China’s Belt and Road Initiative (B.R.I.) – but what happens when the belt gets tight and road gets bumpy – from Russian roulette to China roulette and the possible speculative financial death of Sri Lanka and Pakistan

China has spent nearly five years steering hundreds of billions of dollars toward a bold plan to gain greater global influence by funding big projects across Asia, Eastern Europe and Africa. Now Beijing is starting to tap the brakes.

The value of the deals that Chinese companies are striking under the plan – called the Belt and Road Initiative (B.R.I.) – is smaller than it was a year ago, according to new data. Chinese officials are warning institutions that they need to be careful about how much they lend, and to make sure their international borrowers can pay it back.

Current international conditions in our opinion are very uncertain, with lots of economic risks and large fluctuations for interest rates in newly emerged markets. We believe that enterprises and Belt and Road Initiative countries will face financing difficulties. China has begun a broad review of how many deals have been done, on what financial terms and with which countries, said people close to Chinese economic policy making, who spoke only on the condition of anonymity because the effort has not been made public.

United States and European officials have long worried that Belt and Road represents a diplomatic and economic power grab by Beijing, fueled by the government’s vast wealth and helped by the Communist Party’s laser like focus on achieving long-term goals. Under the initiative, Chinese government-controlled lenders offer money – usually through loans or financial guarantees – to other countries to build infrastructure projects like highways, rail lines and power plants. That money often comes with the requirement that Chinese companies be heavily involved in the planning and construction.

But even with its financial firepower, China has its limits. Its economy is showing signs of slowing, and it’s at the beginning of a trade war with the United States. Beijing is also struggling to tame domestic debt, a problem that an international lending spree has not helped. Too much overseas activity risks creating white elephants that can drag down Chinese companies and their local partners. All types of deals are angling to be associated with the Belt and Road Initiative, including a theme park in Indonesia and a brewery in the Czech Republic.

Also, profligate lending can worsen relations with other countries rather than help. New governments in Malaysia and Sri Lanka have questioned why their predecessors borrowed so much from Beijing. Chinese officials have expressed concerns about lending under the program. While Belt and Road activity remains huge, it has become more restrained, according to official data. In the first five months of 2018, Chinese companies signed contracts worth 36.2 billion US-Dollars, down nearly 6% from the same period a year ago. The number of deals was also down from 2016, by a lesser magnitude.

“I sensed that the level of enthusiasm about B.R.I. had certainly shifted down a few notches relative to last year”, said Eswar Prasad, a Cornell University economist and a former head of the International Monetary Fund’s China division who has recently had conversations with Chinese policymakers.

Project activity could pick up later this year. But an uncertain global economic outlook has given Beijing more reasons to be cautious. A protracted trade war between the United States and other countries, particularly China, could shake confidence and stunt growth. Washington has raised short-term interest rates, making it more costly to borrow money. In the past, increases have sometimes caused financial turbulence, especially in emerging markets. Belt and Road lending seemed a sure thing when the project began under President Xi Jinping in 2013. Loans would be long term, giving borrowers time to pay them back. China also tends to extend loans to countries with significant natural resources. If a resource rich developing country had trouble repaying its loans, it could offer oil, iron ore or even food instead.

Part of the problem now is that the Chinese government doesn’t have a comprehensive picture of its lending. The Finance Ministry and the state-controlled banking system have poured money into projects from the Czech Republic to Laos, and from South Africa to Kazakhstan. The China Banking and Insurance Regulatory Commission estimated this spring that Chinese banks had lent 200 billion US-Dollars for 2,600 projects. Various government agencies have also issued extensive export and loan guarantees and made other financial arrangements as part of the initiative, although some of these overlap with the bank loans. A Belt and Road slowdown may be natural. Official data show Chinese companies were completing projects at nearly the same pace as they were signing deals for new ones, suggesting the initiative may simply be settling into a sustainable rhythm. Still, some Chinese officials are looking more closely where the money is ending up. For example, they have been reassessing the country’s financial exposure in Africa, a continent with immense natural resources that has lured a wide range of Chinese energy and construction companies, people close to Chinese policymaking said.

