China and Sri Lanka’s Debt Crisis: Belt and Road Initiative Blowback

Introduction

Sri Lanka is in the grip of an unprecedented crisis. For several months, the country has been reeling under a severe foreign exchange crisis. In early May, Foreign Minister Ali Sabry said that its usable forex reserves were just $50 million (Daily News, May 5). As a result, Sri Lanka has been forced to suspend repayment of $51 billion worth of debt owed to China, Japan and other foreign creditors (The Hindu, April 12; The Island, April 13). The country has also been unable to pay for imports of essential commodities, and has experienced serious shortages of food, fuel and medicine (The Island, January 15). The economic crisis has in turn triggered a political crisis. Public anger has boiled over onto the streets. Angry protesters have been calling for the resignation of President Gotabaya Rajapaksa and his brother, Prime Minister Mahinda Rajapaksa (Colombo Telegraph, April 7). The Rajapaksa family has dominated Sri Lankan politics for decades and several members of the family are in positions of power as ministers, legislators or heads of corporations and departments. Sri Lankans want the entire clan out. Some of them, including Mahinda, resigned under public pressure in recent months (Island, April 17). Although Gotabaya remains president and under the country’s executive presidential system, continues to wield enormous power, it is evident that the influence of the Rajapaksas has declined.

The unfolding crises in Sri Lanka have implications beyond the island. China is among Sri Lanka’s largest bilateral lenders and has played a big role in the island’s infrastructure development. Sri Lanka is a part of China’s Belt and Road Initiative (BRI). Despite China’s pledges that BRI would boost Sri Lanka’s economic and social development by transforming it into “the hub of the Indian Ocean”, Chinese loans are widely believed to have pushed the country into a ‘debt trap’ (Embassy of the People’s Republic of China in Sri Lanka, June 16, 2017). How have the crises impacted China’s image in Sri Lanka and will the decline of the Rajapaksas, widely regarded as ‘pro-China,’ impact Sino-Sri Lankan relations? Finally, will the Sri Lankan crises affect the fate of BRI?

Sino-Sri Lankan Relations

Relations between China and Sri Lanka, which have been traditionally close, warmed considerably beginning in 2005, when Mahinda began the first of his two terms as president. China was among the strongest supporters of his government’s unrestrained military offensives against the secessionist Liberation Tigers of Tamil Eelam (LTTE) and provided it with weaponry (Economic Times, June 8, 2009). Following the defeat of the LTTE in May 2009, the Rajapaksa regime came under western pressure for alleged war crimes against Tamils in the final stages of the civil war. Despite widespread charges of human rights violations, China largely shielded Sri Lanka from international pressure (The Hindu, March 22, 2012).

During Mahinda’s second presidential term (2010-15), China significantly expanded its role in Sri Lanka. China extended Colombo massive loans for infrastructure projects including ports, airports, bridges, highways and a city on reclaimed land (China Daily, September 17, 2014). Analysts warned that the “ill-conceived, uneconomical and environmentally costly projects [would] bring little or no benefits” to Sri Lanka (Colombo Telegraph, September 18, 2024). China’s strategic influence in Sri Lanka also grew. For instance, in 2014, Chinese submarines docked at Colombo harbor twice, despite India’s objections (China Brief, December 3, 2021).

In January 2015, Mahinda Rajapaksa was defeated in the presidential election as was his Sri Lanka Podujana Party (SLPP) in parliamentary elections a few months later. The end of Rajapaksa rule, during which Sino-Sri Lankan relations had grown remarkably, was expected to result in a decline in the Chinese presence in Sri Lanka and a more balanced relationship with the other big powers. After all, President Maithripala Sirisena had promised “equal relations” with India and China (The Hindu, December 20, 2014). Besides, the new Prime Minister Ranil Wickremesinghe is known to be close to the West and India (Deccan Herald, May 12). Indeed, his government did push through security agreements with the U.S. (Economy Next, July 10, 2019).

