Five Questions on Chinese Development Finance and the Foreign Aid Regime

China has produced a distinctive approach to development assistance. What are some of the core features of the Chinese model?

To a large extent, China’s foreign aid can be explained by the East Asia aid model, which finds its empirical base in the Japanese experience. Like Japan’s foreign aid in the immediate decades after World War II, China’s foreign aid has demonstrated a mercantilist character. To use the terminology of the Organization for Economic Cooperation and Development (OECD), it is completely “tied.” Only legal entities founded in China and owned exclusively by Chinese shareholders are eligible to become contractors, suppliers, consultants, and other service providers for overseas development projects financed by China’s foreign aid. OECD rules generally restrict the practice of tying aid, because aid is often subsidized by government revenue, and using aid to support donor country’s national firms may violate free market principles.

Importantly however, China’s foreign aid only constitutes a small portion of China’s global development finance (see most recent statistics by AidData). The vast majority of lending is provided by China’s two national policy banks: the China Development Bank (CDB) and the Export-Import Bank of China (China Exim). The non-aid portion of the policy bank lending is closer to what the OECD defines as other official flows (OOF)—i.e., official sector transactions that do not meet the OECD’s official development assistance (ODA) concessionality criteria. In other words, OOF are too costly to be considered “aid.” The banks’ non-aid loans can also be understood as export finance, which of course is quite mercantilist, since it supports Chinese firms’ exports and overseas investments. For example, a Chinese firm that seeks to build a power plant in a developing country can fund their project either through a foreign aid loan or an export credit loan. The blurring of the boundary between foreign aid and export finance was also observed in the Japanese case in the early postwar decades.

There are features of Chinese development finance that do not fit into the East Asia aid model, including the cost of borrowing from the policy banks. This is one of your more interesting findings. How is Chinese lending different?

As much existing literature on Japanese foreign aid has found out, Yen loans in the immediate postwar decades were heavily subsidized and provided Japanese firms a price advantage vis-à-vis Western firms and thus facilitated Japan’s industrial catchup. In China, however, only government-supported grants and interest-free loans, and a small portion of China Exim lending, is subsidized by fiscal revenue. The majority of policy bank lending is funded through state-guaranteed bond issues and client deposits. As a result, the cost of borrowing from China’s policy banks is often higher than that from OECD’s official creditors that fund similar projects. An example discussed in my book is the Jakarta-Bandung High-Speed Railway project in Indonesia, for which China competed with Japan in 2015. As the financier of the Chinese consortium, the CDB offered a rather cheap option from its end—a loan with a 2 percent interest rate. But even that was much less concessional than the loans that CDB’s Japanese counterpart offered, which offered interest rates close to zero.

Interestingly, the policy banks’ funding sources used to be safeguarded by fiscal revenue, and yet they decided to not rely on government-apportioned funds and switched to bond issuance in a process I call the “financialization of the state.” The CDB in particular has pioneered the creation of China’s domestic interbank bond market to raise long-term funds. The bank’s approach emerged from China’s own development experience transitioning away from a centrally planned economy. In this process, the state withdrew from a direct role in allocating fiscal revenue, instead creating financial markets and employing financial instruments to achieve public goals. This state-supported, market-based approach to development finance was what enabled Chinese firms to undertake projects in underdeveloped regions that Western financial institutions were not interested in funding. In many cases, rather than offering cheap loans to developing country borrowers, the Chinese banks employ various state-supported financial schemes to enhance the creditworthiness of projects and make them “bankable.”

There is growing concern about whether China’s lending to developing countries is resulting in debt traps. What is your take on this issue?

Some describe Chinese financing in developing countries as debt-trap diplomacy—i.e., intentionally providing finance for financially nonviable projects, thereby gaining political leverage over borrower countries and increasing China’s global influence. The most criticized practice is China’s commodity backed loans, where borrowers repay policy bank loans with future revenues collected from the export of resources to Chinese importers, such as oil. The importers would then make payments to an escrow account opened up at the policy banks.

