Sri Lanka is a blessed land cursed by political volatility, unbridled greed of political leaders and of course, deep-rooted scars of ethnic violence and terrorism.
As a nation, Sri Lanka has been experiencing macroeconomic instability and economic stagnation. It has also been suffering from a twin deficit problem—in the balance of payment and foreign exchange reserves—due to years of economic mismanagement and corruption in government.
An ORF report highlighted that successive governments’ populist economic policy decisions tied with populist electoral policies and favouring reciprocal relationships between the bureaucracies and the wealthiest, led to an unhealthy balance between government revenue collection and gross domestic product (GDP). A combination of tax exemptions and reduced tax collection granted to wealthy people, multinational corporations, and local businesses resulted in a steady decline in tax revenues beginning in the 1990s.[As of 2021, the tax revenue amounted to only 9.6 per cent of GDP, against expenditure close to 20 per cent of GDP. Poor revenue performance resulted in a decline in the government’s expenditure-to-GDP ratio and called for deficit financing.
Sri Lanka cannot hide from the fact that it is facing its worst economic crisis in over seven decades. In April 2022, Sri Lanka declared its inability to repay its debt of over USD 83 billion, with more than half owed to foreign creditors.
Adding to the strain during this period of economic crisis has been the Sri Lankan government policy of large-tax cuts in 2019, a business slump in the tourism industry due to the coronavirus pandemic in 2020 and fuel shortages due to the Russia-Ukraine war in 2022, which still continues.
Sri Lanka initiated negotiations with bondholders and key bilateral creditors, including China, Japan, and India, to meet IMF conditions. Sri Lanka received a USD 2.9 billion IMF Extended Fund Facility but it reportedly had to secure financing assurances for debt sustainability from its creditors through debt restructuring. Sri Lanka has even asked its foreign investors for a 30 per cent reduction in outstanding debt and hopes to reduce its overall debt by USD 16.9 billion.
China employed its devious ‘Debt Trap Diplomacy’ to gain a strategic edge over Sri Lanka. But more than that the main driver of Sri Lanka’s debt problem is the increase in the dollar-denominated international sovereign bonds (ISBs) or Eurobonds borrowed from the international capital market.
China has a simple model, it won’t admit it but it certainly is a debt trap. China extends loans or projects to nations with terms that are too hard to repay and then it pressurises them to make political or economic concessions. China’s aim was to get its own political leverage over Sri Lanka. Reportedly, China is funding infrastructure projects in strategically positioned developing nations through its USD 1 trillion Belt and Road Initiative (BRI) frequently by providing those countries’ governments with sizable loans. As a result, nations are falling into a debt trap that makes them susceptible to China’s sway. As part of its BRI objective, China has made enormous investments in Sri Lanka for the extensive infrastructure programme which intended to construct ports, roads, railroads, and pipelines throughout Asia, Europe, and Africa.
China loaned Sri Lanka USD 1.26 billion to finance the Hambantota Port from 2007 to 2014. China firm China Merchants Ports Holdings took over the management of the port under a 99-year lease for USD 1.12 billion since the debts for Sri Lanka were mounting. Sri Lanka used China’s money to strengthen its foreign reserves. China invested about USD 12 billion in Sri Lanka’s infrastructure projects between 2006-2019.
China has extended its firm support to this Island nation through debt treatment. By end-2020, Sri Lanka owed EXIM China Bank USD 2.83 billion, or nearly 9 per cent of external central government debt, according to IMF data.
Sri Lanka has a total foreign debt of USD 46.9 Billion, 52 per cent of which is owed to China, its largest lender. Reaching a deal with all of its creditors will allow Sri Lanka to keep accessing funds from a USD 3 Billion bailout programme with the International Monetary Fund (IMF). The next tranche – worth USD 330 Million – has been on hold since last month after Sri Lanka and the IMF failed to agree on the terms for its disbursement.
China and India have historically competed for influence over Sri Lanka, which sits on an important sea lane connecting East Asia with the Middle East and Africa.
Sri Lanka is now like a limping lion put on a leash by the Chinese dragon while it hopes that the Indian tiger sets it free from its bondage. But, China’s hegemony in Sri Lanka creates a number of issues for India. Over 30 per cent of India’s container cargo passes via Colombo Port, thus an interruption there could hurt India’s international trade. A firm owned by the Chinese government, China Merchant Port Holdings, owns 85 per cent of the Colombo extension. India’s position as Sri Lanka’s top importer has been replaced by China.
India gave Sri Lanka around USD 3.8 billion in 2022 in the form of loans, currency swaps, food and fuel help. India has been committed to strengthening the bilateral relationship between both countries not only as a response to China’s rising influence in Sri Lanka but as a reassurance of its historical relationship.
The US will provide USD 553 million in financing for a port terminal in Sri Lanka’s capital Colombo being developed by Gautam Adani, as the Indian Tiger and the US Eagle look to curtail the Dragon’s influence over the limping Sri Lankan Lion who borrowed heavily to splurge on Chinese port and highway projects before plugging into its economic meltdown last year.
The crouching tiger and the hidden dragon have intensified their battle over the debt trapped lion’s jungle. While the lion prefers to endear to the tiger, it has been put on a leash by the dragon and only time will tell whether the tiger will help the lion to unshackle itself from the snares of the dragon.