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As a country intending to benefit from the China-led Belt and Road Initiative (BRI) and its development potentials, Nepal needs to consider the criticisms regarding China’s practice of “debt-trap diplomacy.” Nepal also needs to work out the necessary strategies to avoid or escape a debt trap, if it indeed is a substantial threat. Under “debt-trap diplomacy,” borrower countries are unable to pay back to creditors the hefty loans with interest, and creditors are in a position to exert influence over national matters. If this is the case, the next issue is how the law and legal mechanisms may assist Nepal when adopting debt financing for heavy infrastructures.

Firstly, the nature of the debt problem must be understood properly. It is more of a financial issue rather than a legal one. In the BRI strategies, China is, and will continue to grow as, a planner in addition to a leading investor in infrastructure projects that promote greater connectivity and trade. Many BRI countries in Asia, Africa, and Latin America are not only resource-rich or strategically-located, but oftentimes, struggling with weak social, political, and economic institutions. However, these are also the countries that desperately need an economic boost through mobilization of internal and external investment opportunities. They lack the infrastructures to facilitate trade, generate energy, promote the movement of goods and people, and stimulate societal growth, among other things. Needless to say, Nepal falls under this category.

Foreign debt has remained a major issue in international development. Due to the myriad of economic, social, and political obstacles facing such countries, debt trap becomes a major issue when large-scale investments are financed by foreign investors. For a country like Nepal, which has a history of dependence on foreign direct investment and aid, high corruption rates, and slow development, it is important to evaluate the risks of participating in projects under the BRI, as noted above, because the inability to pay back loans can result in a crippling economy, a loss of political power, and, in the worst case, a loss of sovereignty.

Foreign debt has remained a major issue in international development. Due to the myriad of economic, social, and political obstacles facing such countries, debt trap becomes a major issue when large-scale investments are financed by foreign investors. For a country like Nepal, which has a history of dependence on foreign direct investment and aid, high corruption rates, and slow development, it is important to evaluate the risks of participating in projects under the BRI, as noted above, because the inability to pay back loans can result in a crippling economy, a loss of political power, and, in the worst case, a loss of sovereignty.

What does the debt trap look like?

The Center for Global Development’s policy paper entitled “Examining the Debt Implications of the Belt and Road Initiative from a Policy Perspective” (CGD paper) examines the likelihood of problems related to debt sustainability (i.e. rising debt-to-GDP ratios) in 68 borrower countries; it found that eight were particularly vulnerable to debt distress (this did not include Nepal). Among these eight is neighboring Pakistan that has allegedly been charged a 5 percent interest rate on the China-Pakistan Economic Corridor projects that amount to approximately $63 billion, of which $33 billion is invested in infrastructure projects.

Similarly, lawmakers in Myanmar are increasing pressure on the government to pay back its $4 billion debt (with a 4.5 interest rate) to China. Most of the debt is said to have accumulated from 1998 to 2011, when Myanmar was struggling with West-imposed sanctions and only China was willing to lend capital. The debt has caused the government to scale back parts of the Myanmar-China Economic Corridor as well as reexamine the terms of a $10 billion, China-funded port project.

Among the critics of the BRI, Sri Lanka has become an example of how developing countries fall into China’s “debt trap.” In late December 2017, Sri Lanka handed over its Hambantota port and 15,000 hectares of the surrounding land to China on a 99-year lease to pay off $1.1 billion in debt. According to a New York Times investigation, large sums of money “flowed directly to campaign aides and activities for Mr. Mahinda Rajapaksa [(the previous president)], who had agreed to Chinese terms at every turn and was seen as an important ally in China’s efforts to tilt influence away from India in South Asia.” Additionally, Sri Lanka continued to accumulate debt to China with interest rates higher than those offered in the international market. Many questioned why the funding was approved when preliminary reports indicated that it was not a profitable project.

