International Finance

Did China’s debt-trap destroy Sri Lankan economy

Sri Lankan economy
China gave Sri Lanka a total of $11.7 billion in project infrastructure loans between 2000 and 2020

Sri Lankan officials stated that it was time to ask for a bailout from the International Monetary Fund (IMF) when the island nation’s foreign-exchange reserves started to decline under a mountain of debt early in the coronavirus pandemic. But Sri Lanka’s largest single creditor China had other ideas. The Asian powerhouse came up with an alternative.

According to current and former Sri Lankan officials, China had asked the island nation to skip the IMF’s bitter medicine for now and just keep adding on new debt to pay off the old ones. Lanka agreed to the idea and soon the Chinese banks immediately started crediting $3 billion in 2020 and 2021.

That strategy has now failed, throwing Sri Lanka into disarray. The country has run out of money to pay for imports of essential products under crushing debt and sky-high inflation, leaving people in major cities scrambling to keep the lights on and forcing them to wait in queue for hours to buy petrol. By the time Sri Lanka finally made the decision to apply for IMF assistance in April, its economy was slipping into one of the worst recessions since the country’s independence in 1948, fuelling a popular uprising that resulted in the President being chased from his home by thousands of protesters.

In 2022, President Gotabaya Rajapaksa fled Sri Lanka on a military plane on the very day he was supposed to tender his resignation. But nevertheless, within a few days of fleeing the country, he resigned from his post.

Sri Lanka’s caretaker Finance Minister from April to May, Ali Sabry said, “Instead of making use of the limited reserves we had and restructuring the debt in advance, we continued to make debt payments until we ran out of all of our reserves. If you had been realistic, we should have gone [to the IMF] at least 12 months before we did.”

Sri Lanka is the first country in the Asia-Pacific region to default on its international debt since Pakistan in 1999, owing almost $35 billion in foreign debt. Beijing’s willingness to assist in resolving a sovereign debt crisis in the developing world—which opponents claim China’s own lending policies contributed to—will be put to the test in its discussions with the IMF.

The Paris Club, an informal association of 22 major creditor nations, largely Western and some in Asia, including the United States, France, Germany, Japan, and South Korea, has been coordinating sovereign debt restructurings for more than 60 years. The Paris Club, which frequently collaborates with the IMF, has inked 433 agreements with 90 nations, restructuring more than $583 billion in sovereign debt since its formation in 1956.

China isn’t a part of the Paris Club, mainly because of the fact that it wasn’t a major creditor nation until the mid-2000s. In order to finance its strategic Belt and Road Initiative, China embarked on a lending spree. According to World Bank data, China alone is responsible for more loans to low-income nations than the entire Paris Club put together.

The common wisdom in the West holds that debts of troubled borrowers should be written down to manageable levels based on current and projected government income, whereas China often adopts an uncommon approach to debt restructuring. Beijing frequently battles to retrieve every dollar that debtors initially pledged, lengthening the loan term while leaving the principal untouched.

Along with Sri Lanka, major Chinese debtors Zambia and Ethiopia in Africa are currently restructuring their debts. Other developing nations with significant Chinese debts and impending maturities that analysts are unsure whether they can pay include Kenya, Cambodia, and Laos.

In a time of escalating financial turmoil, China is the most significant creditor for the developing world. However, Beijing has sometimes thwarted restructuring efforts.

According to people familiar with the situation, even after Zambia informed creditors that it intended to reduce its existing debt, the Chinese government attempted to offer the country new financing to assist with infrastructure loan repayments as Zambia teetered on the brink of default in the fall of 2020.

China, which is responsible for nearly 30% of Zambia’s external debt, took months to join an official committee of public creditors after the IMF staff decided on a package for the country in December 2021. After receiving condemnation from Western leaders in February of 2022, including Treasury Secretary Janet Yellen, China finally joined. The group has only met once, and conflicts among Chinese lenders have reportedly contributed to delays, despite Beijing’s initial endorsement of the IMF’s debt-reduction plan.

Lex Rieffel, non-resident fellow at the Stimson Center, a Washington, D.C., think tank, wrote, “The main reason why China is unlikely to become a full-fledged Paris Club member is geopolitical: It would be a rule-taker in the Paris Club, and it prefers to be a rule-maker.”

China’s Foreign Ministry, in a statement, stated that it was the first bilateral creditor to offer Zambia debt relief and rejected charges that it had delayed debt talks.

The conditions of China’s loans for significant infrastructure projects throughout Africa, Asia, and Latin America haven’t generally been made public. But as the impacts of the coronavirus, rising interest rates, a strengthening currency, and bond-market fears threaten to drive heavily indebted countries into default, Beijing’s lending methods are coming under increased scrutiny.

