China in Africa

In recent years, China has dramatically expanded its financing and foreign direct investment to Africa. This expansion has served the political and economic interests of China, while providing Africa with much-needed technology and financial resources. This article looks at China’s role in Africa from the Chinese perspective. [1]

China’s Africa Policy of January 2006 aims at promoting “economic win-win cooperation” and focuses on a long-term relationship with, and sustainable development of, Africa. In many respects, China’s efforts in Africa have been shaped by China’s own experience of development. But China and Africa have different economic situations that have to be taken into account to ensure that China’s engagement in Africa leads to sustainable development. It is in China’s interest that the projects in Africa are sustainable. Otherwise, their economic returns will be limited and thus will hinder the economy’s capacity to repay the loans and affect the general growth prospect of the economy and therefore also China’s commercial interests.

Let us consider four aspects of macroeconomic impact:
Dutch disease. Large inflows of foreign capital or aid—whether from China or another financier—have an impact on the macroeconomic situation of the recipient country. Such inflows can influence the exchange rate and the competitiveness of the economy. If external financing to a country is scaled up, the currency of the recipient country might appreciate, which would make the tradable goods sector less competitive (“Dutch disease”). The impact depends on the use or absorption of the additional external financing.

If there is unemployed labor, there might be little reason to expect any major upward increase on domestic wages. However, wage pressure could occur if there is unemployed labor without the appropriate skills and if skilled labor can be attracted only by bidding up wages in competition with other domestic activities. To the extent that Chinese financing has been associated with the use of Chinese labor, it is likely that Dutch disease associated with Chinese financing has been limited. In practice, the use of local labor has varied a great deal among projects. When investments have financed much needed infrastructure such as power projects, this likely has removed constraints on growth, thereby mitigating any Dutch disease effect. It is also probable that China’s aid has been associated with relatively large import content and certainly larger than social sector aid financed by traditional donors. This also suggests that the Dutch disease effect might have been small.

Fiscal implications. The local financing component for recurrent spending for Chinese-financed projects needs to be taken into account to ensure that projects are sustainable. China itself has had a unique experience in scaling up infrastructure investment. The key to successful scaling up was, in part, a policy of nearly full cost recovery. For example, in the case of electricity, by raising electricity prices for users to provide for payments of both future debt service and the cost of operations and maintenance; in the case of railways by increasing the official tariff rates for cargo to generate needed revenue; and in the case of roads, by introducing cost-recovering tolls. Thus, the government budget was not impacted by the financing of the infrastructure investment. In most cases, such pricing policy does not exist in African economies, but governments there could surely benefit from learning about China’s own experience.

Debt sustainability. China focuses on the profitability of each project. The view is that as long as projects are financially viable, there is no reason to consider the macroeconomic consequences. Indeed, as expressed by the President of the China Eximbank, the Debt Sustainability Framework (DSF) of the IMF and the World Bank is too static and does not consider the “development sustainability” of the projects.

In several respects, China and African countries might have had different situations. For example, China’s development was largely financed by domestic savings, not external borrowing. Africa and China might also differ in terms of their ability to carry out investment projects, and in the fiscal and security situations. The profitability or viability of each project can be affected by factors beyond the control of that project. It is fair to say that while some scope exists within the current DSF to argue the case for higher debt levels at various levels of concessionality (the DSF was recently made more flexible in IMF-supported programs), further refinement of the analytical tools are called for to take account of the growth impact of projects, however difficult this might be. In addition, more practical application to individual projects would facilitate the use of the DSF by donors, e.g. when investment has a clear link to foreign exchange or fiscal revenue. This, in turn, would require donors/financiers like China to disclose more information on the projects, e.g., selection criteria and likely rates of return.

Good governance. Extraction of natural resources has often been associated with lack of transparency and corrupt practices, both in the countries that have the assets and in those that are extracting them. If China is concerned whether its financing in Africa contributes to sustainable development, it might show a good example in its own operations, although—to be fair—Western governments have not always done so. In “infrastructure for natural resources” deals, the concession to natural resources is normally negotiated without any competitive bidding. Similarly, the infrastructure projects financed by the Chinese are not always subject to competitive bidding. Ideally, to secure maximum value-for-money, infrastructure projects should be subject to a competitive bidding process (even if it is confined to Chinese companies), evaluated by an independent party. This would contribute to enhancing the effectiveness of Chinese lending, which is at least as important as the financial terms of the loans.

In conclusion, the contribution of China to sustainable growth in Africa—an explicit objective of China’s Africa Policy—requires China to undertake a more consolidated or macro focus on all its operations in a given country or region. While Africa can no doubt learn from China’s own development experience, the economic circumstances are also different and need to be taken into account so that resources are absorbed efficiently and lead to sustainable growth and development in Africa without creating bottlenecks in the economy.