brand logo

Debt trap: Made in China or made in Sri Lanka?

25 Oct 2020

Should our worry be a repeat of Hambantota Port or repaying our sovereign bonds?

A 222 km-long expressway connecting Colombo and the South, a state-of-the-art theatre called Nelum Pokuna in the heart of Colombo with a seating capacity of over 1,200, a largely dysfunctional Norochcholai Power Plant, the iconic but yet to be fully operational Lotus Tower, an international airport once globally recognised as the “world’s emptiest airport”, and a port in Hambantota which has been leased to the financier of the project; these are among the most prominent symbols of China’s financial influence on Sri Lanka over the past 15 years.  In spite of the fact that the majority of Sri Lanka’s external debt is in the form of International Sovereign Bonds (ISBs), Sri Lanka is often globally portrayed as an example of China’s controversial “debt-trap diplomacy”, particularly after the leasing of the Hambantota Port. Whenever Sri Lanka turns towards China for a loan, almost always, the answer from the lender has been a hearty “yes!”, even when its other Asian neighbours have turned down credit requests. In this context, The Sunday Morning Business decided to take a look at China’s loans to Sri Lanka, the diplomatic strategies attached to these loans, whether we should worry about China’s “unwavering” support, and whether we are in danger of seeing another Hambantota Port scenario.  

Game of Loans  

The Government headed by current Prime Minister Mahinda Rajapaksa aligned himself with China early on, and strengthened this relationship after China came forward to support Sri Lanka in ending its decades-long civil war and rebuilding the nation’s infrastructure in the post-war period.  Since then, every single time, the Sri Lankan Government turns towards China for financial assistance; the Government successfully secured the money, be it in the Rajapaksa Government or the Maithripala Sirisena Government. Geopolitical and economic analysts have attributed this willingness of China to its tendency to lend easy, addictive money as opposed to western nations and multilateral lenders which attach stringent conditions to their assistance. In the past 15 years alone, the country has borrowed over $ 34 billion from various international financial organisations and countries, and 33% of these total loans were obtained from China followed by the Asian Development Bank (ADB), Japan, the World Bank (WB), and India.  Sri Lanka’s debt can be put into three categories, namely multilateral, bilateral, and financial markets. The share of the multilateral loans in Sri Lanka’s entire external debt portfolio is 23%, bilateral loans are 17.7%, while loans from financial markets make up the bulk of it with 59.4%, according to a study done by Advocata Institute, an independent policy think tank in Colombo.  In terms of bilateral debt, loans obtained from Japan constitute 9.7% of the total bilateral loans while loans from India are 2.4% and loans from China are 2.2%. These figures suggest that China is a negligible part of not just our entire external debt portfolio, but our bilateral lenders. However, the Export-Import Bank of China (EXIM Bank), which is owned by the Chinese Government, contributes about 7.4% of Sri Lanka’s debt. In a tightly state-controlled nation such as China, borrowing from a government entity is as good as borrowing from the Chinese Government, and with this included, China’s entire stake in Sri Lanka’s international debt portfolio climbs to 9.6%. Therefore, Sri Lanka’s external debt as of end June 2020 was Rs. 6.55 trillion and China’s share in the total debt was around 9% at the end of last year according to the Central Bank of Sri Lanka (CBSL) data. Nevertheless, a report compiled by the International Monetary Fund (IMF) stated that as of November 2019, China contributed to about 15% of Sri Lanka’s total external debt.  While the largest share of Sri Lanka’s debt is in financial market loans, constituting 59.4% of all debt, the lion’s share of these market loans are in dollar-denominated ISBs, amounting to 42.7%. Therefore, Sri Lanka has colossal sums of ISB debt payments coming up annually for the next 10 years. Even though the borrowing procedure in terms of Chinese loans is quite easy, according to Verite Research, Chinese loans have the highest interest rate with an average rate of 3.3% per annum compared to other lending  nations such as Japan and India.  In terms of the maturity period, loans from China again prove to be unfavourable with an average maturity period of about 18 years while WB loans and loans from India have maturity periods of 24 years, ADB loans have 25 years, and loans from Japan have 34 years, the highest maturity period of a lender country. In fact, several countries have been studying Sri Lanka to avoid becoming the Sri Lanka of China.   

