NEW DELHI: Sri Lanka has been in the news for all the wrong reasons over the past year. An unprecedented but not unexpected economic crisis and the ensuing food, fuel and power shortages sparked violent protests that forced President Gotabaya Rajapaksa to flee the country in July. His successor, interim President Ranil Wickremesinghe, declared a state of emergency, sought a bailout from the International Monetary Fund and made it clear that things were likely to get worse before they got any better.
On April 12 last year, days after Sri Lanka’s doctors warned that lack of life-saving medicines could kill more people than the Coronavirus, the government announced it had no option but to default on its foreign debt (estimated at $51 bn) since it had run out of foreign exchange required to import desperately needed goods. When a month-long grace period to come up with US $78 mn of unpaid debt interest payments also expired, the country became an official defaulter.
India stepped up to help Sri Lanka in a major way, sending food, medicines and other essentials during the crisis, as well as about $4 billion in financial relief including credit lines, a currency swap arrangement and deferred import payments.
Talks to unlock a $2.9 billion IMF package, however, are stalled because China—which holds almost 20 per cent of Sri Lanka’s debt—has refused to accept the IMF’s condition that major bilateral lenders must restructure and pare their debt with Colombo to ease financial pressure on the government.
While India and other major lenders including the Paris Club, an informal grouping of mostly western creditors including the US and Japan, have agreed, China’s Exim Bank offered a two-year moratorium instead and argued that multilateral lenders like the World Bank and IMF too should provide debt relief to Sri Lanka as part of a broader restructuring of loans. The IMF, however, argues that this would not only eliminate its Poverty Reduction and Growth Facility programme but also impair the Fund’s financial integrity.
So why is China so vehemently opposed to restructuring its loans to Sri Lanka?
“China has a problem because a number of countries it has given loans to are in distress,” says Umesh Moramudali, a lecturer at the University of Colombo, whose research areas include public debt and finance, and economic development. “These include Sao Tome, Angola, Suriname, Ghana, Zambia and of course Pakistan, to name just a few. Because of that, China has an issue that whatever precedent it sets in Sri Lanka might lead to others asking for similar concessions,” he said.
“Also, their main banks like China Exim Bank and others might get into an uncomfortable situation, because this becomes a global issue for them. Second thing is that it is not the Chinese government but different state owned banks that are actually doing the lending. Like China Development Bank (CDB), Export-Import Bank of China (EXIM Bank), Industrial and Commercial Bank of China (ICBC), People’s Bank of China and other financial institutions,” Moramudali adds. “These banks and institutions have taken these loan decisions independently, and they have different kinds of departments and lending processes. So they need to come to a consensus on how to approach this. Obviously, that will be a lengthy process. There is a lot of back and forth going on between them on this already.”
The third issue, he argues, “is that many of these banks also have issued domestic loans. So if Chinese banks are giving debt reductions or maturity extensions to other countries, there could be an issue with these domestic borrowers demanding some kind of similar support too. And any such move obviously means huge losses for these banks.”
However, “that is not an excuse, since it’s almost a year now since Sri Lanka has defaulted, and China needs to have a solution out quickly. This is important because at this crucial juncture we need to understand how the Chinese lenders plan to deal with such situations not just in Sri Lanka but the developing world, and arrive at common global solutions.” In other words, given its vast funding of projects worldwide, Beijing needs to take a decision which is universally acceptable.
“What we are seeing is a stalemate. Although I suppose a lot of intense discussions are taking place to resolve this,” he said, but “as of now, without China’s significant assurance, the IMF’s Executive board is unlikely to sanction the loan for Sri Lanka.”
However, “we don’t know how the IMF will adjust, since it cannot postpone the approval citing China, because at the end of the day it prolongs Sri Lanka’s suffering. I suppose there are attempts to bring China to the negotiating table and work out a compromise.”
Asked why the IMF also wanted concrete steps to increase revenue, which mostly involves raising taxes and cutting expenditure, given that the country is already financially stressed, Moramudali said that the IMF felt that in order to get other external creditors to provide some relief, you need to show that you are committed as well. That signal of increasing taxes for those who can pay is important, because these high earners might have to cut consumption and expenditure but they won’t starve.”
What happens if the IMF refuses and China offers to fund the loan? “That won’t help because if the IMF refuses, the debt restructuring process will come to a grinding halt. China owns only 20 per cent of Sri Lanka’s debt, and it will be very difficult for Sri Lanka if others don’t restructure their loans, and refuse fresh loans.”
Many others, however, feel that Sri Lanka has become a pawn in geopolitical game involving the US, China and India.
“Before Sri Lanka defaulted, China offered a gap loan at a nominal rate, but once Sri Lanka defaulted, that offer was withdrawn because Chinese law prohibits giving a loan to a country that has officially defaulted,” said another Sri Lankan expert who has been following the issue closely.
“Neither India nor China wants Sri Lanka to fail. China is waiting for the IMF loan to come through, because it cannot provide a loan to a defaulter. Also, China has its own compulsions. It cannot afford to let the Port City to fail,” he said.
Also known as the Colombo International Financial City, this is a special economic zone and International Financial Centre built on reclaimed land adjacent to the Galle Face Green in Colombo. Estimated to cost US $15 billion in 2017, this is a key part of Chinese President Xi Jinping’s flagship Belt and Road Initiative.
The Port City Commission Bill, which allows total tax exemptions for entities operating within that zone for 40 years, was approved by the Sri Lankan Parliament in May 2021. The Chinese want India, Bangladesh, Saudi Arabia and western nations to come and invest there, but at the moment, there is very little interest.
“We will always be grateful for India’s generous assistance during our crisis, and would have actually liked India to do more in terms of investments and other development aid to help kickstart our economy. But the fact remains that India cannot match China in terms of funding capability or technology and infrastructure expertise, although it is catching up fast. Besides, the docking of the Chinese Survey ship Yuan Wang 5 in Colombo in August last year despite New Delhi’s objections obviously dampened India’s enthusiasm significantly. Even otherwise, it is unfair to expect India to match Chinese funds. At the same time, we need more investments than India can provide,” he argued.
At the moment, he said, it was the US that was trying to push China into a corner over this IMF loan, and hopefully disrupt the country’s economy and the Belt and and Road Initiative by making other defaulting borrowers demand major concessions.
According to him, despite the current bickering, the IMF loan would eventually come through in March but Sri Lanka still has a long rough ahead. “But we’ve seen and dealt with far worse, and I am confident that eventually we will emerge stronger, richer, and hopefully wiser.”
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