It is undeniable that China has been Sri Lanka’s largest bilateral creditor stemming from the two countries’ economic relationship, which dates back 70 years to the Rice-Rubber Pact signed in 1952 as one of the first trade agreements between China and a non-Communist country following the 1949 Chinese revolution.
China has provided bilateral aid to Sri Lanka, including bilateral loans, since 1952, mainly during the country’s left-wing regimes. Between 2000 and 2020, nearly $12 billion in Chinese loans were channeled into Sri Lanka for major infrastructure projects such as power plants, a port, and an international airport, all of which became white elephants.
In this regard, Sri Lanka is usually referred to be a country that became engulfed in debt as a result of Chinese-financed public investment projects. One of these investments was the 99-year, $1.12 billion lease of the Hambantota port to China Merchant Port Holdings Limited (CM Port) in 2017. This project is primarily responsible for Sri Lanka’s reputation as a country that became entangled in Chinese debt and was forced to hand over assets critical to its national and strategic interests to China.
According to reports, Sri Lanka was forced to hand over the port to China because it was unable to repay the debts it had borrowed from China to build Hambantota port.
Furthermore, major reservations arose about the necessity of constructing a second international port in Sri Lanka, particularly one financed by market-rate borrowing, as well as whether such a port would be profitable. The Hambantota port, as it turned out, was unable to repay China when the loan installments were due.
However, the real reason for Sri Lanka’s decision to lease the port to China goes far beyond the difficulties of making loan payments on debt incurred to build the port. Unsettlingly, the Hambantota transfer implies that Sri Lanka is currently in the grip of a much worse economic crisis.
The economic reality is that Sri Lanka leased out Hambantota port to China primarily to address a lingering balance of payment (BOP) problem caused by a decline in trade over the years, even as the costs of servicing external debt increased dramatically. Sri Lanka was seriously short on foreign reserves due to the maturities of international sovereign obligations and the imminent debt service commitments. As a result, the country had to consider a variety of options for bringing in foreign currency. Leasing the Hambantota port was one strategy for increasing the country’s foreign exchange reserves.
Despite the fact that the government leased the Hambantota port to CM Port, the debts put out to establish the port were not wiped off, and the government is still required to make the loan repayments under the original terms. The earnings earned from leasing the Hambantota port were used to bolster Sri Lanka’s dollar reserves in 2017 and 2018, especially given the massive foreign debt payment stemming from the maturity of global sovereign debts in early 2019.
According to media reports, the government plans to lease India access to Hambantota’s Mattala Rajapaksa International Airport (MRIA), which is one of the world’s most desolate airports.
Both of these infrastructure projects were backed by Chinese loans and were heavily criticized for making poor financial judgments.
True, China has acquired a much higher percentage of Sri Lanka’s foreign debt during the last ten years or so as a result of sponsoring various infrastructure projects. China accounted for more than 60% of all foreign borrowing between 2008 and 2012.
Having said that, even in the absence of Chinese loans, Sri Lanka would have faced concerns about the sustainability of its external debt and ongoing balance of payment (BOP) issues. Of course, there were significant concerns raised about the viability and necessity of the Chinese-financed projects when they were first launched.
The decision to borrow at commercial rates from international capital markets at a time when Sri Lanka’s exports were declining, even as the government repeatedly failed to address structural issues such as reduced trade, rising protectionism, and decreased government revenue, was the primary cause of the country’s debt crisis. With such core issues, considerable debt management concerns are inescapable. Resolving the issue will necessitate a consistent reform effort, which will present significant political challenges.
In this scenario, China will be required to play a critical role in Sri Lanka’s debt restructuring process, with US$ 7.4 billion or 19.6 percent of outstanding public debt owed to China at the end of 2021 (out of a total of US$ 37.6 billion in total public external debt excluding central bank debt), and it will be the first time a major Asian Belt and Road Initiative borrower goes through the process. As a long-term friend, Sri Lanka expects a lot from China; however, it is highly unlikely that China will extend a helping hand to Sri Lanka.