Debt-trap diplomacy

  Debt-trap diplomacy is when the lending country intentionally extends excessive credit to the borrowing country, inducing the borrower into a debt trap. The intention is to extract either political or economic concessions from the borrowing country when the country is unable to service the debt.  Even the term “debt-trap diplomacy” has been around and applied to many lending practices of various countries; in recent years it has been increasingly associated with China. The term was in fact coined initially to describe China’s lending practices. Under the Belt and Road Initiative (BRI), China’s loans to developing countries grew considerably. It invested billions of dollars including in Sri Lanka, Malaysia, and even in South Africa.    

Walking into a trap?

  It would not be incorrect to say that the Hambantota Port is the most notorious example of debt-trap diplomacy by China in Asia. The Sri Lankan Government built the port despite a government-appointed task force rejecting a feasibility study on the project. A few years later, a debt-ridden Sri Lankan Government ended up leasing a controlling stake to China due the country’s inability in paying back the loan. Today, Sri Lanka has neither the port nor the relief from the loans it borrowed from China. The port in Hambantota, known as the Magampura Mahinda Rajapaksa Port, was built utilising Chinese financial assistance to the tune of $ 1.5 billion. This particular credit facility is the main reason for Sri Lanka’s recognition as a victim of China’s debt trap. The Government felt the need to develop the infrastructure of the country, particularly in the South, and building a port was part of the plan. Initially, the Sri Lankan Government turned towards India, its closest neighbour, for financial assistance. However, as India turned down the request, Sri Lanka reached out to China, by whom the request was happily accepted.  According to Centre for Strategic and International Studies (CSIS) Reconnecting Asia Project Director Jonathan Hillman, constructing a port at Hambantota has been part of Sri Lanka’s official development plans since at least 2002.  In 2003, SNC Lavalin, a French engineering firm, completed a feasibility study for the port. A Sri Lankan government-appointed task force reviewed and ultimately rejected the study, faulting it for ignoring the port’s potential impact on the Colombo Port, which in recent years has handled roughly 95% of Sri Lanka’s international trade.  “Hambantota’s port did not appear overnight, but resulted from a series of Sri Lankan government decisions. Many Chinese-funded projects in Sri Lanka have been unsolicited, but Hambantota’s port is not one of them,” he stated in a publication on this topic.  The construction work of the port with the loan from China began in 2008 and it was opened for operations in November 2010, identifying itself as the second largest port in Sri Lanka. However, it wasn’t fruitful for the Government as the port made an operating profit of just $ 1.8 million in 2016, even after six years of operation. This made Sri Lanka’s debt repayments to China extremely difficult to fulfil. As such, in July 2017, then Prime Minister Ranil Wickremasinghe signed a 99-year lease agreement with China Merchant Port Holdings for $ 1.12 billion. It is notable that this amount is lower than the sum obtained from China for the construction of the port. In the end, Sri Lanka had neither the port nor the relief from the $ 1.5 billion loan it borrowed from China for this purpose.   

Another Hambantota? 

  China cannot singlehandedly pull Sri Lanka out of its large pile of debt. In the case of Sri Lanka falling into a state where it cannot service its debt in time, requesting a moratorium for the loans it took from China or China restructuring Sri Lanka’s debt may not help as Sri Lanka’s exposure to loans from China is in single-digit levels (according to CBSL statistics) while over 40% of the external debt is in the form of ISBs. Which means the country would still have to find a way to repay its ISBs. With the state our economy is in at the moment, that is a daunting challenge.  


More News..