China’s Belt and Road Initiative has raised important questions about the risk of debt problems in less-developed countries. The risks are especially acute for the small and fragile economies of the Pacific. Our analysis, however, finds a nuanced picture. The evidence to date suggests China has not been engaged in deliberate ‘debt trap’ diplomacy in the Pacific. Nonetheless, the sheer scale of China’s lending and its lack of strong institutional mechanisms to protect the debt sustainability of borrowing countries poses clear risks. Chinese lending is more intense as a share of GDP in smaller economies. If China wants to remain a major development financier in the Pacific without fulfilling the debt trap accusations of its critics, it will need to substantially restructure its approach, including by adopting formal lending rules similar to those of the multilateral development banks.

By contrast, there is scope for Australia’s more modest infrastructure lending plans to be sustainable. If Australia wants to do more in the Pacific though, it should reverse the current stagnation in its overall aid budget. Pacific nations, meanwhile, have an opportunity to push for more favourable financing from external development partners. Care must be taken, however, to avoid overly geopolitical aid that prioritises short-term wins over the need for domestic reform and good governance.

Key findings:

  • China has not been the primary driver behind rising debt risks in the Pacific, although a continuation of business as usual would risk future debt problems in several countries.
  • There is scope for a new Australian infrastructure financing facility to provide loans to the Pacific without causing debt problems, particularly as it has adopted key sustainable lending rules.
  • Pacific nations have an opportunity to obtain more favourable financing from official development partners but care must be taken to avoid overly geopolitical aid.
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