Belt and Road has been viewed with increasing skepticism by multilateral institutions as well. They have warned that developing countries should not incur excessive debts. “The first priority”, Christine Lagarde, the managing director of the International Monetary Fund, said at a Beijing conference in April, “is that Belt and Road only travels to where it is really needed”. For Sri Lanka and other countries of the region it would have been better to follow that advice. Every time Sri Lanka’s President, Mahinda Rajapaksa, turned to his Chinese allies for loans and assistance with an ambitious port project, the answer was yes.

Yes, though feasibility studies said the port wouldn’t work. Yes, though other frequent lenders like India had refused. Yes though Sri Lanka’s debt was ballooning rapidly under Mr. Rajapaksa. Over years of construction and renegotiation with China Harbor Engineering Company, one of Beijing’s largest state-owned enterprises, the Hambantota Port Development Project distinguished itself mostly by failing, as predicted. With tens of thousands of ships passing by along one of the world’s busiest shipping lanes, the port drew only 34 ships in 2012.

And then the port became China’s.

Mr. Rajapaksa was voted out of office in 2015, and Sri Lanka’s new government struggled to make payments on the debt he had taken on. Under heavy pressure and after months of negotiations with the Chinese, the government handed over the port and 15,000 acres of land around it for 99 years in December. The transfer gave China control of territory just a few hundred miles off the shores of a rival, India, and a strategic foothold along a critical commercial and military waterway.

The case is one of the most vivid examples of China’s ambitious use of loans and aid to gain influence around the world – and of its willingness to play hardball to collect.

The debt deal also intensified some of the harshest accusations about President Xi Jinping’s signature Belt and Road Initiative: that the global investment and lending program amounts to a debt trap for vulnerable countries around the world, fueling corruption and autocratic behavior in struggling democracies. Months of interviews with Sri Lankan, Indian, Chinese and Western officials and analysis of documents and agreements stemming from the port project present a stark illustration of how China and the companies under its control ensured their interests in a small country hungry for financing.

During the 2015 Sri Lankan elections, large payments from the Chinese port construction fund flowed directly to campaign aides and activities for Mr. Rajapaksa, who had agreed to Chinese terms of every turn and was seen as an important ally in China’s efforts to tilt influence away from India in South Asia. The payments were confirmed by documents and cash checks detailed in a government investigation. Even though Chinese officials and analysts have insisted that China’s interest in the Hambantota port is purely commercial, Sri Lankan officials said that from the start, the intelligence and strategic possibilities of the port’s location were part of the negotiations. Initially moderate terms of lending on the port project became more onerous as Sri Lankan officials asked to renegotiate the timeline and add more financing. At the time when Sri Lankan officials became desperate to get the debt off their books in recent years, the Chinese demands centered on handing over equity in the port rather than allowing any easing of terms. The deal erased roughly 1billion US-Dollars in debt for the port project, Sri Lanka is today in more debt to China than ever, as other loans have continued and rates remain much higher than from other international lenders.

Estimates by the Sri Lankan Finance Ministry paint a bleak picture: This year, the government is expected to generate 14.8 billion US-Dollars in revenue, but its scheduled debt repayments, to an array of lenders around the world, come already to 12.3 billion US-Dollars.

As John Adams infamously said, that a way to subjugate a country is through either the sword or debt. China has chosen the latter. Indian officials, in particular, fear that Sri Lanka is struggling so much that the Chinese government may be able to dangle debt relief in exchange for its military’s use of assets like the Hambantota port – though the final lease agreement forbids military activity there without Sri Lanka’s invitation. In our opinion, such an invitation is an easy task and the only way to justify the investment in Hambantota from a national security standpoint – sooner or later China will bring People’s Liberation Army in. But let’s have a quick look at the history between Sri Lanka and China, and the port.

The relationship between China and Sri Lanka had long been amenable, with Sri Lanka an early recognizer of Mao’s Communist government after the Chinese Revolution. But it was during a more recent conflict – Sri Lanka’s brutal 26-year civil war with ethnic Tamil separatists – that China became indispensable.

