More bad economic news for China.  As reported by The Wall Street Journal, China is reining in its aggressive – and risky – Belt and Road Initiative.

After spending $1 trillion.  In just a decade China became the world’s largest creditor.

@logan_stone21 Bad news for China’s Belt and Road Initiative. #china #beltandroadinitiative #chinatiktok #chinese #economics #politics #politicstiktok #politicaltiktok #political #xijingping #presidentxi #geopolitics #foreignpolicy #politicschina #chinapolitics ♬ Call the Doctor (Instrumental) – Ellen Once Again

This step back for the Belt and Road Initiative follows the strains we’ve witnessed this past year in China’s residential property market, which increasingly looks like a Ponzi Scheme. These economic challenges could disrupt any plans to destroy the western world order.  It also could incentivize geopolitical aggression against their neighbor, Taiwan.

President Xi Jingping cannot afford to completely end the Belt and Road Initiative.  Especially ahead of the upcoming Communist Party conclave where he will continue his push as China’s leader for life.

Let’s explore what has caused the recent setbacks for the Belt and Road Initiative and what might be in China’s future as they continue to try to expand their global economic and geopolitical reach.

A slowing global economy

From rising interest rates to higher inflation, the global economic outlook is very uncertain.  Ever since the pandemic started, volatility has ravaged practically every financial asset class at one point or another.

These economic conditions have been tough on China.  Especially as they have continued draconian COVID-19 lockdowns and as investors have retreated to U.S. dollar denominated products.  The value of the dollar against the Chinese yuan has soared to an all time high. 

A decade ago this may have benefited China.  Their economy used to be primarily export driven and a stronger dollar would have made Chinese goods cheaper in global markets.  But now exports account for only roughly 20% of China’s economy. 

In China today, a cheaper yuan against the dollar hurts China’s economy more than it helps.  It discourages investment in China.  Given the economic shift away from exports, the Chinese yuan needs to hold its own more in global markets.  Otherwise, international investors will put their money elsewhere. 

In these market conditions, aggressive and expensive initiatives like Belt and Road are unlikely to enjoy the same investor support they once did.  The Chinese government would be better off buying U.S. Treasuries for now.

Debt trap diplomacy

Another reason for easing up on the Belt and Road Initiative is the fact that many of the countries where China invested are now in economic distress.  In fact, nearly 60% of China’s overseas loans are now held by countries considered to be in financial distress. 

This type of debt trap diplomacy may work in the short run, but as many western countries discovered in time, it’s bad business as a long term strategy.  Indebting countries like Zambia and Sri Lanka to the point they default and experience social unrest is not a sustainable business model for any economic initiative.  

Zambia recently had to obtain emergency IMF funding.  Some $1.3 billion later, they’re now able to prop up their struggling economy.  While China cannot be blamed for all of Zambia’s economic woes – it has other external creditors too – China is Zambia’s single largest creditor.  An estimated $6 billion is still owed to multiple Chinese lenders. 

This past July, hundreds of thousands of anti-government protestors took to the streets of Colombo, Sri Lanka and ran their President out of office.  China may not have been Sri Lanka’s largest creditor, but Sri Lanka was a key location for its Belt and Road Initiative.  It even financed one of Sri Lanka’s largest ports, which hemorrhaged money and never turned a profit.   

The examples of Zambia and Sri Lanka are illustrative of a larger trend of Chinese investment in Belt and Road Initiative projects that received little to no scrutiny.  Did the Chinese actually expect Sri Lanka to repay its debt on the port, or did they simply want geopolitical control and influence in the Indian Ocean?  It seemed like whenever someone wanted to finance a Belt and Road Initiative project in a lesser developed country, the questions from the Chinese government were not focused on risk and approval.  They were more about how big the loan could be.

And before someone tries to make the western colonialism argument in the comments, remember that China barely gives any aid to the developing world.  The United States, by contrast, currently finances nearly all of its overseas development projects with aid.  China acts more like a banker.  For every dollar of aid given by China, they issue $9 of debt.  For the U.S., it’s the inverse. 

The temptation to control and influence politics through economic development has simply been too great for China over the past decade.  This temptation was fueled by little to no risk controls in issuing Belt and Road Initiative loans.

Few risk controls

For the past decade, the directive from the Chinese government to expand the Belt and Road Initiative led to excessive lending with little assessment of risk.  Instead of backing loans with natural resources or focusing on projects like mines or railways, many of the loans were for projects that would not produce raw materials or create jobs for Chinese or domestic workers.  The Sri Lanka port that failed to generate sufficient traffic is the perfect example of aggressive lending without enough diligence.

Of course, some deals may be justified by ulterior motives unrelated to economics.  National security and geopolitical influence can be priceless.  They may justify otherwise risky investments that overburden another sovereign with debt.  

China also engaged in a practice of extending loans to avoid losses.  On multiple occasions, Chinese lenders extended existing loans and then issued new loans to keep the borrowers afloat.  This practice not only multiplied the risk, but exacerbated the sovereign debt crisis for almost every developing country that did business with China. 

Simply put, China invested far and wide with its Belt and Road Initiative.  The Chinese government encouraged and incentivized risky lending.  Many of the projects simply had no reasonable expectation of a return.  Just ask Pakistan about its power crunch.  China only received pennies on the dollar back from that massive billion dollar loan.   

The Belt and Road Initiative has still achieved great success for China, but with risks to the world

China’s Belt and Road Initiative was always about more than economic growth and development.  By building and developing key infrastructure and industry throughout much of the developing world, China gained access and control.  As the landlord and lender in poorer countries, China not only had the keys to their economic shackles, but the ability to direct their politics as well.

They’ve used this influence to their advantage on the world stage.  Many of their economic partners are now also their political partners.  This has changed the dynamics at international forums like the United Nations, with many African countries for example siding with China.  

This export of Chinese politics and culture to underdeveloped parts of the world that the West largely retreated from decades ago has threatened to upend the global Western order.  So despite China’s step back from the full throttle aggression of its Belt and Road Initiative, don’t expect it to retreat completely.  The project is too important for its power and influence.

As the Communist Party conclave kicks off to determine whether President Xi Jinping stays in power, it’s also clear that Xi cannot afford to shutter the Belt and Road Initiative.  Doing so would only be viewed as a massive failure at his hands. 

This creates a potentially dangerous predicament.  If more Belt and Road Initiative loans sour or lead to default, President Xi may be tempted to exercise power in other ways.  Similar to Russia, which depends on military aggression to exercise geopolitical authority given its stagnant economy, China may find itself in a similar position.

A dangerous position at that.  Especially for its neighbor, Taiwan.