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* China's lending to S.Pacific islands from almost zero to $1.3 bln in a decade
* Tonga's principal repayments to China start in September
* China says it has provided assistance in 'hour of need'
* One-third of countries that recognise Taiwan are Pacific islands
By Charlotte Greenfield and Jonathan Barrett
WELLINGTON/SYDNEY, July 31 (Reuters) - Just over a decade ago, deadly riots in the capital of Tonga, Nuku'alofa, destroyed much of the small Pacific nation's central business and government districts.
Out of the rubble, the government hatched a plan to rebuild the city, including constructing a new cruise ship wharf and renovating the Royal Palace – all bankrolled by a new lender, China.
The initial roughly $65 million in Chinese lending now exceeds $115 million - almost one-third of Tonga's annual gross domestic product - as interest mounted and the government took out a second loan for road development across the country.
An onerous principal repayment schedule starts in September that will double Tonga's debt financing bill has left the government scrambling.
Tonga's precarious position is indicative of a wider debt-fueled hangover hitting small Pacific economies, stoking fears the region risks falling into financial distress and becoming more susceptible to diplomatic pressure from Beijing.
In particular, the loans give Beijing a lever in one of the most contested areas in the world over recognition of Taiwan, which has strong diplomatic ties to the region.
Reuters' analysis of the financial books of 11 South Pacific island nations shows China's lending programmes have gone from almost zero to over $1.3 billion currently outstanding in a decade.
The documents show China is now the region's biggest bilateral lender, although Australia's significant aid programmes mean it remains the largest financial backer in the South Pacific.
Chinese loans accounts for more than 60 percent of Tonga's total external debt burden, and almost half the external debt of Vanuatu. In dollar figures, Papua New Guinea has the biggest debt to China, at almost $590 million, representing about one-quarter of its total external debt.
"Given the vulnerabilities of their economies, given the very few sources of revenues they have, they tend to be in many cases at high risk of debt distress," World Bank director for the Pacific, Michel Kerf, told Reuters in a phone interview.
"Their debt is reaching the limit of what would be considered sustainable."
Most experts believe China's lending in the Pacific, which picked up from 2006, stemmed from Beijing's broader push to increase overseas ties as its economy and global clout rose. Financing packages also provided opportunities for state-owned enterprises to take part in infrastructure projects.
Chinese firms have built facilities throughout the Pacific, from Vanuatu's Luganville Wharf - built by Shanghai Construction Group - to a water network in the Cook Islands' Rarotonga, which is being built by state-owned China Civil Engineering Construction Co.
Chinese Foreign Ministry spokeswoman Hua Chunying said there was no evidence China was responsible for creating unsustainable debt.
"We have, according to the relevant countries' wishes, given financing support to the best of our ability, which has provided assistance in the hour of need in promoting relevant countries' social and economic development, and received the affirmation and welcome of each country," Hua said at a news briefing in Beijing in response to Reuters questions.
She said China's relationship with Tonga was "very good".
Yet experts say China's recent possession of the strategically important Sri Lankan port at Hambantota as Colombo struggled with a spiralling debt crisis demonstrated the Asian giant's awareness its loans are also a powerful strategic tool.
Last year, a Chinese state-owned firm took over a 99-year lease of the port, part of a plan to convert $6 billion of loans that Sri Lanka owes China into equity.
The deal raised concerns from the United States, India and Japan that Beijing might use the port as an Indian Ocean naval base, which both the Sri Lankan government and Chinese embassy in Colombo have denied.
Sam Parker, the co-author of a Harvard analysis of China's offshore financing and diplomacy, said Hambantota was a "wake up call" and identified the Pacific as being similarly vulnerable.
"We don't think there was some huge Chinese plot to lure countries into debt," Parker said in a phone interview. "But now that they have it, we think they'd be willing to use it. They've started to be a lot more aggressive in geo-economics."
Indeed, a recent U.S. National Defence Strategy paper warned China was using "predatory economics" to achieve its strategic ends in particular by coercing neighbours to reorder the Indo-Pacific region to China's advantage. And New Zealand's defence policy statement released last month highlighted growing disruption in the Pacific from the rise of China.
"Steep debt burdens associated with infrastructure projects have potential implications for influence, access and governance," New Zealand noted, drawing a rebuke from China.