Mr. Rajapaksa, who was elected in 2005, presided over the last years of the war, when Sri Lanka became increasingly isolated by accusations of human rights abuses. Under him, Sri Lanka relied heavily on China for economic support, military equipment and political cover at the United Nations to block potential sanctions. The war ended in 2009, and as the country emerged from the chaos, Mr. Rajapaksa and his family consolidated their hold. At the height of Mr. Rajapaksa’s tenure, the president and his three brothers controlled many government ministries and around 80% of total government spending. Governments like China negotiated directly with them.

So when the president began calling for a vast new port development project at Hambantota, his sleepy home district, the few roadblocks in its way proved ineffective. From the start, officials questioned the wisdom of a second major port – in a country a quarter the size of Britain and with a population of 22 million – when the main port in the capital was thriving and had room to expand. Feasibility studies commissioned by the government had starkly concluded that a port at Hambantota was not economically viable under any circumstances.

“They approached us for the port at the beginning, and Indian companies said no”, said Mr. Menor, the former Indian secretary. “It was an economic dud then, and it’s an economic dud now”. But Mr. Rajapaksa still greenlighted the project, then boasted in a news release that he had defied all caution – and that China was on board.

The Sri Lanka Ports Authority began devising what officials believed was a careful, economically sound plan in 2007, according to an official involved in the project. It called for a limited opening for business in 2010, and for revenue to be coming in before any major expansion. The first major loan it took on the project came from the Chinese government’s Export-Import Bank, or Exim, for 307 million US-Dollars. But to obtain the loan, Sri Lanka was required to accept Beijing’s preferred company, China Harbor, as the port’s builder, according to a United States Embassy cable from the time, leaked to WikiLeaks.

That is a typical demand of China for its projects around the world, rather than allowing an open bidding process. Across the region, Beijing’s government is lending out billions of dollars, being repaid of a premium to hire Chinese companies and thousands of Chinese workers, according to officials across the region. There were other strings attached to the loan, as well in a sign that China saw strategic value in the Hambantota port from the beginning.

Nihal Rodrigo, a former Sri Lankan foreign secretary and ambassador to In later years, China, said that discussions with Chinese officials at the time made it clear that intelligence sharing was an integral, if not even public, part of the deal. Mr. Rodrigo characterized the Chinese line as, “We expect you to let us know who is coming and stopping here.” Chinese officials and the China Harbor company went to great lengths to keep relations strong with Mr. Rajapaksa, who for years had faithfully acquiesced to suck terms. In the final months of Sri Lanka’s 2015 election, China’s ambassador broke with diplomatic norms and lobbied voters, even caddies at Colombo’s premier golf course, to support Mr. Rajapaksa over the opposition, which was threatening to tear up economic agreements with the Chinese government.

As the January election inched closer, large payments started to flow toward the president’s circle. At least 7.6 million US-Dollars were dispensed from China Harbor’s account at Standard Chartered Bank to affiliates of Mr. Rajapaksa’s campaign according to a document from an active internal government investigation. The document details China Harbor’s bank account number – ownership of which was verified – and intelligence gleaned from questioning of the people whom the checks were made out.

With 10 days to go, before polls opened, around 3.7 million US-Dollars were distributed in checks: 678,000 US-Dollars to print campaign T-shirts and other promotional material and 297,000 US-Dollars to buy supporters gifts, including women’s saris. Another 38,000 US-Dollars were paid to a popular Buddhist monk who was supporting Mr. Rajapaksa’s electoral bid, while two checks totaling 1.7 million US-Dollars were delivered by volunteers to Temple Tress, his official residence.

Unsurprisingly, most of the payments were from a subaccount controlled by China Harbor, named “HPDP Phase2”, shorthand for Hambantota Port Development Project.

