Illustration of person shouldering large red bag (State Dept./D. Thompson)
(State Dept./D. Thompson)

It is becoming a familiar story: A developing country with great potential announces an exciting new infrastructure-development project. The money for the project comes from a generous-sounding loan. The details of the loan aren’t clear, but the amount is large and both politicians and the lenders promise that the project will be a “win-win.”

After the initial wave of euphoria, some people start to ask questions: What are the terms of the loan? What happens if the developing country can’t pay it back in time? Why is the project using foreign workers instead of creating jobs for the local population?

Countries are waking up to the true cost of too-easy credit and the consequences of getting caught in a debt trap, where the lending country uses debt to obtain strategic assets, such as ports or political influence. Sri Lanka opted for the 99-year lease of a key port to China when faced with a difficult loan-repayment situation with few other options.

Large sea port and highway (© Atul Loke/Bloomberg/Getty Images)
Hambantota Port in Sri Lanka was leased to China for 99 years after Sri Lanka was unable to pay back its Chinese loans. (© Atul Loke/Bloomberg/Getty Images)

Recognizing the danger

In recent months, countries have begun to recognize the danger. Malaysia and Burma, for example, are suspending or reconsidering loan-backed projects as they realize the dangers of too much debt.

Malaysia recently declined to go forward with a loan-financed railroad project because of excessive costs. “It’s all about borrowing too much money, which we cannot afford and cannot repay because we don’t need these projects in Malaysia,” Malaysian Prime Minister Mahathir Mohamad said.

Burma also recently scaled back a project, reducing the external investment in the Kyauk Pyu port project by more than 80 percent. “My priority is to ensure there is no debt burden for the Myanmar government,” Deputy Finance Minister Set Aung said.

A better alternative

The United States, the world’s largest provider of foreign aid, avoids debt trap problems by working with countries and local communities to establish long-term partnerships rather than debt relationships.

Through the Overseas Private Investment Corporation, for example, the United States works with private businesses and other organizations to provide financing for wind power in Pakistan and mobile phone towers in Burma. By working directly with the local communities, U.S. aid and investment ensures genuine development and transparency that leads to real growth.