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Can Africa Avoid Default Using The China-Laos Debt-For-Equity Swap

africa debt illustration
Credit: Maritime Nigeria

Africa’s debt continues to be up for debate and criticism. The focus is primarily on whether Africa will default on its debts, who Africa should take loans from, and why lenders should dismiss Africa’s outstanding debt. However, is there another feasible option to add to that list? Looking at how Laos has maneuvered their loans from China through a debt-for-equity swap, this could be an option Africa should take notes from.

In 2017, Sri Lanka was in the news for allegedly defaulting on the Chinese loans it acquired to build a port in Hambantota – a port city in the country. The contentious part of the news was the allegation that China had seized the new port to make up for Sri Lanka’s default. Some deep sigh followed the announcements – proponents of the debt trap narrative felt vindicated. At last, the long search for evidence to buttress their claim has ended. However, when fresh evidence emerged challenging the allegation that China seized the port, this sense of vindication was cut short.

Despite the paucity of evidence, many in Africa have jumped onto the bandwagon of the debt trap narrative. The overwhelming majority of Africans on Social Media has for some time now heavily referred to it in conversation about Africa-China relations. Some African corporate social organizations have joined this bandwagon as well. Some African political parties in opposition, quite opportunistically, have also reined in on the narrative to score political points. 

In this article, I talk about how the debt trap narrative, though largely false, would prevent African leaders from exploring a market approach to debt – debt-for-equity swap. In light of the economic hardship, which has become an indelible mark of the pandemic, this approach could actually save African countries from its impending economic crisis.

Debt-for-equity swap in Hambantota?

Umesh Moramudali, writing in The Diplomat, disentangled the myths from the realities pertaining to the Chinese financing of Hambantota, a.k.a Magampura Mahinda Rajapaksa Port. Not only did Umesh exonerate China from predatory lending – deliberately loading Sri Lanka with unsustainable debts, he also invalidated the claim that China engaged in a debt-for-equity swap – I will explain this in detail later on. According to him, Sri Lanka leased the port, which was valued at US$1.4 billion to China Merchant Port holding (CM) at a price of US$1.2 billion for 99 years. CM, which now owns 70% of the stakes in the port, would, however, only handle a management role. The security of the port is entirely the responsibility of the Sri Lankan government. 

Umesh continues to explain that the decision to lease the port to CM, contrary to what has widely been reported, was not influenced by the alleged inability of the government at honoring its Chinese debt obligation, estimated to be US$100 million a year. On the contrary, underpinning the decision was the prevailing macroeconomic problems facing the country.  Prior to the leasing of the port, the country’s economy was in bad shape, characterized by shrinking foreign reserves and Balance of Payments (BOP) deficits. The lease afforded the country some of the much-needed liquidity to solve its BOP problems.

Given the fact that the port was running at a loss (almost US$300 million), it is reasonable that the government decided to lease the facility for foreign reserves and additional injection of capital into the operations of the port from CM – something the country was in no position to do.    

Laos adopts debt-for-equity swap to dodge defaulting on Chinese loan amid COVID-19 pandemic

Two years after the Sri Lankan debacle, the tiny Southeast Asian country of Laos faces similar challenges. It has oversubscribed to Chinese debt. Laos is also dealing with dwindling foreign exchange reserves, due to a fall in government revenue as the pandemic bites the country’s tourism industry. Debt services due seem to be swallowing the country. Instead of defaulting, Laos has rather taken the debt-for-equity swap approach to its debt, which for countries, is an unusual and quite controversial route. 

A debt-for-equity swap is when an entity offers equity to its lenders in exchange for a debt write off so that the entity could avoid default. According to some analysts, the debt-for-equity swap used in relation to China’s lending is contentious because it is conceived as evidence for the dreaded Chinese debt trap.  In the case of Laos, the country has ceded majority shares in its state-owned electric grid company, Electricite du Laos (EdL) to China Southern Power Grid Co. However, according to the website of the Chinese embassy in the country, “Laos can also gradually repurchase the shares during operations.” Aside from having not to deal with a default, additional benefits of Laos’s debt-equity swap include recapitalization, opportunity to share in the Chinese company’s extensive experience, and superior technology.