After nearly five years of helter-skelter expansion for China’s Belt and Road Initiative across the globe, Chinese officials are quietly trying to take stock of how many deals have been done and what the country’s financial exposure might be. There is no comprehensive picture of that yet. Some Chinese officials have become concerned that the nearly institutional graft surrounding such projects represents a liability for China, and raises the bar needed for profitability. President Xi acknowledged the worry in a speech last year, saying “We will also strengthen international cooperation on anticorruption in order to build the Belt and Road Initiative with integrity”. The part of integrity makes me smile. In Bangladesh, for example, officials said in January that China Harbor would be banned from future contracts over accusations that the company attempted to bribe an official at the ministry of roads, stuffing 100,000 US-Dollars into a box of tea, government officials said in interviews. And China Harbor’s parent company, China Communications Construction Company, was banned for eight years in 2009 from bidding on World Bank projects because of corrupt practices in the Philippines. Since the port seizure in Sri Lanka, Chinese officials have started suggesting that Belt and Road is not an open-ended government commitment to finance development across three continents.

“If we cannot manage the risk well, the Belt and Road projects cannot go far or well”, Jin Qi, the chairwoman of the Silk Road Fund, a large state-owned investment fund, said during the China Development Forum in late March.

In Sri Lanka’s case, port officials and Chinese analysts have not given up the view that the Hambantota port could become profitable, or at least strengthen China’s trade capacity in the region.

But let’s move to another dead project as the seaport is not the only grand project built with Chinese loans in Hambantota, a sparsely populated area on Sri Lanka’s southeastern coast that is still largely overrun by jungle.

A cricket stadium with more seats than the population of Hambantota’s district capital marks the skyline as does a large international airport – which in June lost the only daily commercial flight it had left when FlyDubai airline ended the route. A highway that cuts through the district is traversed by elephants and used by farmers to rake out and dry the rice plucked fresh from their paddies. Mr. Rajapaksa’s advisers had laid out a methodical approach to how the port might expand after opening, ensuring that some revenue would be coming in before taking on much more debt. But in 2009, the president had grown impatient. His 65th birthday was approaching the following year, and to mark the occasion he wanted a grand opening at the Hambantota port-including the beginning of an ambitious expansion 10years ahead of the Port Authority’s original timeline. Chinese laborers began working day and night to get the port ready, officials said. But when workers dredged the land and then flooded it to create the basin of the port, they had not taken into account a large boulder that partly blocked the entrance, preventing the entry of large ships, like oil tankers, that the port’s business relied on. Ports Authority officials, unwilling to cross the president, quickly moved ahead anyway. The Hambantota port opened in an elaborate celebration on November 18, 2010, Mr. Rajapaksa’s birthday. What a birthday memorial – then it sat waiting for business while the rock blocked it.

China Harbor blasted the boulder a year later, at a cost of 40 million US-Dollars, an exorbitant price that raised concerns among diplomats and government officials. Some openly speculated about whether the company was simply overcharging or the price tag included kick-backs to Mr. Rajapaksa as a kind of bowtie towards his memorial. By 2012, the port was struggling to attract ships-which preferred to berth nearby at the Colombo port – and construction costs were rising as the port began expanding ahead of schedule. The government decreed later that year that ships carrying car imports bound for Colombo port would instead offload their cargo at Hambantota to kick-start business there. Still, only 34 ships berthed at Hambantota in 2012, compared with 3,667 ships at the Colombo port, according to Finance Ministry annual report. But there is another reduction ad absurdum. “When I came to the government, I called the Minister of National Planning and asked for the justification of Hambantota Port”, Harsha de Silva, the state minister for National Policies and Economic Affairs, said in an interview. “She said,” We were asked to do it, so we did it.”

Determined to keep expanding the port, Mr. Rajapaksa went back to the Chinese government in 2012, asking for 757 million US-Dollars. The motto must have been “If you are in trouble-double”. And the Chinese agreed again. But this time, the terms were much steeper. The first loan, at 307 million US-Dollars, had originally come at a variable rate that usually settled above 1 or 2% after the global financial crash in 2008. For comparison, rates on similar Japanese loans for infrastructure projects run below half a percent.