The issue ignited recently over media reports China wanted to establish a military base in Vanuatu after funding a wharf big enough to handle warships. Both China and Vanuatu denied the reports.
Despite Beijing's growing clout in the region, U.S. Secretary of State Mike Pompeo said last week he was confident South Pacific nations would choose the United States as an ally over China.
"I think the South Pacific, like most places in the world, understands the enormity of having an American ally - a country that consistently over decades projects the democratic values," Pompeo said after meetings with Australian Foreign Minister Julie Bishop.
THE TAIWAN QUESTION
While the loans are relatively small on a global scale and the Pacific islands are less obviously of strategic significance, the region has attractions for the ascending power.
Washington and its allies have warned Beijing against any attempt to establish military bases in an area that proved pivotal in the Pacific battles of World War II.
Each Pacific state represents a vote at international forums such as the United Nations, and they control vast swathes of resource-rich ocean.
What's more, one-third of countries which have formal diplomatic relations with Taiwan are in the South Pacific. China views the island as a wayward province, to be taken back by force if necessary.
Both Taiwan and China have used lending and aid packages to help keep their supporters loyal, after decades of several Pacific nations switching allegiances.
In February, Taiwan's Foreign Ministry said China had forced Papua New Guinea to change the name of Taipei's representative office in the country and remove diplomatic license plates from diplomats' cars.
"Recent moves suggest a return to heightened cross-Strait competition in Pacific islands," said a June report from the U.S. Congress's U.S.-China Economic and Security Review Commission.
TERMS AND CONDITIONS
Much of the criticism around Chinese lending in the Pacific has focussed on the projects debts have been used for, and conditions tied to loans.
The Cook Islands has been critical of some of its China-led projects after accepting grants for public buildings including a courthouse and a police station, and a concessional loan for a stadium that used imported labour and materials.
"A lot of the buildings are so substandard that they are starting to fall apart," said Mark Short, former secretary of justice for the Cook Islands.
Short said the stadium was rusted and unsafe less than a decade after being built. A make-shift pen was built outside the courthouse because the cells beneath it ran out of oxygen if occupied for more than two hours.
Cook Islands Deputy Prime Minister Mark Brown acknowledged there had been some issues with the selection of materials and quality of workmanship in parts of the buildings.
"To their credit, China has recognised the shortcomings...by undertaking to carry out renovations work on all three buildings," Brown said in an email. "Chinese assistance was available to meet urgent infrastructure needs in the Cook Islands and we took advantage of those opportunities."
The majority of China's financial support comes in the form of concessional loans, while traditional regional players like Australia, New Zealand and the United States tend to provide gifts and leave lending to multilateral institutions such as the World Bank and the Asian Development Bank.
Australia and New Zealand have both recently diverted more funding to the region after years of apparent indifference.
Vanuatu's recently retired Sydney consul, William Longwah, told Reuters China was an easier financier to deal with than Australia.
"And Australia, when they do something they take so long to process, so long to send the funds," Longwah said in a phone interview.
Now, debt pressure is mounting on several Pacific island governments.
China has showed no signs it will forgive debt, refusing Tonga's request to do so in 2013, although it did suspend principal repayments for five years.
Tonga plans to repay principal of about $5.7 million of its China loans in 2018-19; almost doubling the country's annual external debt service bill and representing about 4 percent of its overall budget of $135 million.
Tonga's financial challenges have already prompted the government to withdraw from hosting the 2019 Pacific Games, an Olympic Games-style event held every four years, sparking anger and legal action from the council responsible for organising the games in the sports-mad nation.
Lopeti Senituli, political and media advisor to Prime Minister 'Akilisi Pōhiva told Reuters Tonga is still negotiating with Beijing to see if it can get its debts forgiven, but is preparing to start payments.
"Of course it would put any government under major financial stress and we are doing the best we can."
He acknowledged Pacific islands experienced pressure from Beijing but denied it was different to any other country with an economic relationship with China, which is asserting "massive" pressure globally.
"You cannot simply say it's only happening in the Pacific islands. No, it's happening to all of us regardless of the size of your economy, regardless of the political status of your government structure."
(Reporting by Charlotte Greenfield in WELLINGTON and Jonathan Barrett in SYDNEY; Additional reporting by Tom Westbrook in SYDNEY and Michael Martina in BEIJING. Editing by Lincoln Feast.)
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