ecuador, Venezuela and Brazil (the very creditworthy nation in the group) and the lion's share of the finance is for energy, mining, oil, and infrastructure projects.
More than $46bn of the $75bn in loan commitments are commodity-backed.
Contrary to claims that China is making windfall profits, the country buys a pre-specified number of barrels of oil each day and pays spot prices on the day of shipment. China then deposits a portion of the revenue into the borrowers' account before withdrawing the funds from that account for loan repayment.
In fact, the oil-sale agreements allow China to give loans to otherwise non-creditworthy borrowers by reducing the risk of borrower default. The Chinese banks can siphon interest directly out of an oil payment, ensuring that, if the country wants to export oil to China, they will have to pay back the loan. And lower risk of default means lower-risk premiums and reduced interest rates for Latin American borrowers.
Latin Americans already pay a premium for Chinese finance. For example, a $10bn 2009 line of credit to Brazil was at 280 basis points above market rates (Libor), whereas a line from the World Bank to Brazil was 55 basis points above market. A 2010 line to Argentina for a rail system will also be $10bn and was 600 basis points above market, whereas recent World Bank loans to Argentina were 85 basis points above market.
Without the oil-backed loans, these rates could be even higher.
In this light, the deals appear to be win-win for China and Latin America. They allow China to put dollar reserves to productive use, expand the usage of the Chinese yuan, and secure oil. For Latin America, especially its less creditworthy countries, Chinese banks offer a new and large source of finance. Also attractive is that Chinese finance does not come with the infamous "conditionalities" that accompany western finance.
That said, Chinese finance is literally fuelling a region that is increasingly returning to commodity-led growth. Such growth has never proven to be sustaining, nor is it sustainable. The environmental consequences of commodity-driven growth are alarming, and our research shows that China's banks require very little in the way of environmental monitoring of such loans.
So Chinese finance in Latin America is not as bad as we are led to believe. But Latin Americans would do well to invest some of the money into productive development and environmental protection, or there won't be much left when the money and resources are gone.
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