But to secure fresh funding, that initial loan was renegotiated to a much higher 6.3% fixed rate. Mr. Rajapaksa acquiesced. The rising debt and project costs, even as the port was struggling, handed Sri Lanka’s political opposition a powerful issue and it campaigned heavily on suspicions about China. Mr. Rajapaksa lost the election. The incoming government, led by President Sivisena, come to office with a mandate to scrutinize Sri Lanka’s financial deals. It also faced a daunting amount of debt: Under Mr. Rajapaksa, the country’s debt had increased threefold, to 44.8 billion US-Dollars when he left office. And for 2015 alone, a 4.68 billion US-Dollar payment was due at year’s end.

The new government was eager to reorient Sri Lanka toward India, Japan and the West. But officials soon realized that no other country could fill the financial or economic space that China held in Sri Lanka. “We inherited a purposefully rundown economy – the revenues were insufficient to pay the interest charges, let alone capital repayment, “ said Ravi Karunanayake, who was finance minister during the new government’s first year in office. “We did keep taking loans”, he added. “A new government can’t just stop loans. It’s a relay; you need to take them until economic discipline is introduced.” The central bank estimated that Sri Lanka owed China about 3 billion US-Dollars last year. But Nishan de Mel, an economist at Verite’ Research, said some of the debts were off government books and instead registered as part of individual projects. He estimated that debt owed to China could be as much as 5 billion US-Dollars and was growing every year. In May, Sri Lanka took a new 1 billion US-Dollars loan from China Development Bank to help make its coming debt payment. Government officials began meeting in 2016 with their Chinese counter-parts to strike a deal, hoping to get the port off Sri Lanka’s balance sheet and avoid outright default. But the Chinese demanded that a Chinese company take a dominant equity share in the port in return, Sri Lankan officials said – writing down the debt was not an option China would accept. When Sri Lanka was given a choice, it was over which state-owned company would take control: either China Harbor or China Merchants Port, according to the final agreement. China Merchants got the contract, and it immediately pressed for more: Company officials demanded 15,000 acres of land around the port to build an industrial zone, according to two officials with knowledge of the negotiations. The Chinese company argued that the port itself was not worth the 1.1 billion US-Dollars it would pay for its equity-money that would close out Sri Lanka’s debt on the port. Some government officials bitterly opposed the terms, but there was no leeway, according to officials involved in the negotiations. The new agreement was signed in July 2017, and took effect in December.

The Deal left some appearance of Sri Lankan ownership: Among other things, it created a joint company to manage the port’s operations and collect revenue, with 85% owned by China Merchants Port and the remaining 15% controlled by Sri Lanka’s government.

But lawyers specializing in port acquisitions said Sri Lanka’s small stake meant little, given the leverage that China Merchants Port retained over board personnel and operating decisions. And the government holds no sovereignty over the port’s land. When the agreement was initially negotiated, it left open whether the port and surrounding land could be used by the Chinese military, which Indian officials asked Sri Lankan government to explicitly forbid. The final agreement – in Trump’s word “The Art of the Deal” – bars foreign countries from using the port for military purposes unless granted permission by the government in Colombo, which might not be to challenging for China after the next election in Sri Lanka.

China had a stake in Sri Lanka’s main port as well: China Harbor was building a new terminal there, known at the time as Colombo Port City.

Along with that deal came roughly 50 acres of land, solely held by the Chinese company, that Sri Lanka had no sovereignty on. That was demonstrated toward the end of Mr. Rajapaksa’s term, in 2014. Chinese submarines docked at the harbor the same day that Prime Minister Shinzo Abe of Japan was visiting Colombo, in what was seen across the region as a menacing signal from Beijing. When the new Sri Lankan government came to office, it sought assurances that the port would never again welcome Chinese submarines – of particular concern because they are difficult to detect and often used for intelligence gathering. Now, the handover of Hambantota to the Chinese has kept alive concerns about possible military use – particularly as China has continued to militarize island holdings around the South China Sea despite earlier pledges not to.

