China’s Japanese-Inspired Project Approval Process in Sri Lanka
With several Chinese infrastructure projects in South Asia turning out to be white elephants, China’s project approval process has increasingly come under scrutiny in the region.
Several projects in Sri Lanka have turned out to be economically unviable. The decisions to fund an airport in Mattala in Sri Lanka (the town is in the middle of nowhere), the Lotus Tower in Colombo, which is the tallest self-supported structure in South Asia, and several buildings such as the convention center at Hambantota, seem rather perplexing. There are many such examples in other South Asian counties too and these projects have caused China to suffer major losses in the court of public opinion.
So what is the Chinese project approval process and how has China’s own developmental experience in the 1980s played a role in how it does business with other countries in the 21st century?
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The Chinese project approval process is flexible and faster than that of the OECD Development Assistance Committee (DAC). Since most politicians work with electoral cycles in mind, this is one of the reasons why many countries like to take Chinese commercial loans.
Let’s look at how the Chinese government sources project proposals and vets them prior to approval. In most cases, the process begins when a government that needs project funding approaches the Economic and Commercial Counselor Office (ECCO) attached to China’s diplomatic mission with a proposal. The ECCO determines if the proposal meets a minimum viability standard. If it does, ECCO submits the proposal to the Ministry of Commerce and the Ministry of Foreign Affairs in Beijing.
Then a team of technical experts from the Ministry of Commerce arrives in the country to carry out a project and budget feasibility assessment. This is done in consultation with local authorities. When the team from the Ministry of Commerce returns to Beijing, they prepare a final project proposal for the State Council’s consideration. If the State Council approves the project, the Ministry of Finance will transfer funds to the Ministry of Commerce and the procurement process begins.
There are several vulnerabilities in this process. Unlike institutions like the World Bank, which usually negotiate projects with technocrats in the line ministries of recipient countries, China works with the Office of the President or the Prime Minister to prepare and submit project proposals. This gives political leaders a lot of leeway. The Chinese themselves have admitted to the flaws in the project approval process and the need to change it.Advertisement
Japanese in China in the 1980s
In the early decades of its existence, the People’s Republic of China mainly gave away aid in the form of grants or interest-free loans. For example, between 1965 and 1973, when the per capita income of China was around $200, the government spent approximately $12 billion on foreign assistance. However, following Deng Xiaoping’s reorientation of the Chinese economy, China started giving commercial loans, especially through the Preferential Buyer’s Credit tool, although still below market rates.
As the country reoriented its 21st-century development finance strategy toward bankable projects, it has drawn from its own experience as an aid recipient during the late 1970s, 1980s, and 1990s.
Once Deng opened up the country, a large number of Japanese companies began to operate in China and Tokyo funded large-scale development projects through a request-based system of project identification and approval. In the 1980s, Japanese companies operating in China would develop project proposals and pitch them to Chinese officials. The Chinese officials would then ask Japanese development finance institutions to support these proposals.
The Japanese also introduced China to the concept of commodity-backed loans. For example, in response to the 1973 oil crisis, Japan sought to secure access to reliable oil supplies. Realizing that reliable oil supplies can be found in China’s Daqing oil fields, Japan exported new technologies to China and was repaid with Chinese oil exports.
In 1978, China signed 74 contracts with Japan to finance turn-key projects that would form the backbone of China’s modernization and all were repaid in oil. The Chinese never perceived these commodity-backed loans to be coercive or exploitative.
These features are now among Beijing’s workhorse lending instruments. Chinese aid agencies and state-owned banks will not green-light a development project unless they first receive a formal request from the host government. It also gives commodity-backed loans.
While these features of the project approval system allow Chinese financed projects to be responsive to the needs and preferences of political leaders in host countries, they also make these projects vulnerable to political capture, corruption, and artificially inflated costs. These were problems that we saw in Japan’s twentieth-century request-based system, and they now plague twenty-first-century Chinese development projects.
The Road Ahead
Whenever a country “goes out” for the first time and makes major investments in developing countries, like the U.S. in the 1920s, the Soviet Union in the 1950s, Japan in the 1970s, etc., they made the same set of mistakes. Like them, China, operating at a time of rapid growth and soaring commodity prices, underestimated the risks and overestimated the value of its own domestic experiences and strategies.Advertisement
Chinese companies, state-owned or otherwise, had little experience in commercial lending to the Global South and adhered to a high-risk– high-volume paradigm, and ended up with a pile of debt. In 2022, it has become evident that most of this debt is unsustainable and recent attempts to restructure debt in Zambia and Sri Lanka showed how inexperienced and unprepared Chinese lenders are.
In the past, China has rejected offers to join the Paris Club and bring its lending policies more in line with OECD DAC. China also does not participate in international reporting systems, which makes it difficult for scholars and policymakers to study how Chinese development finance is allocated over space and time. However, in recent years, China has shown a degree of willingness to increase coordination with Western powers through trilateral cooperation programs and a newly established Multilateral Cooperation Center for Development Finance.
A much-needed change in development project selection mechanisms too should be a priority for Beijing, for its own sake, to ensure that it is not seen as a rogue donor or lender that threatens the coherence and stability of the global development finance regime.