Indian scholars argue that the debt trap is caused primarily because of China’s high interest rates, and that countries, like Sri Lanka that handed over the China-funded Mattala Rajapaksa International Airport (MRIA) to India to operate, could benefit from low-interest loans of 1 percent from India. Additionally, Indian critics, like Brahma Chellaney, are especially fearful that China’s “imperial giant’s velvet glove cloaks an iron fist – one with the strength to squeeze the vitality out of smaller countries.”

How does China handle debt trap?

These issues beg the question of how China has and will approach projects that face issues of debt repayment. The CGD paper explains that China has largely dealt with the issues in a case-by-case manner. This has included writing off debt in exchange for disputed territories, forgiving or restructuring debt, and debt-for-equity swaps. However, if China officiates a single, integrated approach, smaller countries will gain more confidence regarding avoiding the issues of a debt trap.

China is also encouraged to join, rather than just observe, as it is doing currently, the Paris Club. The Paris Club is a “non-institution” institution comprising of 22 permanent members that are largely western, creditor nations. The objective of the Paris Club is to “find workable solutions to payment problems faced by debtor nations” that demonstrate a need for debt relief and a willingness to implement the International Monetary Fund’s (IMF) suggested economic reforms. The Asian Development Bank, where China has the third highest voting power, is also an attending member. At the least, China is advised to coordinate its efforts of handling debt with the Paris Club and show transparency in its lending. China’s presence certainly shows that China takes the allegations seriously.

How can Nepal approach the problems of debt traps?

Despite these “debt traps,” countries, including Nepal, will continue to approve China’s investment. Sri Lanka and China are expected to sign a free-trade agreement this year to encourage Sri Lankan exports to China. The Sri Lankan ambassador to China has emphasized that the BRI is a great opportunity to make Colombo Port city a financial center in South Asia. Moreover, China and Singapore are in negotiations with Sri Lanka to invest $1.1 billion in cement and steel plants.

There are various measures that Nepal can implement to prevent debt trap from becoming a reality. For domestic debt, in The Debt Trap in Nigeria: Towards a Sustainable Debt Strategy (2002), authors Okonjo-Iweala et al. argue that the inability of a weak legal and institutional framework, especially at the local levels, to handle public resources can lead to the mismanagement of economies and the problems related to debt overhang (p. 11). Legal reforms should focus on encouraging “effective and efficient utilization of present and future public resources [and] would ensure probity in public resource use, due diligence, transparency, and accountability …” (p. 16). The logic applies in the case of international investment as well.

Additionally, the existence and safeguarding of legal protections are also necessary in ensuring that assuming foreign debt is seriously considered by both the government and the public; for example, the Constitution of the Philippines allows the President to contract foreign debt only at the approval of the Monetary Board, and local laws ensure public participation via governmental representatives.

The CGD paper suggests that China needs to engage in multilateral lending practices of debt sustainability (e.g., transparency and concessionality) that is largely lacking in its bilateral lending practices. It furthers two recommendations to China: “1) to finance technical legal support to developing country borrowers, through new and existing multilateral mechanisms; and 2) to offer debt swap arrangements in support of environmental objectives” (p. 24). Additionally, Nepal itself needs to ensure the right funding plans, whether that’s grants or soft loans, are in place for large infrastructural projects like the trans-Himalayan railway or the Budhigandaki Hydropower Project.

Borrower countries will accumulate significant debt if the projects do not produce anticipated profits. Therefore, it’s important to study and evaluate which infrastructures are essential to the country’s development and will stimulate the economy via, for example, trade, employment, and further investments. For example, in the Philippines, the “combination of domestic economic demand, diversity in aid funding, and a contentious political culture and civil society make a Chinese-dominated debt trap unlikely.”

Furthermore, the current administration in the Philippines is ensuring that China has no sway in deciding which projects the Philippines ought to pursue; additionally, only after gaining project approval from the National Economic and Development Authority Board can the government of the Philippines take its proposal to the Chinese government. Typically, the government of the Philippines asks for at least three bidders nominated by the Chinese government, so that it is also involved in the process of picking the bidders and can be held accountable.