Sri Lankan officials are quick to point out that the government explicitly rules out China’s military use of the site. But others note that Sri Lanka’s government could be pressured to allow it. And, as Mr. de Silva, the State minister for national policies and economic affairs, put it, “Governments can change”. Now, he and others are watching carefully as Mr. Rajapaksa, China’s preferred partner in Sri Lanka has been trying to stage a political comeback. The former president’s new opposition party swept municipal elections in February. Presidential elections are coming up next year, and general elections in 2020. And let’s assume that Russia had certain influence in the American election, why China could not have a certain influence in the Sri Lankan election.

Although Mr. Rajapaksa is barred from running again because of term limits, his brother, Gotabaya, appears to be readying to take the mantle. “It will be Mahinda Rajapaksa’s call. If he says it’s one of the brothers, that person will have a very strong claim,” said Ajith Nivard Cobraal, the central bank governor under Mr. Rajapaksa’s government, who still advises the family. “Even if he’s no longer the president, as the constitution is structured, Mahinda will be the main power base.” And that most probably could mean for China military access in Sri Lanka. And if this all can happen in Sri Lanka, why not also in Pakistan.

Pakistan has already asked China to keep lending it money to overt a foreign currency crisis, warning that Beijing’s planned 60 billion US-Dollar investment in the South Asian country was at risk if it failed to do so. Pakistan borrowed 4 billion US-Dollars from China in the year ending June 2018, according to government officials, and wants to keep the money flowing to avoid having to ask the International Monetary Fund for a bailout. Officials in Islamabad have warned their Chinese counterparts that, if the lending dries up, it could threaten the future of the China-Pakistan Economic Corridor (CPEC), the cornerstone of President Xi Jinping’s Belt and Road Initiative. They say that, if Pakistan is forced to approach the IMF instead, it may have to disclose details of how the scheme is being funded and even cancel some of the planned infrastructure projects, like Malaysia did recently.

One Pakistan official said: “We had a detailed discussion with the Chinese and we shared our concern. The main issue is that, once we are locked in an IMF program, we will have to make full disclosure of the terms on which China has agreed to build the CPEC.” Another added: “Once the IMF looks at CPEC, they are certain to ask if Pakistan can afford such a large expenditure given our present economic outlook.”

Pakistan’s stocks and foreign reserves has been falling for the past two years, as imports rise and remittances from abroad have fallen. But the slide has gathered pace in recent few months, thanks in part to higher oil prices pushing up the price of imported goods. By beginning of June, the State Bank of Pakistan had just 10 billion US-Dollar worth of foreign currency, down from 16.1 billion US-Dollars a year earlier and not enough to cover two months’ worth of imports. The situation in our opinion is set to become even more urgent next year when 12.7 billion US-Dollars of external repayments are due, compared with 7.7 billion US-Dollars this year.

Stephen Schwartz, a senior director at rating agency Fitch said: “We have elections at the end of July and the new government will have to immediately draw up further and considerable policies to stabilize the external finances”. Islamabad has avoided having to return to the IMF since exiting its last program in 2016. This has been achieved in part through Chinese lending and more recently by devaluing its currency 13% against the dollar. The dependency on money from Chinese state-backed banks has started to worry some, however, who argue that the country’s increasingly close economic and military ties with its northern neighbor risk turning it into a de facto client state.

Many in the country of Pakistan have now begun to argue that it should instead face the perceived humiliation of returning to the IMF– including us. Sahib Sherani, a former adviser to the finance ministry, said Pakistan must raise a further 28 billion US-Dollars this financial year to keep up with debt repayments. “It is vital to restore the market’s confidence in Pakistan’s ability to keep up with its repayments,” he said. “The IMF is the only option to deal with this tough situation.”

But Sri Lanka and Pakistan are not the only emerging markets who are facing liquidity shortages. Based on rising US interest rates and a resurgent dollar. Many analysts expect more trouble in the months to come. Seema Shah, global investment strategist at Principal Global Investors, warns that repeated rounds of US tariffs will not only damage growth in China but also affect the rest of Asia through the integration of global value chains. “Emerging Asia will be collateral damage,” she said.

For now, we can just hope that the escalating trade tensions between the US and China will only end up in a trade war.