Sri Lanka Crisis: Time to Revisit China’s Debt-Trap Diplomacy

Earlier this month, Mahinda Rajapaksa was forced to resign as the Prime Minister of Sri Lanka amidst violent protests over his government’s handling of an unprecedented crisis that has brought the economy of the debt-laden island nation to its knees. He was replaced by 73-year-old veteran politician Ranil Wickremesinghe, brought in for his sixth term as the PM. Last week, Sri Lanka became the first country in the Asia-Pacific to default on its debt for the first time in the 21st century, according to credit rating agency Moody’s.¹ The economic crisis has rendered the country incapable of paying for its essential imports, leading to fuel shortages, debilitating power cuts and soaring food prices, forcing infuriated civilians to come out on the streets in hoards to protest. Even though the root cause of this crisis lies in the government’s mismanagement and faulty policies, including deep tax cuts implemented before the Covid-19 pandemic, a growing chorus of voices has attributed it to China-backed projects and investments. 

China’s investment and aid in Sri Lanka

China is one of the biggest lenders to Sri Lanka, alongside Japan and the Asian Development Bank. It accounts for at least 10% of its total $51 billion external debt; however, the number is pegged to be much higher if the loans to state-owned firms and the central bank are also included. Most of these loans are to finance ambitious infrastructural projects, of which the major ones are in the Rajapaksa family’s native regions. The Hambantota port, for instance, has come to be the hallmark of unsustainable infrastructural projects that successive governments kept on bank-rolling. Located in the southern district, the deep seaport was built on $1.4 billion in loans but soon ran into troubled waters as it failed to make money as soon as it became operational. It lost $300 million in six years and was handed over to a Chinese state firm on a lease for 99 years. The then Sri Lankan government faced brickbats for giving China a strategic foothold in the Indian Ocean, making its neighbourhood giant India raise its head in concern for the first time. Other projects that have served the Rajapaksa clan, which has been accused of bias toward China, include a conference centre that cost over $15 million but has been lying largely unused and the Rajapaksa Airport, which cost $200 million but has barely been able to ring up its electricity bill.² Adding to this list of ill-thought-out projects is Colomba Port City, an artificial island of 665 acres that is projected to become a financial hub along the lines of Dubai and Singapore. The Rajapaksa government took a loan of $1.4 billion from a Chinese investor who has a 43% stake in this project on a 99-year lease. There are already sounding alarms that this project will also run into trouble and put the country further into debt.

To understand the depth of China’s financial engagement in Sri Lanka today, it is essential to trace it back to the early 2010s when the island nation was still reeling from the aftermath of the end of the three-decade-long civil war. The then Rajapaksa government was in its second term when China loaned over $5 billion in infrastructural projects. It put in another $1.4 billion as part of Xi Jinping’s flagship Belt and Road Initiative (BRI) projects. With funding spread across over one-third of over 300 loan-funded projects in the bankrupt South Asian nation, China slowly edged out Japan and India as its leading lender. What sets apart Chinese loans from others is the much higher interest rate. According to a report by Colombo-based think tank Verite Research, the average rate on Chinese loans was 3.3% compared to the 0.7% for Japanese loans. 

Further, the maturity period for Chinese debt was an average of 18 years as compared to 34 years for Japanese debt and 24 years for Indian debt. China’s deep pockets were also subsequently sought by pro-Western governments, and the impact of the pandemic caused by coronavirus tipped the scale further in favour of Beijing. In early 2020, the island nation accepted a $1 billion bailout from Beijing. Countries who opt for Chinese investment do so for different reasons, including but not limited to easy accessibility, fewer demands and interferences in their domestic affairs, and the inability of other lenders to come forward.

Debt-Trap Argument

However, China hawkers in India and the West have often accused China of using its investment and aid to secure strategic assets of the borrower country in what is called ‘debt-trap diplomacy’. The term has come to imply that China traps economically vulnerable countries by offering attractive yet unsustainable loans. In cases where the countries are unable to repay their debts, it takes hold of their strategic assets. It has been accused of specifically targeting economically vulnerable countries with a bad credit rating or no rating at all and lading them with unsustainable and expensive infrastructure projects. The Hambantota port project discussed above is a prime example of this. When Sri Lanka failed to make its debt payment in 2017, China converted the loans to equity and acquired 70% ownership in the port on a 99-year lease. Sri Lanka, Myanmar and Pakistan are the debt-laden nations in South Asia that have responded favourably to Chinese investment, while Bangladesh which recently recorded impressive economic growth, continues to remain vary. 

While this argument holds strength, it is equally important to highlight that the crisis in countries like Sri Lanka and Pakistan is mainly owing to their economic mismanagement and ill-thought-out policies. A recent study for Carnegie by Katharine Adeney and Filippo Boni on the China-Pakistan Economic Corridor (CPEC) revealed the many instances where domestic considerations of the borrower country were a factor in the planning and strategizing of the infrastructure projects.³ While China was aiming at economically viable locations, the ruling party in Pakistan decided on sites keeping in mind its electoral strongholds and targets. Further, the projects are often politicized (as has also been seen in the cases of Sri Lanka and the Maldives) and subject to cumbersome bureaucratic red-tape. Therefore, to say that the infrastructural investments made by China are intended to run into losses to trap strategic assets of the borrower country is a stretch. The considerations of the borrower country are also a huge factor that plays into the sustainability and economic viability of such projects. 

Sri Lanka’s economic crisis comes at a ripe time for Chinese hawkers to gage Beijing’s true intentions and priorities with its investments and aid. How China acts hereon with Colombo in its crisis will help better understand the arguments on debt-trap diplomacy and, indeed, caution those nations in South Asia who have been waiting with bated breath on Chinese financing.

References

1. Financial Times, May 20,2022, ‘Sri Lanka defaults on debt for first time as economic crisis deepens.’ 
2. The Hindu, May 11, 2022, ‘China infra projects in focus as crisis worsens in Sri Lanka.’
3. Katherine Adeney and Filippo Boni, May 24, 2021 ‘How China and Pakistan Negotiate.’