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China's Oil-for-Loans Gambit in Latin America Has Backfired

Marina Daley | Latin America Fellow

For two decades, Latin America has cultivated closer ties with China on the pretence of minimising dependence on the United States.

In 2018, China overtook the US to become the region’s top trading partner excluding Mexico. In this period, Chinese state-owned banks distributed USD$138 billion in loans to the region, with Brazil, Ecuador, and Venezuela being the top recipients.

Increased financing in Latin America is an example of Chinese debt diplomacy, whereby loans are offered to countries otherwise unable to access them via safe lending, taking resources as collateral. Critics argue China lends money to low-income countries to entrap them with unsustainable debt, such as what happened with China’s lending to Sri Lanka and Pakistan.

Oil-backed loans: China's ace in the sleeve

These cases have sparked fears of similar outcomes occurring in the region, particularly given its lending has already exceeded that of the combined amount lent by the major development banks.

Much of Brazil, Ecuador, and Venezuela’s loans to China are 'oil-backed' loans. These loans represented an exchange of oil for cash over a period of time, or lending backed on future incomes from the sale of oil. The emergence of oil-backed loans coincided with the halt in financing flows towards emerging economies driven by the 2008-2009 Global Financial Crisis, which meant the region had limited access to loans.

In response, China quickly became an important lender in the region, as institutions such as the World Bank and Inter-American Development Bank only mildly increased lending during this time. An estimated USD$110 billion was lent during 2009-2010 by China, with two-third of the loans in the form of loans-for-oil. While the loans were considered largely beneficial, not all parties are better off.

China's belt of influence in Latin America

Much of Brazil’s relationship with China is shaped by its long history as partners. Brazil was the first developing country to have a strategic partnership with China. Petrobras’ 2014 corruption scandal made it the world’s most indebted oil firm, unable to access capital markets.

However, China Development Bank’s (CDB) 2016 deal guaranteed oil supply in exchange for cash with Petrobras. This meant that it was able to honour some of its debts, which otherwise would have been impossible. In 2019, Petrobras was able to prepay its debt with CDB, terminating its preferential supply obligation. China provided cash when Petrobras was unable to obtain it, without resulting in unmanageable debt loans.

Similarly, for Ecuador, Chinese lending has been a key source of foreign financing since its foreign debt defaults in 2008. Former President of Ecuador Rafael Correa refused to honour the debts, claiming debt servicing would deprive resources needed for development and that the bonds were illegally issued by corrupt officials. With the dismissal of the International Monetary Fund (IMF) and the World Bank, Chinese loans, made to Petroeducador, the national oil company, were critical in providing financing in exchange for two years supply of oil.

Corruption, defaults, and instability

The dependency on China was evident when in 2013, Chinese financing covered USD$3.8 billion of its financing needs, with options available for up to 90 per cent of Ecuador's future oil shipments in return. Much of its oil supply was locked up in presale loans earmarked for China, who then profitably resold to other countries.

This has been further complicated by corruption and poor contractual terms. As a result, Ecuador committing to deliver 1,325 million barrels of oil until 2024 to China, five times more oil than what was required to cover the debt. This was a clear instance of debt-trap diplomacy. With Ecuador facing debt repayment issues, China restructured loans by reducing payments, and negotiated a new price formula for its crude oil. Nonetheless, its large debt has meant that Correa’s unpopular plan to drill the Yasuni National Park to guarantee crude oil for PetroChina has become a reality. In the end, Ecuador still risks another debt default, this time with China.

In the case of Venezuela, China is in a credit trap. Venezuela has been unable to maintain its oil production capacity. With production falling from 1.5 million barrels per day in 2018—a decrease of more than 50% below 2006 levels—and corruption diverting profits, timely payments have been difficult. To work around the US imposed sanctions, transporting oil to China has been outsourced to a defence firm, with limited global financial exposure.

This situation has left China in a lose-lose situation. It could abandon its investments in Venezuela, writing off USD$60 billion in loans, or to continue its investing money in a sinking ship. Even after the 2014 fall in oil prices, China continued to loan more money to Venezuela. It invested USD$20 billion to assist with the economic slump caused by the further drop in 2015, a two-year debt moratorium in 2016, and another USD$5 billion in 2018 to help boost oil production. Its policy of non-intervention makes it difficult for the Chinese government to enforce stricter requirements, such as economic reform.

Venezuela and Ecuador have offered a lesson for China. Resource-backed loans were not enough to overcome challenging lending conditions. Even within the region, China has significantly slowed its lending. At its peak in 2010, Latin America received USD$35.1 billion, and more recently in 2015, USD$21.3 billion. In 2022, only three countries—Brazil, Guyana, and Barbados—have new Chinese loans, amounting to a mere USD$813 million.

In general, China has moved towards commercial loans to fund its company’s projects in the region, and generally rethinking its approach towards lending in the emerging world. Beyond debt-trap diplomacy, China is now on a new trajectory, lending in a more focused manner to friendly neighbours and less risky countries in the region.

Marina Daley is the Latin America Fellow for Young Australians in International Affairs. She holds a Master of International Relations from the University of Melbourne.

Having completed an internship with the Peru-Australia Chamber of Commerce and a sustainability consultancy in Buenos Aires, Argentina, she was able to gain relevant local experience in Latin American affairs. She also has a keen interest in sustainability and climate change, as a past member of the Youth Advisory Committee at AMP Limited and through an internship in climate change and sustainability with EY. Marina is excited to combine her many areas of focus to explore key themes and challenges of the region.


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