Sri Lanka is going through a severe economic crisis, the likes of which only a few countries in the world have witnessed. The crisis is such that the country’s people lack even basic necessities to sustain daily lives, such as fuel, electricity and food.
While some will say the Sri Lankan crisis is a mess of its own making, the reality is somewhat different. By the end of 2021, Sri Lanka owed China US$ 7.4 billion, which accounted for 19.6 percent of its debt. And because China, which is the island nation’s largest bilateral creditor, holds a large share of Sri Lankan debt, the “Chinese debt trap” narrative is back in the spotlight. With the ongoing crisis, Sri Lanka will be hard-pressed to make interest payments to China with no hope of returning the principal amount any time soon.
What is going on in Sri Lanka and how did this happen?
In the most simple terms, Sri Lanka’s economy has collapsed. Years of mismanagement by the country’s ruling elite and Mahinda Rajapaksa’s stubbornness not to turn to the International Monetary Fund (IMF), have only exacerbated Sri Lanka’s economic woes.
Sri Lanka is presently battling hyperinflation, budget and account deficits, a devalued currency and a ballooning foreign debt that it can no longer repay. Following the 2009 civil war, the country (or rather its ruling political elite) took out massive loans to help with war expenses and to start overblown, unnecessary and expensive infrastructure projects that had little practical impact or hopes of return.
The Covid-19 pandemic ravaged Sri Lanka’s tourism, which was the country’s main source of foreign currency. At present, the country must work with international institutions to help restructure its debt to China and other lenders.
Sri Lanka’s debt to China
The story of China lending money to Sri Lanka is a long and complicated one. The narrative of Sri Lanka being caught in a Chinese debt trap has come up numerous times in the last few years.
Sri Lanka handed over a national asset, a newly revamped port to China in 2017, on a 99-year lease in exchange for China forgoing the debt that Sri Lanka took to make the port in the first place. The Hambantota International Port project was a politically motivated infrastructure project, which started in the home district of the Rajapaksa family that led Sri Lanka’s government from 2005-2014 and from 2019-2022.
From the get-go, there was much criticism regarding the port’s construction, and money being poured into a project that might not yield sufficient returns. At the time the port’s construction began, Sri Lanka already had a functioning port in Colombo situated on a major global shipping lane and, therefore, had sufficient traffic.
The new port became tied to Mahinda Rajapaksa’s legacy and economic vision for Sri Lanka. Its economic success was meant to ensure his re-election for a third presidential term. This caused the Sri Lankan government to push and speed up the construction and launch of the Hambantota port while ignoring the advice and recommendations of all feasibility studies.
The port construction, however, did not help Rajapaksa as in 2015 he lost the presidential election and, thus, came the appointment of Maithripala Sirisena and a new cabinet. It was this new government that realised its inability to pay back loans it had taken from China for the port and signed a lease agreement with China Merchants Port in December 2016. The agreement would allow Sri Lanka to reduce the port’s losses while further developing it without taking on more public sector loans.
According to then president Ranil Wickremesinghe, leasing Hambantota port to the Chinese greatly assisted the country in improving its financial situation. If not for the lease, Sri Lanka’s debt would currently be increased by US$1 billion. Another thing to be pointed out is that in addition to the port being leased to China for 99 years, 800 hectares of industrial zone surrounding the port was also included in the agreement.
Debt restructuring and China’s role
The only avenue for Sri Lanka at this stage of its financial crisis is to look into debt restructuring and, in that regard, China will play a major role. Chexim Bank and China Development Bank are among Sri Lanka’s largest individual creditors with US$4.1 billion and US$3 billion, respectively.
The debt relief that China is willing to provide Sri Lanka through these two banks is crucial. Based on China’s history of debt restructuring with other countries, it is clear that the process will take time.
A closer look will reveal that multiple factors led to Sri Lanka’s ongoing economic crisis, but it is also an undeniable fact that China lending Sri Lanka enormous sums at exorbitant interest rates has played a major role in its current predicament. In addition to Hambantota port, which has already been leased to Chinese entities, other such projects are being undertaken in Sri Lanka that are financed by Chinese loans like Colombo Port City, which was unveiled by Chinese President Xi Jinping in 2014.
Experts have claimed that this new port city will be the next Hambantota, that is, Sri Lanka will have to lease the city to China to manage its debt. And now, at this junction, it wholly depends on China and its whims for its revival.
The example of Sri Lanka should serve as a stark reminder of the consequences of borrowing from China. A great example of this would be the train to nowhere, which is a US$1.5 billion stretch of track funded and built by China linking Kenya’s port city of Mombasa to the Ugandan border. The track has failed to turn a profit and has shown poor performance.
Kenya is also following Sri Lanka’s footsteps, unfortunately, and the country borrowed US$9.8 billion from China between 2006 and 2017. And it is still only the third-largest recipient of Chinese loans in Africa. The Sri Lankan economy has already collapsed and will largely rely on Chinese goodwill and help from external factors if it hopes to recover.
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