The debt-for-equity swap could be the answer for Africa’s China debt problem

According to an article posted on Corporate Finance Institute, the advantage of a debt-for-equity swap includes the preservation of credit ratings. This fact makes the debt-equity swap a wholesome alternative for African countries as they struggle to honour their debt obligations amid the pandemic. Despite coming under the serious financial stress of the pandemic, Ghana, Kenya, Nigeria, and Rwanda have developed cold feet for G20’s Debt Service Suspension Initiative (DSSI) due to fears over credit rating downgrading. The fears of these countries are justifiable though. 

According to the IMF, the pandemic has caused the worst recession since the Great Depression. To come out of this recession, the world needs more capital injection, not less. Particularly for Africa, the continent needs to spend its way out of the mess. To this end, Africa needs to borrow more, not less. Therefore, by rejecting the DSSI, these countries are running away from policies that will lead to a downgrading of their credit rating, which could limit access to loans in the future. For such countries, a debt-equity swap may serve them right, since it would save them from the downgrading that they want to avoid. 

Debt-equity swaps could be controversial because they might lead to the takeover of very lucrative state businesses, which generates substantial revenue for governments. In this case, debt-for-equity swaps may leave debtor countries worse off. For Africa, debtors and lenders could structure debt-for-equity swaps that will ensure a win-win for the parties involved.  The swap should allow creditors to recoup their investments without resulting in a loss of domestic revenue for debtor governments. The following paragraph explains how. 

Africa is host to so many potentially profitable but loss-making State-Owned Enterprises (SOEs), contributing to dwindling government revenues. The only reason some of these SOEs are operating despite their losses is to protect local jobs. For example, according to Ghana’s Ministry of Finance 2018 State Ownership Report, SOEs in the country for that year had recorded a net loss of GH₵3 billion or US$514 million. 

African countries can trade-off struggling, but potentially profitable, SOEs to lenders in exchange for debt write off.  Most of the time, the right management practices and little capital injection can turn the fortunes of these loss-making enterprises around. Lenders, more so than the governments, are in a better position to do this. Just as in the case of Laos, governments should have the option to buy back shares in these enterprises after creditors have recouped their investment. Exploring this route has many benefits for African governments. This includes no more debts, loss-making enterprises turned into profit-making ones, more revenue for government through taxes, and no credit rating downgrading allowing for future borrowing if need be, etc.

If China gets debt-for-equity swaps, what of private European lenders?

This alternative does not leave out the Paris Club, a group of private European creditors, neither does it favour the Chinese to the detriment of other lenders. Compared to other lenders under the Paris Club, China is in a better position to handle debt-for-equity swaps. China has both state-owned and private companies with the requisite capital and expertise to turn around failing African SOEs. Since China holds about a third of Africa’s debt, equivalent to all of Africa’s private debt, debt write-offs coming from debt-for-equity swaps will help free up some fiscal space. This will allow some African government to honour its private debt obligations. 

Debt write-offs will liberate the national budgets of African countries. Debt-for-equity swap turns loss-making African SOEs profitable in the long run, resulting in more revenue in the form of taxes for the government.  The liberation of the budgets could result in more economic growth, making payment of private creditors even more possible. With the SOEs now making a profit, Chinese creditors could also recoup their investments. This approach leaves no one behind – the Paris club, African governments, or Chinese lenders

Nice idea, but African leaders will not try it

Personally, I do not think African leaders would explore this alternative. The narrative of debt-trap diplomacy explains why. The idea that China is intentionally piling unsustainable debts on African countries has resonated with so many in Africa, as much as in the West. The alleged motive is to overwhelm African countries so that China could extract undue political and economic advantage. Allegations of debt-trap diplomacy in Zambia in the past have provoked waves of anti-China backlash in Africa. Therefore, amid the pandemic, news of a debt-for-equity swap in Africa will surely rekindle this sentiment, since it is seen as evidence of Chinese debt-trap diplomacy. 

The political consequence of the debt-for-equity swap in Africa is fatal. It could be politically suicidal for African leaders seeking re-elections given that polls are in the offing. Also for the sake of its international reputation, China would want to avoid debt-for-equity swap as much as African leaders. But without a debt-for-equity swap and an extension of the DSSI, Africa’s debt crisis would probably linger on.

Despite the barrage of misinformed negative sentiment this may generate, debt-for-equity swaps amid this pandemic remain a mutually beneficial means of cooperation between Africa, China, and the world at large.

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