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Tonga’s debt challenge

Risk of Debt graph. Pic: ADB

Are we a victim of Chinese debt-trap diplomacy?


Suva, Fiji – May 8, 2019: 8pm (Nuku’alofa Times): Tonga is a high debt risk country, one of only three in the Pacific to have to loans to China that comprise more than one third of its debt according to two new reports.

These reports and media stories and commentary in Australia, the United States and other developed countries raise questions as to whether Tonga is a victim of “debt trap diplomacy”.

There is no doubt Tonga is having difficulty paying back its loans to China.

The Asia Development Bank’s Pacific Economic Monitor for December 2018 and a paper titled ‘China in the Pacific: is China engaged in “debt-trap diplomacy”?’ both state that Tonga is in a high level of debt distress and acknowledge the role of Chinese loans in creating this situation..

Chinese lending dominates – the result of two large concessional loans provided by China Eximbank in 2008 and 2010.

But a leading academic in the region says Tonga is caught in this tight situation not because of a deliberate strategy by the Chinese government but because of the actions of Chinese firms hunting for business..

University of the South Pacific’s Associate Professor Dr Sandra Tarte said Tonga’s loans were business driven and not necessarily a government loan. That means Tonga will have to repay the loan and with interest if the repayment is late.

Dr Tarte said the loan was given before the Belt and Road Initiative now being implemented by China.

“What was happening before the Belt and Road Initiative period, there were Chinese enterprises actually leading the way, seeking projects that they could use aid to actually develop,” Dr Tarte said.

“These organizations do this and undercut a whole lot of costs from competitors.

“And you see these companies coming into the region to fund infrastructure and compete with other interested countries.

So this was aid that was driven by those companies, not by the government of China.” Dr Tarte said.


Chinese loans in the region

A paper written by Australian researchers Rohan Fox and Matthew Dornan said Tonga is maybe the only country in the region in which the claims of ‘debt-trap diplomacy’ might have some truth.

The paper said that the rise of Chinese aid and lending is being seen as a threat to Pacific nations’ sovereignty and to the West.

“China, so the narrative goes, is aggressively lending to smaller nations who do not have the capacity to pay back the loans. Some commentators have even described such lending as “debt-trap diplomacy”, implying that lending forms part of an intentional strategy by the Chinese state to pressure Pacific island governments,” the paper states.

It is only in Tonga, Samoa and Vanuatu that Chinese lending comprises over one-third of total debt.

In Samoa, lending by the multilateral development banks has been greater than lending by China. In Vanuatu, which is not at high risk of debt distress, the rise in debt to China is a recent phenomenon – and if government statements are anything to go by, appears to have come to an end.

“That leaves Tonga as the only country where the “debt-trap diplomacy” narrative has some basis. Tonga is in a high level of risk of debt distress, and Chinese lending dominates – the result of two large concessional loans provided by China Eximbank in 2008 and 2010,” the paper states.

“However, anyone with knowledge of how those loans came about would argue that the Chinese state-centric “debt-trap diplomacy” narrative is a far stretch.”

Tonga’s first loan came about in exceptional circumstances, following the 2006 Nuku’alofa riots which destroyed a good portion of the central business district (CBD).

“…and the government wanted to fund rapid reconstruction,” the paper stated.

The second loan for road re-development was driven by political aspirations after Members of Parliament from outside of Nuku’alofa sought to attract loan-financed spending in their electorates outside of the CBD.

The government rebuilt the city with Chinese financing, and the roughly $65 million in China’s initial loans to the island has now ballooned out to $115 million, due to interest and additional borrowings.

This represents almost one-third of Tonga’s annual gross domestic product.

“In the background, (for-profit) Chinese construction firms that would implement the projects sought to ensure that both loans went ahead. In other words, the Chinese state did not drive either loan. In fact, given current tensions resulting from their repayment it would be fair to argue that the loans have come to pose a headache for Chinese engagement with Tonga,” the paper by the two ANU experts says.

Tonga has since signed up to China’s Belt and Road Initiative and has the approval for an extension to their repayment.