For countries that find themselves entrapped in debt, debt restructuring (i.e., reconsidering the terms and due dates of debt toward the advantage of the debtor) is a common tool used for resolution. In 2018, China engaged in talks about debt restructuring with Zambia after warning from the IMF about an impending debt distress. (27 percent of Zambia’s external debt is owed to China.) Scholars recommended that Zambia should increase transparency of its debt and perform a review of and strengthen its existing debt-management system. Moreover, others argue that, unlike the Western approach of measuring a project’s “success” in five years, the return on investment on China-funded infrastructure projects should be considered in a longer term of one to two decades.

What can we take away for Nepal?

Some experts opine that the debt traps caused by China’s investments counter China’s own interests and are not motivated to gain influence; in many cases, China is the only available lender of construction services or capital (as was the case with Myanmar). Debt traps would also pressure China’s foreign-reserve exchanges, as investments in infrastructure projects are funded by said exchanges. With BRI projects’ cheap financing and Chinese companies’ willingness to take on unprofitable projects, China would lose more if debt traps are widespread.

Additionally, some argue that corruption and political interests, not Chinese investments, are major factors in projects turning over a loss and entrapping governments in unsustainable debt. Even still, the BRI has been accused of enabling and sustaining corrupt authoritarians who accept bribes or embezzle funds so that the country eventually goes into severe debt. Demanding transparency about the funding agencies and discouraging anonymity of investors will be important solutions in this regard.

Criticisms about debt trap vis-a-vis China-funded projects often originate from Western media and, in the case of Nepal and other smaller South Asian countries, India. Recently, US Vice President Mike Pence criticized China for drowning borrower countries in debt from loans they cannot afford. In response, China has emphasized that BRI projects have helped with development and improved livelihoods. (Currently, the US is promoting the Asia Pacific Economic Co-operation (APEC), a counterpart of the BRI, to promote free trade in the region.)

On a positive note, China has defended the BRI and demonstrated its support for multilateralism and global governance standards. The Center for Strategic and International Studies estimates that the infrastructure needs of the developing parts of the Asia Pacific will require $26 trillion by 2030, and China has only pledged $1 trillion; this clearly indicates that the BRI is an opportunity for multilateral and private investors from the West, and not a Chinese hegemony. Therefore, Western critics and nations also have an equal opportunity to invest and demonstrate what they preach.

Moreover, critics accuse the West of misrepresenting cases that supposedly exemplify China’s practices of “debt-trap diplomacy.” While the New York Times suggestively claimed that China forced Sri Lanka to “cough up a port” to pay back a part of its loans, local coverage of the exchange shows that it was Prime Minister Ranil Wickremesinghe who suggested the exchange during talks of debt restructuring, and it was largely perceived as a positive development. Similarly, others point out the requirements of IMF’s loan conditionality has hurt Pakistan’s economy and required multiple bailouts by IMF itself, further indebting Pakistan.

Lawrence Freeman, a political-economic analyst, stresses that the accusations of debt trap are Western “propaganda and gossip” against China; he points to the British Jubilee Debt Campaign’s 2018 brief entitled “Africa’s growing debt crisis: Who is the debt owed to?” which shows that the maximum debt owed to China by African countries is estimated at $100 billion or 24 percent of the total debt. The rest is owed to a combination of other creditor groups: members of the Paris Club, the World Bank, the IMF, other multilateral institutions, and the private sector (excluding that of China).

Debt trap is definitely an important consideration for Nepal as it joins the BRI. As of early 2018, foreign debt comprised of 16.9 percent of the total GDP and was owed largely to multilateral institutions like the World Bank and the Asian Development Bank followed by Japan, China, and India. The CGD paper does not consider Nepal to be at risk of debt distress, and Nepal has actively engaged in talks with China about bilateral lending for infrastructure projects. As far as China is concerned, it has always been considerate in its engagements with Nepal. This relationship is a major strength in dealing with a debt-trap scenario.

