Rethinking the IMF to Counterbalance Chinese Debt Traps

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By: Hamad Abbas, Columnist

In recent years, China has strategically used its lending practices for coercive influence in the Indo-Pacific. The United States should approach countering Chinese debt-trap diplomacy through encouraging the International Monetary Fund (IMF) to improve its lending practices. For instance, China has used loans to coerce its neighbors into backing down in the South China Sea.[i] In response, the U.S. has relied mainly on demonstrations of hard power such as movement of American carriers and destroyers around the South China Sea, however, this will not do much to prevent Chinese expansion and increasing demands for control over the disputed waters. Only in combination with enhanced economic engagement in the region can China’s expansion be effectively contained. The IMF can be an effective tool to start with.

China, for its part has been aggressive in expanding’s its influence through the Belt Road Initiative (BRI), pouring billions of dollars across the globe into various international investments.[ii] The investments come in many forms, mainly loans. States have utilized the loans on projects such as construction of roads and real estate, often built by Chinese companies. In turn, China has benefited from access natural resources and closer partnerships with loan recipient states.[iii] Yet these investments and loans can be predatory. As a recent example, China took control of the strategic port of Hambantota in Sri Lanka by granting the government significant loans to develop the port, once the government struggled to pay back its Chinese financiers, President Mahinda Rajapaksa of Sri Lanka reached a deal with the Chinese government, handing over the port to China for the next century.[iv] Expansionism through economic pressure has proven effective for Chinese ambitions, continuing to expand their claims to the South China Sea, and establishing footholds across Asia and Africa.[v]

Lacking a large investment fund of its own, the United States nonetheless has several tools in its arsenal to compete monetarily with China. Much of the Chinese aid comes in the form of loans, which the U.S. can compete with via international institutions like the International Monetary Fund (IMF). The IMF has up to a trillion dollars in capital to extend to nations in need, as the IMF’s largest contributor the United States has strong influence in the institution and holds a significant share of votes among the IMF’s governing bodies. [vi] [vii] If the IMF can be accommodating towards political realities of loan recipient states, the United States will be able to offer an alternative to Chinese loans and development projects. A stumbling block for many nations is IMF loans come with strings attached, for example, forcing the recipient state to accept strict budgetary cuts and reforms, in exchange for IMF capital. Leaders in recipient state view such deals as an encroachment on their national sovereignty, motivating them to seek alternative funding to their financial problems, and only seeking the IMF support as a last resort. [viii]

Unlike IMF loans, Chinese loans do not come with many strings. China has been generous with its loans, offering recipient nations substantial loans with the promise of not interfering in a state’s internal affairs, making it attractive for recipient leaders.[ix] What recipient leaders often overlook is the tendency of Chinese loans to be stricter when it comes to repayment, requiring recipient states to pay back the loans much quicker than the IMF would. In this regard, IMF loans tend to be better for stabilizing countries and making them financially solvent in the long run. [x] [xi]

The IMF approach will need softening to make it more politically acceptable to recipient states. For example, IMF loans can become more palatable to recipient states by not requiring immediate severe budget austerity as part of a deal. Austerity, even if needed in the long run, can be counterproductive to developing nations. IMF may force recipient nations to cut social services, education and health budgets, affecting potentially the poorest in the population and kneecapping development of the poor nations.[xii] By ensuring the loan terms are not politically suicidal, and are not perceived as their own debt-trap, IMF loans can become a preferable to China’s. In the long run, such softening of an approach will benefit both the IMF and the recipient states. Negating the need for otherwise reluctant states to rely on support from China. If recipient states are overburdened with debt from China, they will inevitably turn to the IMF for help. For instance, facing American disapproval, nations like Pakistan and Ecuador are negotiating IMF bailouts, which are partially due to significant Chinese debt.[xiii] [xiv] Thus, it is in the interest of the IMF to provide an alternative to Chinese debt-trap. When countries request IMF assistance, it is helpful if their financial situation is not caused or exasperated by the BRI.

There are still fundamental issues that have prevented using the IMF as counterweight to Chinese loans. First, the IMF as an institution may be hesitant to be involved in the midst of a geopolitical competition. Secondly, there will be hesitancy within the IMF to soften its existing approach, it fundamentally operates to fix local economic structures, and forcing national governments to adopt unpopular actions can be necessary for states to be on a path towards solvency. However, despite these obstacles, Chinese debt-traps have the potential for long term ramifications and the United States ought to encourage the IMF to adapt its lending practices to respond to the current environment.