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26. Aug. 2021

How Germany Can Prevent a Balkan Debt Trap

Photo of Montenegrin President Milo Djukanovic
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In March, Montenegro’s government lobbied for a bailout from the EU as it grappled with a huge debt payment to China. The EU refused and the country turned to the banks. Story over in Germany. In the Western Balkans, by contrast, citizens know the crisis was merely postponed, and they are watching to see whether the next German government learns the lessons from Greece’s sovereign-debt crisis. The signs are not good, but a far-sighted approach by Berlin is still possible. This is why and how.


In 2014, Montenegro’s government, led by then prime minister Milo Djukanovic, signed a loan agreement with China to construct the first stretch of the Bar-Boljare highway. This 169-kilometer highway is intended to connect the Adriatic seaport of Bar to Serbia’s road network and will be built in four phases. Having failed to interest foreign companies to partner in its construction, the government financed an initial 41-kilometer stretch through a $944 million loan from the Export-Import Bank of China with a 2 percent annual interest rate and a six-year grace period.

At the time, Montenegro’s level of public debt already exceeded 60 percent of GDP, the upper threshold indicated by the Maastricht criteria for membership in the European Union. Furthermore, the government’s feasibility studies had shown that there would not be enough traffic to justify building such an expensive highway, which explains why the government was unable to finance it through concession agreement with foreign firms. It went ahead regardless.

By the end of 2020, Montenegro’s debt hit 105 percent of GDP, and it was facing the first repayment of $67.5 million in July 2021. In March 2021, still without a confirmed state budget, the government asked the EU to assist in repaying the loan and, in the wish list set out by the deputy prime minister, “exchange that loan for a loan with a European bank, enter into cooperation with a European financial institution, and put an end to Chinese influence.” The EU refused to step in, signaling that it would not condone moral hazard by offering Montenegro a bailout.

Montenegro’s government thus made an agreement with four Western banks instead. Goldman Sachs International, Merrill Lynch International, Société Générale, and Deutsche Bank are now guarantying the risks related to fluctuations in the euro-dollar exchange rate, effectively reducing the interest rate from 2 percent to 0.88 percent. This puts a stop to the expensive cross-currency transfers that have already cost Montenegro €109 million in extra losses. (To put that figure in context: China itself accounted for just $71 million of direct investments in Montenegro in 2020, despite trumpeting its status as second largest investor.)

Crisis Postponed

Thanks to this hedge agreement, Montenegro’s government will now know exactly how much it needs to return to the Export-Import Bank of China. But this does not resolve the underlying problem – the intrusive terms of the original loan. China, which seems to have turned its calamitous former habit of making bad loans into a geo-economic strategy, exploited the weakness of the country’s economy in 2014. It inserted provisions that would allow the bank to seize sovereign territory as collateral. If the loan went to arbitration, Chinese terms, conditions, and courts would apply, not the International Court of Arbitration in Paris. Those terms still prevail.

Montenegro has only managed to stave its debt crisis off for a moment and will soon be looking to the EU again. Last year, the country suffered a deep recession with GDP shrinking by an estimated 15 percent; according to the World Bank, it will not recover before at least 2023. Dissatisfied with the previous government’s stewardship of the economy, Montenegrins voted for a change in August 2020 – the prelude to the March effort to reengage with the EU. But the old government’s toxic legacy of isolation and crippling debt makes the country even more vulnerable to outside powers like China.

It is more than understandable that the EU chose to discipline Montenegro with a sharp refusal. Trust is low: Montenegro hid the terms of the Chinese contract for years; many of the documents related to the highway construction agreement are exempt from any kind of public scrutiny; the deal with the Chinese bank was made through secretive face-to-face governmental negotiations; and the implementation of the project was overshadowed by corrupt dealings, especially in subcontracting local companies, and dubious environmental impact assessments. The new hedge agreement is almost as secretive.