Debt trap is definitely an important consideration for Nepal as it joins the BRI. As of early 2018, foreign debt comprised of 16.9 percent of the total GDP and was owed largely to multilateral institutions like the World Bank and the Asian Development Bank followed by Japan, China, and India. The CGD paper does not consider Nepal to be at risk of debt distress, and Nepal has actively engaged in talks with China about bilateral lending for infrastructure projects. As far as China is concerned, it has always been considerate in its engagements with Nepal. This relationship is a major strength in dealing with a debt-trap scenario.

Every investment assumes a reasonable level of risk. Most importantly, Nepal needs to carefully evaluate the process of selecting projects, of creating an investment portfolio (including considering the debt-to-equity ratio), and complying with the established laws and policies. The decision-making process must be based on the rule of law and the transparency of transactions. A competitive bidding process must not be compromised either. Additionally, the Nepali public should demand the opportunity to bring forth its concerns and actively engage in the process of finalizing important deals. Successful outcomes will depend on how well Nepal is able to negotiate the process of securing loans, resolve arising issues, and cultivate an environment that is conducive to sustainable investment and growth.

Dr Bipin Adhikari is a constitutional expert and is currently associated with the Kathmandu University School of Law. Bidushi Adhikari is associated with Nepal Consulting Lawyers, Inc as a research assistant.

From land acquisition to hiring of personnels-challenges abound to implement contracts under the Belt and Road Initiative (BRI)

[A version of this article appeared in the Kathmandu Post on February 15, 2019 entitled “Rough Road Ahead.”]

Nepal and China have shared close bilateral ties for many years, reinforced by mechanisms such as the Joint Consultation Mechanism, Nepal-China Inter-Governmental Economic and Trade Committee, Nepal-China Joint Committee on Agriculture Cooperation, and Border Law Enforcement Cooperation, among others. After the first “economic aid” ties in October 1956, China has risen to become one of the leading investors in Nepal; for the third consecutive fiscal year, in 2018, China topped the foreign direct investment ranking in Nepal, accounting for 84 percent (approximately $427 million) of the total investment. Since 2013 and as of December 2018, Nepal and China have signed contracts for investment in Nepal amounting to $3.32 billion.

While western investors have generally viewed Nepal’s political instability and its rugged terrain as challenges to infrastructure investment, Chinese investors have deemed Nepal adequate for investment “because of investment-friendly policies from government side.”

While western investors have generally viewed Nepal’s political instability and its rugged terrain as challenges to infrastructure investment, Chinese investors have deemed Nepal adequate for investment “because of investment-friendly policies from government side.” As Nepal continues to sign and expedite major projects under the Belt and Road Initiative (BRI) in the “hydropower generation, manufacturing, river training and agricultural industries,” for example, it is especially important to evaluate how infrastructure projects have fared in Nepal and what kinds of challenges they face in upholding the terms of the contract, progressing, and meeting deadlines.

Political and Geopolitical Challenges
According to Deloitte’s analysis of BRI projects and their conversations with BRI clients, political risks tops the other risks associated with the implementation of contracts for BRI projects. Deloitte suggests that this risk can be mitigated by understanding and overseeing the stability of the host country’s government through the duration of the projects. Such political instabilities are true of Nepal as well. For example, in late 2017, the $2.5 billion Budhi Gandaki hydropower project (anticipated to meet Nepal’s demand of 1,200 megawatts of the total 1,400 megawatts requirement) was scrapped by the government. The cancellation followed a change in the leading party of government from the Maoist-led government, although a lack of efficiency was named one of the reasons for the cancellation. Political interests will no doubt play a role in the future as well, as governing parties’ priorities change. It is important for the leadership to ensure that the progress of the national-interest projects continues.