Dr. Bradley Parks, executive director of the AidData Lab at the College of William & Mary, said, “China hasn’t gone through the painful learning process from lending unsustainable amounts to sovereigns that have solvency problems, such as the United States did with countries in Latin America during the 1980s.”

Due to its location alongside important shipping channels and history as a focal point of rivalry between major countries, Sri Lanka found it simple to get Chinese funding. This became particularly significant after 1997, when the World Bank promoted the nation to lower-middle-income status, denying it access to development funds intended for low-income countries’ infrastructure.

After a civil war that ended in 2009 between the government and an ethnic-minority Tamil insurgency in the northern regions of the country, Mahinda Rajapaksa, who served as Sri Lanka’s President from 2005 until 2015 and is the brother of the recently overthrown leader, attempted to use infrastructure projects to revive the island nation’s economy. His goal was to make Hambantota, a small coastal town in southern Sri Lanka and the hometown of his family, a thriving metropolis that could compete with Colombo.

In his presidential election manifesto in 2010, he said, “The people of our country are now awaiting the victory in the ‘economic war,’ in a manner similar to our victory in the war against terrorism.”

He turned toward China for the war funds. A varied range of projects, including roads, power plants, railway extensions, a port, an international airport, and a cricket stadium, were funded over the past 10 years by billions in Chinese lending.

Some, such as the Lakvijaya Power Plant, located 80 miles north of Colombo, assisted in bringing energy to some of Sri Lanka’s most remote and undeveloped regions for the first time in the country’s history. However, many of the other initiatives haven’t met with the same success as the government had hoped for.

Since it was constructed for the 2011 Cricket World Cup, the cricket stadium has only occasionally played host to international events. The airport, which was designed to hold a million foreign travellers, is losing money. There were no commercial flights landing there in April and May.

Additionally, Hambantota’s deep-water port didn’t bring in enough money to pay off its debt. The government in 2017 gave a Chinese state corporation a 99-year lease on the plant as it struggled to pay back the loan. This was criticised in Sri Lanka as an instance of “debt-trap diplomacy,” where loans were given to the country in order to make it reliant on Beijing.

A 20-year-old retail assistant selling household appliances in Hambantota, said, “The problem is we haven’t seen any benefits from all the infrastructure.”

He claimed that as a result of consumers tightening their budgets as a result of the economic crisis, the business has only seen approximately 10% of the typical number of clients in recent months.

“The pitch was that every youth would get a job, we were expecting these projects would give us jobs, but it never happened,” he said.

China gave Sri Lanka a total of $11.7 billion in project infrastructure loans between 2000 and 2020. In its most recent general credit lines, it has increased its debt by an additional $3 billion.

However, as interest costs increased and the government’s massive deficit persisted, Sri Lanka was forced to issue foreign sovereign bonds in order to pay off its mounting debt of primarily dollar-denominated, high-interest Chinese project loans.

The country had to turn to international bond markets to help pay off Chinese debts, according to Kabir Hashim, a former investment minister and current opposition leader, because the government had borrowed money for low-profit projects.

He said, “It’s like a vicious cycle.”

Everyone is attempting to determine China’s intentions now that Sri Lanka is facing restructuring.

According to a statement from the Chinese Foreign Ministry, Beijing intends to work with global financial institutions to help Sri Lanka overcome its current challenges by easing its debt burden and achieving sustainable growth. It further stated that scientific planning and in-depth analysis have always guided its engagement with Sri Lanka, with no additional political conditions.

Beijing has signed the standard framework for debt restructurings in low-income countries, which was approved by the Group of 20 countries in November 2020 in response to the economic difficulties brought on by the COVID pandemic.

Beijing has indicated it is unhappy with the government’s decision-making and has revoked Sri Lanka’s access to a $1.5 billion swap line and a planned $2.5 billion credit facility that was in the works as of March, despite the fact that China now claims it plans to support Sri Lanka through its IMF programme and upcoming debt restructuring talks.

Meanwhile, China and India have been requested by the central bank of Sri Lanka to write off their debts as quickly as possible. Sri Lanka, a country in financial turmoil, missed debt payments and agreed to a $2.9 billion (£2.4 billion) bailout. However, the International Monetary Fund would not disburse the funds until China and India consent to lower Sri Lanka’s huge debt.

The governor of Sri Lanka’s central ban told BBC Newsnight that prompt action was in everyone’s best interest. Nandalal Weerasinghe said, “The sooner they give us finance assurances that would be better for both [sides], as a creditor, as a debtor.”


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