Photo: iStock
Szabolcs Mikó
25/08/2023 08:00
Interest rates versus environment
As the oft-quoted saying goes, "the planet was given to us on loan", and we are trying to preserve it by borrowing (green lending, green bond issuance). However, the debt-based model of the green transition may itself become unsustainable as a result of recent interest rate rises. Prior to today's inflation shock, borrowing for sustainability had been growing dynamically year on year, but soaring prices have forced central banks around the world to tighten, making borrowing more expensive - at a time when further investment is more urgently needed than ever to meet climate targets. Moreover, the interest rate hikes have brought to the fore once again a problem that had been almost forgotten in the context of the loose monetary policy of the recent past: the dangers of rising debt burdens. Typically, the more vulnerable a country is to climate change, the greater its debt financing burden, as the damage caused by natural disasters increasingly pushes sovereigns onto an unsustainable debt trajectory (witness last year's floods in Pakistan and the payment difficulties that have since followed).
The emerging economies most affected by both challenges are, for the most part, active participants in the Belt and Road Initiative (BRI), which is mainly funded by China and involves infrastructure investment to link regions and economies with a "New Silk Road". This opens up a unique opportunity for Beijing to create a new form of financing that addresses the twin challenges of environmental and cost sustainability.
"Our currency, your problem"
- These were the words used by President Nixon's Treasury Secretary in the 1970s to describe the role of the US dollar in the global financial system. Today, we find ourselves in a similar situation: the Federal Reserve (Fed), as the central bank of the United States, of course sets the interest rate conditions of its national currency in accordance with its own national economic interests - but it is also the world's number one reserve currency, so the effects of the Fed's monetary policy do not stop at the US borders. At present, the vast majority of global debt is denominated in dollars, so the Fed's interest rate hikes directly make it more difficult to finance the emerging economies, which account for an increasing share of the world economy.
Despite this, China is regularly accused of deliberately pushing countries participating in the BRI into a debt trap through its lending. From Mao, through Deng, to Xi, the traditional four-character proverb (chengyu) from the Book of Han, translated into Hungarian as "seek the truth among the facts," has been much quoted. The fact is that China is playing an increasingly important role in lending to developing countries, as is the fact that more and more of them are sinking into debt crisis. But the truth is that it would be a mistake to link the two phenomena. On the one hand, the People's Bank of China (PBoC) did not participate in the global interest rate hike cycle that started in 2021, and has provided a total of USD 170 billion of liquidity to its partners in payment difficulties through renminbi swap lines with central banks in the BRI countries. On the other hand, the debt of the countries concerned is also predominantly denominated in dollars, so its unsustainable path was triggered by the Fed's interest rate hikes, not China's. On the contrary, in line with China's strategy of strengthening the renminbi's international status, there is openness to reducing the proportion of dollar debt through debt restructuring, and in an environmentally friendly way, as recently proposed.
Green Road, Green Belt
Since the Bretton Woods conference, the practice of the International Monetary Fund (IMF) and the World Bank, which is at the heart of the world financial system, has never been far from incorporating economic policy requirements into lending. While these institutions, in the spirit of the Washington Consensus, have typically demanded market-friendly reforms - privatisation and the dismantling of trade and regulatory barriers - in return for their assistance to troubled sovereign debtors, the Chinese proposal would tie debt resolution to a much broader consensus condition: saving the planet.
At the request of the PBoC's Green Finance Committee, researchers at Fudan University have developed a proposal that could help developing countries participating in the BRI to tackle both debt and climate change. The idea is that countries in financial difficulties would have part of their debt cancelled in exchange for green investments needed to adapt to climate change. This would ensure that the country remains solvent so that it can repay its remaining debt - converted into renminbi - and that China, as the world's largest green investor, benefits from the implementation of the necessary projects, while debtors are better prepared to tackle climate change.
In particular, green debt swaps can be effective in countries where exposure to climate change damage is a significant element of country risk. This includes, above all, the aforementioned Pakistan, which is currently facing a natural disaster debt crisis and owes more than USD 26 billion to its trans-Himalayan neighbour after projects to develop the China-Pakistan Economic Corridor, which is also strategically crucial for Beijing. As Western creditors have so far shied away from a comprehensive multilateral debt restructuring, the Fudan and PBoC initiative may be the only way to permanently rebalance the budget of a country of 200 million people, which as a nuclear power is geopolitically "too big to fail" - its stability is in the vital interest of the entire international community. Also notable for the proposal is Brazil, a key player in tackling climate change, which has so far not participated in the BRI, but whose high Chinese debt could encourage closer ties.
The growing support for green debt swaps is illustrated by the fact that the IMF CEO, among others, has already spoken out in favour of the initiative. In any case, the question posed in the title is still open: Chinese policymakers will have to decide whether to put their short-term financial interests ahead of longer-term strategic returns. If the latter is the case, the next few years may well cement their leading position in international lending vis-à-vis the Bretton Woods institutions.
The author is a student at John von Neumann University (NJE)