Delays in the decision-making process are another major issue that threatens the productivity of infrastructural investments. As of late 2018, the Chinese government was still waiting on approval from the Department of Roads in Nepal to move forward with the second phase of the Ring Road expansion project. Delays from the Chinese side have also been an issue, as has been the case with Kulekhani-3 Hydropower Project, where one of the contractors, Jheijian Jialin, responsible for the electromechanical works of the project, has been repeatedly asked by the Nepal Electricity Authority to speed up construction and has been imposed with a fine of Rs. 80 million for the delays. The Upper Trishuli 3A Hydropower Project faced similar delays, as the lending bank, Export-Import (Exim) Bank of China, has delayed the deployment of funds to the contractor for construction.

In the same vein, Nepal’s increasingly close ties with China threaten to change the geopolitics of South Asia. After India-funded projects that failed to be completed, including road and hydropower projects, China has presented itself as a reliable partner for investment in infrastructure, including gifting a new training academy in 2018 for Nepal Armed Police Force, previously a project claimed by India. China promotes a narrative of unity in South Asia, supposedly to downplay the tensions between the two countries, and has asked India to join China in investing in infrastructural projects in Nepal. This type of proposition has hardly come from India; while China has promoted the connectivity of the China-Nepal-India economic corridor, India has generally been wary of the project.

Transparency and Fair Competition

At the European Business Summit held in the first half of the 2018, European delegation raised the issue of transparency of China-funded projects so that European companies can apply for projects and also ensure their sustainability. According to Nikkei Asian Review, 89 percent of contractors participating in Chinese-funded transportation projects are actually Chinese. In contrast, projects funded by multilateral agencies such as the World Bank and the Asian Development Bank are much more diverse, with 29, 40.8, and 30.2 percent contractors that are Chinese, local, and foreign, respectively. The reason for the popularity of Chinese contractors could be that Chinese contractors are highly competitive, and some contracts require recipients to hire only Chinese contractors. While this practice has been commonly used by Western lenders in the past, because of their inefficiency, the lack of a competitive bidding process, and pressures from international interest groups, the practice was abandoned.

Before the contract awarded to China Gezhouba Group Corporation for Budhi Gandaki hydropower project was briefly scrapped by the government in late 2017, it faced various delays to move forward in the process of construction (e.g., failing to receive an official letter from the PM’s office deciding to provide the viability gap funding). Following the delays, the government decided to mobilize domestic resources to build the infrastructure, and then, to call for international tendering to find the most competitive bidder. Ultimately, however, the $2.5 billion Budhi Gandaki hydropower project was restored in September 2018 to the China Gezhouba Group Corporation. But the details are yet to come out.

Before the contract awarded to China Gezhouba Group Corporation for Budhi Gandaki hydropower project was briefly scrapped by the government in late 2017, it faced various delays to move forward in the process of construction (e.g., failing to receive an official letter from the PM’s office deciding to provide the viability gap funding). Following the delays, the government decided to mobilize domestic resources to build the infrastructure, and then, to call for international tendering to find the most competitive bidder. Ultimately, however, the $2.5 billion Budhi Gandaki hydropower project was restored in September 2018 to the China Gezhouba Group Corporation. But the details are yet to come out.

Currently, the Budhi Gandaki Hydropower Project is only at 9.9 percent in terms of physical progress and financial progress is only 10 percent. The compensation of land acquisition to the displaced is still underway in various areas of the project, namely Arughat Bazar of Gorkha and Khahare Bazar of Dhading district. Critics quickly pointed out that the project should have undergone a competitive, international bidding process instead of simply being handed back by the Nepali government. The lack of a competitive tendering process can hurt the efficiency of the projects and the opportunities for local contractors as well as violate local tendering laws. Many things depend on the goodwill of the host government.

Patrick M. Norton, an independent arbitrator based in New York City, argues that there are two basic sets of contracts (performance agreements to construct infrastructure and underlying financial agreements) that BRI infrastructure projects will require. Various parties, including investors, contractors, local governments, and operational parties, will without doubt become involved in the projects during and much after the construction as well. To resolve contractual disputes arising from such joint ventures, Norton suggests a government-to-government mediation process, judicial resolutions (for, e.g., cases involving local laws in the areas of tax and real estate disputes), and arbitration (which will require a venue and an institution for administering the process).

