Sri Lankan Debt Crisis and the Role of China’s Diplomacy

An Overview of Sri Lanka’s Economy

Sri Lanka’s civil war began in 1983, and ended in 2009 – marking a period of around 3 decades, and taking around 1,00,000 lives. The island nation suffered greatly in this brutal war caused by the conflicts and tensions arising between the Sinhalese and Tamil citizens.

The economic growth and expansion accelerated in Sri Lanka post the civil war, and hence a surge could be witnessed in the investments in this economy. Although all the investments were made in infrastructure, they were in the form of debt. The investment in infrastructure was majorly done to build airports, seaports, and power plants. There is no denying the fact that all developing nations undertake investments through external debt, but the country particularly faced a lot of strain due to it. The primary reason for this strain was the inability to repay the debts and making defaults. The investments did not reap out the desired result, and this led to default on their loans. Along with defaults, the current government is grappling with an external debt of almost $65 billion.

The economic parameters of the economy do not depict a good picture. In last decade, interest payments, external debt, and current account deficit have ballooned up. Trade deficit has also increased to a greater extent owing to the fact that while the economy has increased the rate of imports, it is not able to keep up with the exports. The export composition reveals that the economy majorly depends on agricultural commodities and labor intensive textile industries for its exports. Due to the competitive nature of this sector, the island nation’s economy is not able to expand. Since the exports and trade form a vital source for the foreign exchange revenue, it is important for any economy to make a position in the international market.

GDP Slump in the Economy

Presently, economic growth has been paralyzed due to political and constitutional crisis. Current and fiscal deficit has already made the economy quite vulnerable to external shocks, and hence the growth rate of the 3rd quarter has seen a drastic low of 2.9%.

Various important sectors have contributed to the growth of the economy. The agricultural sector has contributed favorably by 3.3%, compared to 3% in the 3rd quarter of last year. The contribution of the services sector has also increased from 2.8% to 3.9%. The involvement of the industrial sector saw a decline from 5.3% to 1.9%, thus marking a drastic contraction in the economy, highlighting the low competency of the sector.

Growth has suffered majorly due to a combination of tight monetary policy, along with fiscal consolidation. Also, the agricultural sector suffered a double whammy of drought and floods, affecting industrial production through backward and forward linkage effects.

The figure below depicts the growth rates in different Asian economies and highlights the low rate of growth for Sri Lanka in 2018. India stands at second position after Bangladesh, at a growth rate of 7.3% amid the reforms of GST and demonetization, whereas Sri Lanka is at second lowest after Afghanistan.

Source: Asian Development Bank, Outlook 2018 update

China: An Ally or Enemy of Sri Lanka?

Mahinda Rajapaksa was elected as the President of Sri Lanka in 2005, and he served for a few years during and post war. Throughout his tenure, the country was heavily dependent on China for its economic support, and expansion. It was during his presidency, that a call for a second major airport, i.e. Hambantota port was made. Many government researches did depict that the economic viability of this port was not much, and the existing port in the capital had a lot of scope of improvement. The government required massive funds for this port, for which they contacted India, as well as China. It was seen that after Sri Lanka accepted the proposal of China Harbor (a Chinese company) as the port builder, China was onboard for providing funds. As a result,  the first loan sanctioned was of $307 billion from Import Export Bank of China. This is typical of Chinese officials, who tend to provide loans, and ask for returns and premiums, along with hiring of Chinese companies and workers. This starkly illustrates that China and the other companies under its control try to ensure a stake in countries looking for finances.

Hambantota port is one of the most unproductive ports in the world, and due to its poor performance, all the investments failed to garner returns. More than 90% of the Sri Lankan government revenue went towards servicing of the external debt. Since the economy failed to repay this debt, it handed over 70 percent of the ownership of the port to a company named China Merchants Group, on a 99 year lease in return for loan amount of USD 1.1 billion. Local citizens have a feeling that the company is being sold to the Chinese.

The government was re-elected in 2015, and the new government is facing a debt crisis due to the actions of its predecessor, which included the building of different ports. These investments were done without conducting a proper cost benefit analysis, and as a result, those investments failed to reap any benefits for the economy.

Sri Lanka has to repay $5.9 million of external debt this year. Amid this crisis, the government is still planning to take a loan of $1 billion from China to construct a highway linking Colombo to Kandy.

Impact on Indian Economy

The Indian government had offered to help Maldives, which had fallen a prey to Chinese debt trap, following Pakistan and Sri Lanka. China may acquire many other assets like Hambantota port through the debt trap system. It may run a railway line in Kenya, or a failed port in Sri Lanka in the near future, and India may have to face serious security implications due to the widening presence of China in India’s periphery.

Author’s Take

Looking at the current economic parameters of Sri Lanka it is an urgent need for the island nation economy to modify its policies in order to face the current debt crisis.

Sources: Wall Street Journal, South China Morning Post, Quartz, Economic Times, Observer Research Foundation, Sunday Times (Sri Lanka)

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