An In-Depth Look at Sri Lanka’s Debt Crisis: No ‘Chinese Debt Pitfalls’

A view of the Colombo Port City construction site in Colombo, Sri Lanka Photo: Xinhua

The global inflationary crisis in 2021 and more dramatically in 2022 triggered a default by Sri Lanka on the payment of $78 million of foreign bonds due in April 2022. On May 18, the Central Bank of Sri Lanka said that the country was in preventive default. Political turmoil ensued as the government failed to provide fuel and imported food, prices rose dramatically while the government’s ability to provide foreign currency to support continued imports dried up.

The West and components of Indian mainstream media, think tanks and research centers, and even many government officials have made the Sri Lankan port of Hambantota a world-famous name and the prime example of “diplomacy of the China’s debt trap”, although this has been fully proven. be a fake story. As our own research and expert interviews will show here, the whole story of China being the source of Sri Lanka’s debt is bogus through and through.

Who owns Sri Lanka’s foreign debt? Two key facts are overlooked when Western media report on Sri Lanka’s external debt: the composition of the debt, and the real causes of the debt. Exactly as in the case of Pakistan, China’s share of Sri Lanka’s external public debt is only 10%. Western financial institutions, including private credit markets, and their ally Japan hold the lion’s share of the debt.

According to the Sri Lankan Department of Foreign Resources, the percentage composition of Sri Lanka’s external debt as of April 2021 was as follows:

International capital market borrowings 47%, Asian Development Bank 13%, China 10%, Japan 10%, World Bank 9%, India 2% and other 9%.

Thus, a simple look at the facts usually ignored or masked shows that China is not what it is portrayed. The real culprits, as this article shows, come from the same Western countries, in which the “China debt trap” narrative was concocted.

First, borrowing from international capital markets: After a devastating civil war that ended in 2009, the government resorted to expensive borrowing from international bond markets for the reconstruction process. These sovereign loans, coming mostly from Western financial investors such as the American BlackRock and the British Ashmore, constitute the largest part of the country’s external debt (47%). It was the rush to repay part of this debt, which matured in 2017, which prompted the Sri Lankan government to offer the port of Hambantota for lease. China accepted the offer in return for $790 million which was used to repay debt to international markets, not China.

The bond market is a brutal, profit-seeking force that has a secondary market where investors sell the sovereign debt of troubled countries to so-called “vulture funds” that buy the debt at a steep discount from investors to demand more full payment of the debtor nations later. Repayments must be made on time, otherwise the country will no longer be able to lend. Vulture funds sue sovereign debtors in UK and US courts where, under threat of seizing those nations’ overseas assets, the courts generally rule in favor of these vulture funds.

Second, the trade deficit: Sri Lanka relies heavily on imports of oil and gas and their refined products for transportation and power generation. In recent years, world prices have increased but in 2021-2022 have skyrocketed. These items, in addition to fertilizers, make up the bulk of the country’s imports. In 2020, total exports were $10 billion, while imports were $16 billion (deficit of $6 billion). In 2021, the deficit increased to $8 billion, with exports rising to $12 billion and imports to $20 billion. Consequently, the current account deficit widened considerably to reach 4% of GDP in 2021, compared to 1.5% of GDP recorded in 2020.

Third, the collapse of the tourism sector: According to the Tourism Authority of Sri Lanka, tourism revenue has been the main contributor to the services account surplus for many years. Incomes, in foreign currencies, and the level of employment were substantial until their collapse.

First, the Easter terrorist attack by suicide bombers in April 2019 was a major setback for the tourism sector. A second disaster struck with the outbreak of COVID-19 in 2020, which reduced the number of tourists visiting the country to a trickle.

A look at the numbers gives a clear picture. Foreign tourism revenue reached $3.9 billion in 2017, $4.4 billion in 2018, $3.6 billion in 2019, $682 million in 2020, and $507 million in 2021.

The government supported the industry by compensating for losses and avoiding social and political unrest. The price the government paid was that borrowing increased internally and externally. It is important to note that the tourism sector makes up a significant portion of Sri Lanka’s workforce of 8 million workers (the total population is 20 million).

Fourth, declining remittances: Over the past two decades, annual remittances from Sri Lankan nationals abroad have accounted for almost a quarter of total external current account credit, on average, and exceptionally, this share exceeded more than a third (35 percent) in 2020. Remittances increased from $7 billion in 2020 to $5 billion in 2021.

The government of Sri Lanka has been plagued by persistent budget deficits for decades, forcing it to continually borrow in domestic and foreign markets and, in doing so, accumulate public debt. As a result, a large portion of government revenue and foreign currency inflows into the country are needed to pay debt service, leaving little room for productive investment.

Increasing the productivity of the Sri Lankan economy is the key solution. But this requires large investments in infrastructure, industrialization and modernization of the agricultural sector. Finding alternatives to very expensive imports of petroleum products is another very important part of the solution for Sri Lanka.

China has no magic wand to change the conditions of nations. The reason China has succeeded in eradicating extreme poverty and building the most productive economy in the world is through hard work and massive investment in infrastructure and manpower through the education.

China’s role in Sri Lanka is seen as positive as it focuses on developing the productive aspects of the economy such as upgrading infrastructure. Contrary to the “debt trap” narrative, China is not Sri Lanka’s biggest creditor, but rather the biggest foreign direct investor in the country. China’s investments in Sri Lanka are long-term projects that gradually increase the productivity of the economy. But they are not a quick fix.

What the United States and Europe need, rather than pushing the completely debunked “debt trap” narrative against China, is to partner with China and the Belt Initiative. and the Road” to help rapidly increase Sri Lanka’s productive capacities through investment and long-term, low-interest credit for infrastructure projects, industries and modern agricultural production.

The author is vice president of the Belt and Road Institute in Sweden.

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