DEBTOHOLIC: IS CHINA RESPONSIBLE FOR SRI LANKA’S DEBT CRISIS?

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China isn’t used to recipients of its assistance later questioning the terms of the offering. Following a government change in 2015, when China’s role in Sri Lanka’s infrastructure development, the utility of projects it funded, its costs and terms were questioned, the government in Beijing pushed back with cold disdain.

However, a decade or so earlier, Sri Lanka’s relationship with China grew cozier following the roll out of the Belt and Road Initiative (BRI), a global infrastructure building scheme that sought to better link China with the rest of the world. In Sri Lanka, a port in Hambantota funded by a Chinese loan and launched in 2010 was the poster child of China’s BRI ambitions and its excesses. However, without supporting infrastructure, and lacking a business plan but costing over a billion dollars, the port failed to attract business and required hundreds of millions more in investments to become viable.

Costing 6.3% a year in interest, the phase one loan for the Hambantota Port was costly during a time when rates were declining due to global financial crisis-related monetary easing. That $307 million loan wasn’t adequate to complete the first phase, because in its haste, the port was opened without clearing a giant boulder at its entrance channel, and its subsequent clearing resulted in the first stage cost rising to $361 million.

Sri Lanka’s political leadership after 2015 describing Chinese largesse, like the Hambantota Port and an airport nearby, as white elephants appeared to irk, but Beijing didn’t launch into confrontational tirades. Its uncharacteristic patience held even when criticism suggested that China had lured Sri Lanka into a debt trap, which had compromised its management of finances and its sovereignty.

The potential of Sri Lanka’s position in the middle of the eastwest trading route, which China wants to draw closer to its orbit, and not wanting enemies along its Belt and Road countries may have been reason for its cautious reaction.

Loans funding the Hambantota Port and the international airport close by were at commercial terms. These two projects lacking feasibility, as few shipping lines or airlines were interested in calling or flying there, wasn’t China’s responsibility. However, these challenges were compounded by the borrowing’s commercial terms.

When the port being offered for sale to anyone elicited no interest, China drew a hard bargain, due possibly to its viewing suggestions of a debt trap and its undermining Sri Lanka’s sovereignty as lacking merit. Of Sri Lanka’s outstanding foreign debt by the central government, around 9% is owed to China, according to the Institute of Policy Studies (IPS), a think tank.

Foreign debt makes up about 60% of Sri Lanka’s total debt, according to IPS. That includes Rupee treasury holdings by foreigners, which is fairly volatile. IPS’s Dushni Weerakoon says that, of the 60% of foreign debt, 36% is to the central government, 3% is held by the Central Bank and 20% by state-owned enterprises.

Weerakoon and Verité Research, a private sector think tank, are behind two recent analyses of Chinese loans.

Verité suggests that Chinese loans to state-owned enterprises account for about 6.2% of total foreign borrowings, and loans to the central government were equivalent to 8.4% of foreign debt in 2017, bringing the total share of Chinese loans to around 15% for foreign loans. Foreign debt is held by state-owned businesses such as utility companies for electricity and water, SriLankan Airlines, banks and the Sri Lanka Ports Authority.

Verité’s estimate of 8.4% of Chinese debt to IPS’s estimate of 9%, to the central government, roughly corresponds. Verité’s Executive Director Nishan De Mel says that, as at 2017, Sri Lanka’s central government debt outstanding to the World Bank, ADB and Japan were comparable in size to those it owed to China (see Chart 1).

Although China may not be the problem, Sri Lanka does suffer from a debt addiction. Sri Lanka took barely a decade since 2007 to issue $15.3 billion worth of International Sovereign Bonds (ISBs) or dollar bonds to investors hungry for yield. Murkier syndicated loans have been piled on top of this. A debt crisis is now real.

With international sovereign bonds, Sri Lanka borrows at over 6%, and on average, these loans are for seven years, according to De Mel. He told a seminar that, from a Sri Lankan perspective, there are significant and simple financial advantages to borrowing from China at 2% and having a rated average period of 19 years to complete repayment, rather than borrowing from international financial markets at over 6% and having only 7 years to recycle it. This high cost is the first lesson about international bond markets.

By 2017, debt owed to international financial markets were 33% of total debt outstanding and 54% of foreign debt.

The SLFP-led government that was in office until 2015 piled on dollar bonds. However, there isn’t any infrastructure or assets to show for these loans. Whatever its faults, Sri Lanka at least had a port to lease back to China for its borrowing. Other concessional Chinese loans have funded power plants, expressways and railway infrastructure.

The 2015 SLFP loss at the polls resulted more than anything due to nepotism and the stench of corruption. However, the scepter of chumminess also gave the creeps to the electorate and to regional powers who worried about China toppling the South Asian geopolitical balance.

A second lesson about international bond market creditors is that they don’t have any regard for how a country spends its borrowings. For years now, it’s been apparent that Sri Lanka was hurtling towards a debt crisis. With an IMF standby loan, it tried to apply the brakes, but much of the damage had been done in the decade preceding 2015. Nothing can keep Sri Lanka away from its addiction now. A spike in interest rates over the last few years should have provided discipline. However, most of Sri Lanka’s outstanding sovereign bonds are maturing in the next three years. In 2019, it must repay $5.9 billion in maturing debt.

A conservative analysis by Verité Research, which assumes that Sri Lanka pays an average interest rate of 4% and 9%, respectively, on its foreign currency and Rupee borrowings, fi nds that 48% of the debt raised after 2015 would be required to just pay interest on the debt taken between 2005 and 2014.

In addition to paying interest, Sri Lanka must repay capital on maturing loans and borrow some for building infrastructure and other expenses. Verité’s De Mel says that it’s clear that the Mahinda Rajapaksa government that left offi ce in 2015 borrowed too much. But, that’s not the real issue. “It’s also clear that we are paying too much for our debt.”

BY 2017, DEBT OWED TO INTERNATIONAL FINANCIAL MARKETS WERE 33% OF TOTAL DEBT OUTSTANDING AND 54% OF FOREIGN DEBT

He adds, “Neither in quantity nor in cost can China be considered the biggest problem.”

However, it isn’t that Chinese bilateral lending is perfect. Responsible bilateral lenders like the Japanese government, and multilateral ones like the World Bank and ADB demand prudent economic reforms as a condition for help. Th ey don’t want to be caught out with increasing a country’s indebtedness without creating economic advancement.

China puts much less emphasis on good governance and sensible reforms. Governments may also find that money with no strings attached is easier and faster to borrow. Easy money feeds an addiction. It also diminishes the clout of responsible lenders. De Mel highlights academic studies that show how the costs of building roads and railways in Sri Lanka have escalated at an alarming rate. Chinese-funded roads are more expensive than those funded by the Japanese government and ADB.

Clearly, bilateral funding (like Chinese loans) is escalating the cost of new infrastructure, a huge disadvantage to the people. Normally, multilateral institutions create checks and balances to mitigate that problem. We must take that problem seriously, says De Mel. “Just because the debt is cheap, it does not become feasible if the initial capital cost has been unreasonably high.”

Th e Chinese government shields behind the rubric that Sri Lanka is a democracy. By that, it ignores that its loans, which is easy money even for a poorly governed country, cause terrible consequences for people who have to repay these.

“That can’t be a free pass. China must take some responsibility as other countries and multilateral institutions have.”