However, neither China’s role in Sri Lanka’s economy nor its strategic grip diminished in the 2015-2019 period, when the Rajapaksas were the political opposition. Sri Lanka’s borrowing from China continued throughout that period (Adaderana, March 24, 2021). As Sri Lanka’s capacity to repay loans has diminished, China’s grip on the island nation has tightened. The Wickremesinghe government was hoping to renegotiate the terms of debt repayment on the Hambantota Port with China but the talks culminated in Sri Lanka giving Beijing a controlling equity stake and handing over the strategic port to China on a 99-year lease along with providing 15,000 nearby acres for an investment zone in lieu of unpaid loans (The Hindu, December 9, 2017).

Return of the Rajapaksas

In November 2019, Gotabaya Rajapaksa, who was minister of defense during Mahinda’s presidency, was elected president, while Mahinda returned as prime minister.  The return of the ‘pro-China Rajapaksas’ to power set off alarm bells in New Delhi (News18, November 20, 2019). This concern was not misplaced as the India-China contest for infrastructure projects in the island saw Beijing gain at New Delhi’s expense. This was the case with the East Container Terminal project at Colombo Port, for instance. In 2019, India, Japan and Sri Lanka had signed a Memorandum of Understanding to jointly develop the project. Citing opposition from port worker unions to India and Japan holding 49% stake in the ECT project, the Rajapaksa government scrapped the deal in February 2021 and awarded the project to the China Harbour Engineering Company in November of that year (The Hindu, November 24, 2021). India was ‘compensated’ with a deal to develop and operate the West Container Terminal along with a 51% stake in the project (The Print, October 1, 2021).

While China’s role in Sri Lankan infrastructure building continued to grow during Gotabaya’s presidency, India’s economic and strategic footprint has also expanded in recent years. In January, India signed agreements with Sri Lanka to refurbish and use the Trincomalee Oil Tank Farm, which is adjacent to the strategic Trincomalee harbor. In reaching this agreement, India pre-empted several other powers, which had been seeking to develop their presence in the area. The Indian presence here is expected to offset China’s expanding presence in Sri Lanka (The Diplomat magazine, February). Thus, unlike Mahinda Rajapaksa’s second presidential term, when India rapidly lost economic and strategic ground to China, the return of the Rajapaksas to power in 2019 saw an Indian diplomatic pushback that resulted in New Delhi recovering some ground in the island. Thus while Mahinda Rajapaksa’s presidency, especially the second term saw his government strongly embrace China, the post-2019 Rajapaksa rule has sought a more balanced relationship. Its cautious approach may have been the outcome of the role that Indian intelligence agencies reportedly played in sewing together a coalition that defeated Mahinda in 2015 (Adaderana, January 18, 2015).

China and Sri Lanka’s Economic Crisis

Unlike India, China has not had to contend with anti-China sentiment and protests in Sri Lanka in the past, but this has changed with the recent economic crisis. Beijing is widely seen as responsible for running Sri Lanka into a debt trap. “The Rajapaksas’ corruption and closeness to China and their heavy borrowing from China for projects, which earned Sri Lanka little, are being blamed for the collapse of the Sri Lankan economy and the food and fuel shortages,” a Sri Lankan government official said. [1]

Under the Rajapaksas, Sri Lanka borrowed heavily for swanky vanity projects that were intended to boost the Rajapaksas’ image among their supporters in the family’s stronghold rather than strengthening the national economy overall or serving the needs of ordinary Sri Lankans. Projects like the Hambantota port and the Matalla airport were white elephants that drew little business and earned Sri Lanka no tangible benefits. From the start, the Hambantota port lost money (The Hindu, May 11, 2022).

Analysts have highlighted that 10% of Sri Lanka’s total foreign debt is owed to China, which is around the same amount that it owes Japan and far less than its obligations to international sovereign bondholders and the Asian Development Bank. However, Chinese loans are particularly burdensome due to their unfavorable terms. For example, Chinese loans carried an average interest rate of 3.3% compared to Japan’s 0.7%. The maturity period for Indian and Japanese loans were 24 years and 34 years respectively, compared to 18 years for Chinese loans (Nikkei Asia, May 13).

