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Sri Lanka-China Debt Restructuring Agreement : Economic Recovery Or Another Debt Trap For Sri Lanka?

After being in a worst economic crisis since its independence in 1948 for more than a year, Sri Lanka has been on a path of economic recovery with extended support of several friendly nations and the IMF this year. In September 2022, Sri Lanka became eligible for an IMF Extended Fund Facility amounting to $2.9 billion. The initial installment of $330 million was received in March 2023. The IMF specified that the loan was subject to  a "prior action" involving securing assurances for debt sustainability from creditors, necessitating negotiations and debt restructuring with other countries. To comply with IMF conditions, Sri Lanka initiated talks with bondholders and major bilateral creditors like China, Japan, and India in September of the same year.

The recent announcement of a preliminary debt restructuring agreement between Sri Lanka and China has drawn hopes for economic recovery. The Sri Lankan government has officially confirmed the achievement of a preliminary agreement with China regarding the restructuring of their debts, a significant advancement or seen as a "big step" for the country's economic recovery as it is currently grappling with financial challenges. The agreement with China’s EXIM Bank will assist Sri Lanka to navigate the first review of the IMF program in the upcoming weeks and facilitate the disbursement of the second IMF tranche, totaling around $334 million.

The Ministry of Finance released a statement on October 11, stating that they had successfully negotiated key principles and indicative terms for debt treatment with China's Export-Import Bank. China holds a majority share of about 52% of Sri Lanka's total external credit, amounting to $46 billion. Secretary to the Treasury, Mahinda Siriwardena extended his gratitude to China Exim Bank on behalf of Sri Lanka for its invaluable support in resolving their country’s debt situation." He emphasised that this agreement represents a pivotal milestone in Sri Lanka’s continuous efforts to promote economic recovery.

However, According to Dhananath Fernando from the Colombo-based think tank Advocata, there are concerns that China secured special conditions for the loans. Mr. Fernando suggests that if preferential treatment was indeed given to China, another creditor will have to shoulder the burden.

Japan, India, and France claim they were unaware of the EXIM deal and are requesting equal terms in the restructuring talks. China is known for confidentially negotiating such agreements and keeping the specifics undisclosed. For other creditors,  China’s assistance to Sri Lanka will be seen as another means through which it is investing in deepening its ties with the island nation. In recent years, Sri Lanka also joined the Chinese infrastructure financing project, the Belt and Road Initiative (BRI).

Is China responsible for the Sri Lankan crisis? 


A year ago, Sri Lanka defaulted on its foreign debt amid its worst financial crisis in decades, plunging the nation into severe shortages and soaring prices. Sri Lanka grappled with a series of crises: power cuts and fuel shortages, pushing inflation to a staggering 50% annually. The fuel scarcity strained vital services like transportation and healthcare, as the nation lacked foreign reserves for imports, causing fuel prices to skyrocket. In June 2022, the Sri Lankan government took a drastic step by prohibiting the sale of petrol and diesel to non-essential vehicles for a two-week period. Even after this period, fuel sales continued to face stringent restrictions, affecting transportation and various sectors reliant on fuel.


To preserve resources, schools had to shut down, and the people were urged to work from home. The distress led to protests erupting in Colombo by April, spreading throughout the nation rendering even public transport non-functional due to a lack of funds to purchase fuel. The dire situation forced a return to pandemic-era measures like online learning and remote work, hampered by extended power outages lasting up to 13 hours daily, compounding the struggles of the populace.

Shortages of vital necessities like food, medicine, and other essentials worsened the already dire situation, aggravating the crisis. In the scorching heat, people endured long queues, resulting in the tragic loss of at least 16 lives, predominantly among the elderly.

The major reason for this collapse can be dated back to the end of the civil war in 2009, after which President Mahinda Rajapaksa secured substantial foreign loans to cover war expenses and fund extravagant infrastructure projects aimed at attracting tourism and rewarding allies. Unfortunately, this sparked a detrimental cycle as the government continually relied on foreign lenders, particularly the Chinese, to manage pre-existing debt due to limited foreign reserves. Instead of focusing on increasing reserves through economic reforms, the Rajapaksas opted for tax cuts to maintain political support.