Contractual Disputes
Patrick M. Norton, an independent arbitrator based in New York City, argues that there are two basic sets of contracts (performance agreements to construct infrastructure and underlying financial agreements) that BRI infrastructure projects will require. Various parties, including investors, contractors, local governments, and operational parties, will without doubt become involved in the projects during and much after the construction as well. To resolve contractual disputes arising from such joint ventures, Norton suggests a government-to-government mediation process, judicial resolutions (for, e.g., cases involving local laws in the areas of tax and real estate disputes), and arbitration (which will require a venue and an institution for administering the process).

China enjoys a competitive advantage because oftentimes, it offers the cheapest alternative to building infrastructural projects. However, some glaring issues may arise once the contract has been awarded, including quality assurance, speediness of the work, and meeting deadlines. These issues may lead to the violation of the terms of the contract between the parties as well. This was true for the Guangxi Transmission and Substation Construction Company, the contractor responsible for the first section of the Tamokoshi-Kathmandu Transmission Line Project. After multiple warnings, delays, and only eight percent of the project completed in the 74 percent of the elapsed contract period, the Nepal Electricity Authority finally fired the contractor in late 2018. Currently, the NEA is looking for another contractor who will be given 820 days to complete the remainder of the project.

In late 2018, at the conclusion of the Nepal-China Joint Oversight Mechanism, the officials associated from both countries with various joint ventures in Nepal put forth the issues they were facing in pushing their projects forward. It was reported that the Chinese side was especially concerned with the issues surrounding land acquisition for the projects as well as the ease with which foreign, Chinese works can attain work permits. The Chinese also expressed concerns over the limit on the number of foreign workers per project, an issue that the Nepalese representatives said they would take up with the relevant authorities. Given the complexities of these issues, many expressed that it would take some time before these changes are realized.

The issue of land acquisition spills into the issues of resettlement and rehabilitation of populations that would be displaced by the projects. In August 2018, Nepalese authority expressed that the West Seti Hydropower Project was financially unfeasible due to the high costs of rehabilitation and resettlement. They requested a revision of the contract, which included lowering the energy generation from 740 KW to 600 KW and extending the power purchase agreement to 12 years from 10 years, all the while maintaining the initial award of $1.2 billion. As of January 2019, the project is at a standstill, and the Nepali government has organized a task force to evaluate the future of the project and to produce a report with recommendations.

Issues relating to personnel can also hinder the progress of the projects, causing continued delays. For example, during the construction phase of the Upper Marsyangdi ‘A’ Hydropower Project in Lamjung, workers belonging to trade unions held multiple strikes and sit-ins when the authorities did not heed their demands for minimum wages, retirement benefits, life insurance, and leaves. They also claimed to have been unfairly compensated when compared with their Chinese counterparts and asked for the dismissal of a Chinese foreman accused of “manhandling the workers.” Chinese laborers are supposedly preferred over local laborers due to the language barrier and the finer skill level of Chinese laborers. Similarly, Chinese contractors tend to import from China the materials necessary for construction; this could further increase Nepal’s trade deficit.

As Nepal hopes to secure more investment in infrastructural projects in Nepal from China, it is important to carefully evaluate these challenges and find ways to combat them effectively.

Conclusion
As Nepal hopes to secure more investment in infrastructural projects in Nepal from China, it is important to carefully evaluate these challenges and find ways to combat them effectively. Even after projects have been completed, their functioning could be delayed further for, for example, maintenance, as was the case with the Middle Marsyangdi Hydropower Station that was halted from operation for ten days back in early 2018. It is important for project stakeholders to maintain the terms of the contract and resolve arising issues through arbitration and mediation, as litigation can cost both parties unnecessary capital. It is in the best interest of the country to ensure progress via quick resolutions of arising conflicts, such as those mentioned previously.

[Bipin Adhikari is a constitutional expert. Bidushi Adhikari is associated with Nepal Consulting Lawyers, Inc as a research assistant}

Published: 15-02-2019 07:33