However, blaming Sri Lanka’s economic crisis on China’s financing practices alone is flawed. As noted security analyst, Nilanthi Samaranayake argues, “Sri Lanka’s economic crisis and failure to adapt its debt management approaches predate the rise of China and reflect some of the challenges associated with middle-income transitioning countries. In particular, most of Sri Lanka’s external debts are in the form of international sovereign bonds and loans from multilateral development banks. This proportion is significantly larger than debt owed to China.” [2]

While the Rajapaksas did drive the island into a debt trap, the roots of Sri Lanka’s economic crisis go back to policies pursued over decades by successive governments. Furthermore, an import-oriented economy that is dependent on tourism with little manufacturing capacity was bound to run into trouble in the event of a crisis such as the recent onset of the pandemic.

Future of Sri Lanka’s Ties with China

China’s image and credibility in Sri Lanka has taken a severe beating in recent months. Given the mood at the protest sites, China’s stock in Sri Lanka has never been lower. “That Beijing has been less generous than India has not gone by unnoticed,” the Sri Lankan government official interviewed for this article said. Should the political situation in the island worsen and result in the resignation of Gotabaya as well, China would lose its strongest patrons in the island – the powerful Rajapaksa family, he said. [3] 

Despite the bleak outlook, the current crisis is not the end of the road for Chinese influence in Sri Lanka for several reasons. First, the Rajapaksas may be down, but they are not defeated. The family has risen from  past political setbacks and the possibility of them doing so again cannot be ruled out. Second, Sri Lanka has turned to the International Monetary Fund (IMF) for loans which comes with conditions that will not be popular with the masses. The anti-IMF/West sentiment and mass protests that are likely to follow could serve to reduce anger with China. Third, Sri Lanka turned to China for loans because other countries and banking institutions either lacked the resources or were unwilling to lend without conditions, which remains the case. As Samaranayake points out, “regardless of who is in the domestic political leadership [that is whether or not the Rajapaksas are in power], any Sri Lankan leader will need to work with China as a critical development partner.” [4]

Lessons from Sri Lanka’s Crisis

This is the case with other BRI countries too. China’s deep pockets and willingness to fund their infrastructure development drew several Asian and African countries to join BRI. Of course, these countries have been observing Sri Lanka’s experience in recent years, including its handing over of Hambantota Port to China and they have drawn lessons from it. “Bangladesh has been careful to maintain healthy foreign exchange reserves, while Nepal has discussed its preferred approach of relying on grants and avoiding commercial loans as it has graduated from low income to lower middle-income country,” Samaranayake observed. [5] They will be monitoring the current crisis for the role that Sri Lanka’s Chinese loans played in triggering the crisis. If Sri Lanka, a country with relatively good socio-economic indicators had to collapse the way it did, what would be the fate of less developed BRI countries like Myanmar or Ethiopia? Asian and African countries would be watching to see how China responded to Sri Lanka’s crisis.

In January, the Gotabaya government appealed to China for a restructuring of its debt payments (Daily Mirror, January 10). That Beijing has been reluctant to do so – its hesitancy is being attributed to a difficult economic situation at home due to the pandemic and a reluctance to get mired in a messy political situation in Sri Lanka  – would not have been missed by other BRI borrowers (Straits Times, April 14). Certainly, Sri Lanka’s economic crisis will make BRI countries more cautious borrowers but given their need for financial resources, they may continue to engage with China.

Conclusion

The Sri Lankan political and economic crises are a setback for China. It has sullied its image as a lender in the eyes of not just the Sri Lankan people but also, governments and people in other developing countries, especially BRI member-states. However, given their need for funds to finance infrastructure development and the fact that as of now, only China has the deep pockets to extend loans, their dependence on Beijing will continue. How Sri Lanka manages its borrowings from the IMF and deals with its crises will also impact the future of Sino-Sri Lankan relations.

Dr. Sudha Ramachandran is an independent researcher and journalist based in Bangalore, India. She has written extensively on South Asian peace and conflict, political and security issues for The Diplomat, Asian Affairs, and the Jamestown Foundation’s Terrorism Monitor and Militant Leadership Monitor. She can be contacted at sudha.ramachandran@live.in 

Notes

[1] Author interview, official in the Ministry of Finance, Sri Lanka, May 24.

[2] Author interview, Nilanthi Samaranayake, Director of the Strategy and Policy Analysis Program at CNA, a non-profit research organization in the Washington, D.C. area, May 22.

[3] Sri Lankan official, n. 1.

[4] Samaranayake, n.2.

[5] Ibid.