Then there were a series of other reasons that led to the collapse of an economically promising Sri Lanka. Firstly The tourism sector, a crucial source of foreign revenue for Sri Lanka, suffered significantly due to the 2019 Easter bombings and the COVID-19 pandemic. In 2021, Gotabaya initiated a ban on chemical fertilisers, envisioning an all-organic farming approach for Sri Lanka, severely impacting the tea industry, the country's primary export, worsening the already bad situation

This fertiliser ban which eventually reversed, along with global grain shortages due to the conflict in Ukraine, heightened food insecurity within the nation. 


Rajapaksa's economic plan turned out to be a series of missteps that became the reason for the downfall of Sri Lanka, but he later escaped the nation and the government was handed over to Ranil Wickremesinghe.


Chinese Debt Trap Diplomacy in Sri Lanka is a lie?


China has significantly expanded its global trade and investment presence using various economic diplomacy strategies and strategic geographical positions. However, there is growing concern among policymakers, researchers, and strategists regarding China's increasing involvement with South Asian nations and the potential implications as it strives to become a global power.


In 2013, China initiated the Belt and Road Initiative (BRI), a massive global infrastructure project. China is financially backing infrastructure projects in strategically positioned developing nations through its substantial $1 trillion "one belt, one road" initiative. This often involves providing sizable loans to these countries' governments, leading them into a debt trap and rendering them vulnerable to China's influence.


The projects funded by China typically prioritise advancing Beijing's access to natural resources or establishing markets for affordable Chinese goods, rather than focusing on enhancing the local economy. Chinese projects also often entail the deployment of Chinese construction workers, minimising job opportunities for the local population, which can contribute to tensions and anti-Chinese sentiments. As a significant aspect of its Belt and Road Initiative, China has made substantial investments in Sri Lanka, particularly in an extensive infrastructure program aimed at constructing ports, roads, railroads, and pipelines across Asia, Europe, and Africa. 


One prominent example illustrating the impact of China's debt trap diplomacy is Sri Lanka's Hambantota port. The Sri Lankan government initiated the billion-dollar Hambantota port project to enhance logistics and commerce by boosting ship traffic along the east-west shipping route, alleviating congestion at the Colombo port. Allegedly, Beijing encouraged Sri Lanka to secure loans from Chinese banks to fund this project which lacked commercial viability. Moreover , political instability in 2010 led to a halt in construction, straining Sri Lanka's ability to repay the debt. Consequently, Sri Lanka engaged in negotiations and executed a "debt-to-equity swap agreement" with China Merchant Port Holdings Limited (CM Port), leasing the Hambantota port to them for 99 years. The combination of burdensome terms and inadequate revenues eventually led Sri Lanka into default, allowing Beijing to assert the port as collateral. Subsequently, the Sri Lankan government was compelled to give control of the port to a Chinese firm.


Contrary to the narrative portraying China as the primary cause of Sri Lanka's debt accumulation, some sources argue that China's role is overstated in the so-called "Chinese debt trap." The largest contributor to Sri Lanka's debt over the past decade has been the International Sovereign Bonds (ISBs), often referred to as Eurobonds. 


In Sri Lanka's context, China is not the sole creditor, as India and Japan, among other nations, also hold a substantial portion of Sri Lankan debt and are actively engaged in complex discussions regarding repayment and aid. However, China's involvement in the country stands out and is viewed as more prominent and problematic, according to Alan Keenan of the International Crisis Group.


Michael Ondaatje, a significant chronicler of Sri Lanka, "In Sri Lanka, a well-told lie is worth a thousand facts." This aptly characterises the perception that the debt-trap narrative, specifically concerning China's involvement, is indeed a powerful lie.

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