My book challenges the mainstream narrative that China has been trying to “debt trap” developing country borrowers. First, the financial practice of collateralized lending was not invented by China. Traditional creditors provided commodity-backed lending to developing countries in the 1970s and 80s. China itself was such a borrower: in 1979, it borrowed from Japan to fund the development of an oil field and then repaid the loan with oil exports.

More importantly, despite controversies, this “debt-generated” development finance has been the very means by which China has funded its own growth over the past decades. In the 1990s, the CDB began to assist Chinese subnational governments in creating financial vehicles, transforming government organs into market borrowers. By collateralizing subnational governments’ future land and fiscal revenues, these financial vehicles borrowed from the policy banks, commercial banks, and other Chinese financial agencies in order to capitalize infrastructure and industrial projects in their regions, speeding up urbanization and industrialization across China.

While conventional wisdom describes Chinese lending in developing countries from a geopolitical or foreign-policy perspective, my book offers an alternative explanation. Through policy-bank lending, China has globalized a development finance approach that has facilitated its own growth.

China is not a member of the OECD’s Development Assistance Committee, which seeks to set norms on bilateral assistance. You have a counterintuitive model of how China’s approach to aid is affecting the global regime in this area. Can you spell it out?

In response to China’s increasing financial presence in the developing world, Global North donors have revitalized an approach to development they once criticized: engaging the private sector in development projects and tying aid to national firms. For a long time, funding development projects undertaken by private firms through official development assistance was viewed with suspicion, as it involves government subsidization of business and thus violates market-oriented principles. Practices such as tied aid were therefore restrained by OECD rules, especially in the 1970s and 80s.

Yet the narrative and the development policies of OECD countries have changed drastically. Public financial agencies of advanced industrial economies are now encouraged to cooperate with private sector investors to undertake projects in the developing world. Aiming to counter China’s state-led Belt and Road Initiative with a “Western alternative,” the United States established the International Development Finance Corporation in 2019, a government organ that seeks to mobilize private capital to finance projects in low-income and lower-middle-income countries. In 2021, the United States introduced an updated version of the American approach, calling on the Group of Seven (G7) nations and like-minded partners to launch a grand infrastructure initiative titled the “Build Back Better World” to compete with China. The initiative was rebranded as the Partnership for Global Infrastructure and Investment at the 2022 G7 summit. The major policy turnaround in the past decade implies convergence in the global governance of bilateral development finance. Traditional and emergent development finance providers are becoming more alike, incorporating commercially oriented business actors in facilitating global development.

Finally, you push back on the idea that Chinese foreign assistance reflects the state’s strategic interests and foreign policy considerations. Why?

Foreign assistance is often seen as an instrument of politics in both academic and policy discussions. The competition between the G7’s Partnership for Global Infrastructure and Investment and China’s Belt and Road Initiative is somewhat reminiscent of the 1950s and 60s when the United States and the USSR competed through dueling aid programs.

Examining China’s global development finance through this lens can be helpful to some extent, as the Chinese banks and firms are certainly guided by state-led initiatives. But Chinese development finance is no just motivated by geopolitical concerns. If political influence was the only driver, the Chinese government would have channeled much more cheap capital—budgetary funding raised through taxation—to support Chinese banks’ lending. Political imperatives also do not explain why Chinese policy banks have been less willing than Paris Club creditors to write down debt obligations owed by developing countries, which has been a major issue affecting the ongoing International Monetary Fund-led sovereign debt restructuring negotiations.

These unexplained parts of Chinese lending need to be understood through a closer look at the interplay between the state and the market in a Chinese context. The business and financial objectives of Chinese economic actors—e.g., state banks and state-owned enterprises—and more fundamentally, China’s market-oriented development logic emerged from its own experience transitioning away from a centrally planned economy better explains the Chinese lending practices we see today.

Muyang Chen is assistant professor of international development at Peking University’s School of International Studies. Her recent contribution to International Affairs examines China’s reshaping of sovereign debt relief. Stephan Haggard serves as Research Director for Democracy and Global Governance at the UC Institute on Global Conflict and Cooperation (IGCC).

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