But what message does it send to Montenegrins – or to citizens of other Western Balkan countries like Serbia or North Macedonia that have also taken loans from China? And what about those Balkan states that will soon be seeking funds to overcome the significant economic losses caused by COVID-19? There is a risk that the EU’s hard stance sends them into a spiral of negative behavior, pushing them further from its regulatory ambit even as they still sit as an enclave inside the EU.

The EU’s Self-Fulfilling Suspicions

The EU exercises huge geo-economic power, but it has got into the habit of making defensive decisions that tend to make its suspicions self-fulfilling. Its shift towards transactionalism is one such example. The EU believes it must incentivize Balkan states to behave in a responsible way and sanction bad behavior, afraid that they are becoming rogue. The paradoxical effect is that governments that have a self-interest in responsible behavior suddenly require rewards. This approach takes away local responsibility. The result is moral hazard.

Had the EU instead treated Montenegro as a future mature member state, it would have gained much more leverage. Of course, it would never have been able to block a sovereign country from developing its infrastructure in this superfluous way, but it could have steered a future member in a positive direction. Likewise, it could never have stopped Montenegro from taking a loan from a third party, but it could surely have been much stricter in insisting that an accession country comply with the Maastricht criteria and good investment practices.

No one wants another poor and dysfunctional country from the region to accede to the EU. But withholding funding – essentially denying these countries the means to improve so as to keep them out of the club – cannot be a way to avert this. The Instrument for Pre-accession Assistance III and the Economic and Investment Plan for the Western Balkans are tiny compared with the packages provided to member states through the New Generation EU recovery fund and the EU budget for 2021 to 2027. Instead of increased economic convergence, the region will experience growing divergence from the EU.

A clear plan supported by a financial framework for repaying Montenegro’s loan and for the completion of the remaining parts of the highway is required. Unlikely as it may seem, this “white elephant” project may yet turn out to be useful. If nothing else, the EU would succeed in building local administrative capacities that will be necessary for Montenegro to absorb European Structural Funds as a future member state. A modern state needs to be able to routinely manage resources for infrastructural projects of this magnitude.

Can Germany Jump Over Its Shadow?

Fairly or not, voters and reform-minded elites across the Balkans will see Montenegro’s case as a litmus test for the next German government. Within the EU, the Balkans are considered Germany’s sphere of interest, not least thanks to its attempts to drive forward engagement in the region (notably through the Berlin Process). But more than this: a decade ago, Balkan countries felt at first hand the fallout of what they saw as the attempts of Chancellor Angela Merkel’s government to apply moral discipline to Greece. They want to know if Germany has drawn lessons from the sovereign debt crisis.

Anecdotal evidence from the region suggests considerable skepticism. Locals have a sense that the sovereign-debt crisis of a decade ago is about to repeat itself, and not just because the Montenegro case revealed a familiar German emphasis on moral discipline. Some of the Western banks involved in the hedge agreement were the very same banks that helped Greece to hide the true extent of its debt in order to enter the eurozone while making huge profits. Yet Germany seems to perceive their involvement as a cause not for alarm but complacency – at least they are Western banks.

Balkan societies are asking themselves two questions. First, is Germany ready to trust them? And, second, is it willing to act upon this trust? They feel that they have repeatedly showed their commitment to the EU and its transformational approach to governance – to investment standards, environmental rules, and so on. However, this is badly served by European transactionalism and needs to be tied to a bigger cause, namely EU membership. Instead, at the time of writing, the EU is effectively entrusting its relationship to the Western Balkans to time and the value of the dollar.

If no support is forthcoming, these countries may feel ready to punish a German-led EU for its lack of solidarity. Turkey did this during the 2015 to 2016 migration crisis, instrumentalizing its own vulnerabilities to acquaint the EU with its own exposure. The EU ended up having to pay Turkey to do something it had a self-interest in doing anyway – getting its borders under control – and left itself dependent on Ankara’s goodwill for its own internal stability. If Western Balkan countries cannot use the potential movement of people from the Middle East and Afghanistan in this way, they may well use their debt exposure and vulnerability to third powers.