Minister for Environment and Climate Change (MEIDECCC) Poasi Tei was in China last week to put ink to paper for Tonga, signing the Kingdom on as a recipient and player in the BRI.

Mr Lopeti Senituli, political advisor to Tongan Prime Minister ‘Akilisi Pōhiva, has confirmed that the concessional loan had been deferred for five years.

He said Tonga is currently paying off interests on the loans.

Being prone to natural hazards such as cyclones and as one of the top two countries most vulnerable to climate change does not augur well for the Kingdom, the ADB report said.

Having to find funding to help in rebuilding process after Cyclone Gita in February last year has meant more debts.

Disasters and costs

The ADB report says Tonga is ranked as the second highest country at risk of disasters in the 2017 World Risk Report due to its high exposure to weather disturbances and sea-level rise as well as weak disaster management.

The report says that the impact of natural hazards in Tonga are severe both in the magnitude and cost of the damage.

There were four major cyclones that caused substantial damage in Tonga in the last two decades —three of which struck the country this decade.

Cyclone Gita damage cost the economy an estimated TOP$164.3 million in losses which is equivalent to 37.9% of Tonga’s GDP.

Reconstruction and recovery efforts after disasters reduce resources available to other sectors, further tighten the already limited government budget, and expose the economy to higher debt risk.

The IMF–World Bank 2017 Debt Sustainability Analysis indicated that reconstruction costs due to disasters had significantly contributed to the accumulation of the country’s external debt. Although external debt remains stable in the short term, the external debt distress rating has been increased from moderate to high risk due to worsened external debt dynamics for Tonga in the medium term.

Using the baseline scenario (no disaster until fiscal year 2023), the present value of external debt-to-GDP ratio was projected to hit the debt ratio ceiling of 40% of GDP in fiscal year 2037.

However, the reconstruction following Cyclone Gita has resulted in increased borrowing and latest data indicate that the debt-to-GDP ratio of Tonga is now at 43.2% – breaching the debt ceiling..

The increase in Tonga’s external debt risk rating indicates the fragility of the economy and the significant impact of disasters on the country’s debt sustainability.

The government’s policy of no non-concessional external debt has helped in controlling the country’s outstanding debt.

However, to maintain fiscal sustainability, the IMF and World Bank are recommending prudent spending to achieve and maintain a budget surplus equivalent to 1.0% of GDP over the medium term as well as providing for buffers at a minimum of 4–5 months of the government’s recurrent expenditure.

These actions can help prepare the country for future reconstruction efforts and insulate it from the variable nature of transfers and remittance flows.

Debt management

Former Finance Director and current ADB Tonga in-country officer Tatafu Moeaki said Tonga has managed to carefully weather the risks of any major debt storm as the government pursued a proactive debt management approach led by the Ministry of Finance and National Planning.

“Active debt management measures have been adopted, including the annual preparation of an underlying macroeconomic and fiscal framework for the annual budget, setting a debt target, the implementation of a Medium-Term Debt Strategy for 2015–2018, joint donors budget support with mutually agreed policy reforms as triggers, and developments in the domestic debt market,” Mr Moeaki said.

“In addition, a decision was made in 2013 to restructure the repayment terms of an EXIM Bank of China loan to provide additional fiscal space.

“This development led to the establishment of a sinking fund in 2015 to assist in managing the foreign exchange risks and the need to accumulate adequate proceeds to match the increased interest and principal payments for the EXIM Bank of China loan estimated at T$13 million additional per annum.

“The annual repayments from the on-lent borrowers from the EXIM Bank of China loan supplemented by the government on an annual basis were the source for the sinking fund.”

Finance Minister Hon Dr Pohiva Tu’ionetoa is leading Tonga’s delegation at the 2019 Forum Economic Ministers’ Meeting (FEMM) here at the Pacific Islands Forum Secretariat in Nasese.

(Iliesa Tora’s participation at FEMM 2019 has been made possible by PACMAS and the Pacific Islands Forum Secretariat).

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