China has a Hand in Sri Lanka’s Economic Calamity

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The beleaguered island nation of Sri Lanka enters a new phase of its rolling crisis Wednesday as the country’s Parliament selects its next president. The panicked departures and resignations of President Gotabaya Rajapaksa and Prime Minister Mahinda Rajapaksa, two brothers who loomed large over the country’s politics for more than a decade, came amid an astonishing economic collapse that precipitated mass protests. Now, the victor of the secret ballot vote in Parliament will preside over a shaky unity government that will pave the way for fresh elections.

But whoever emerges has a miserably difficult job on their hands, including charting a path forward with negotiators from the International Monetary Fund. Sri Lanka is bankrupt; it is unable to pay for imports of essential goods, including food, medicine and fuel, in part because it is unable to service existing debts given its essentially empty coffers of foreign currency. Spiking inflation has a vast swath of the country’s 22 million people in need of food assistance. Schools and many businesses remain shut, while ordinary citizens wait days in mile-long lines for gas.

To the rest of the world, Sri Lanka has become a cautionary tale of misgovernment and misfortune. The profligacy of the Rajapaksa brothers, along with a misguided plan to convert the nation’s farming industry into a solely organic enterprise, collided with a set of factors out of the country’s control. Those included the sweeping impact of the pandemic, which crashed the vital tourism sector, and then the Russian invasion of Ukraine, which disrupted global supply chains and accelerated the inflationary spiral that dragged Sri Lanka’s economy into the abyss.

International experts warn that other debt-ridden countries — from Laos in Southeast Asia to Kenya in East Africa — are teetering toward a similar fate. “Countries with high debt levels and limited policy space will face additional strains. Look no further than Sri Lanka as a warning sign,” International Monetary Fund (IMF) Managing Director Kristalina Georgieva said during meetings of the Group of 20 finance ministers this weekend.

One of the major players in Sri Lanka’s calamity is China. Beijing is Sri Lanka’s lone biggest creditor, accounting for some 10 percent of the country’s foreign debt. Between 2000 and 2020, it extended close to $12 billion in loans to the Sri Lankan government, largely for a slate of major infrastructure projects that turned into white elephants — including a costly port facility in the Rajapaksas’ hometown of Hambantota, which was effectively ceded to Chinese control half a decade ago after Sri Lankan authorities recognized they could no longer pay off the loans.

After spending vast sums becoming the de facto creditor of much of the developing world, however, Chinese state banks have in recent years become more interested in debt collecting. A slowing economy at home has curbed Beijing’s appetites for risk abroad.

But Sri Lanka walked into what Beijing critics have dubbed China’s “debt trap” diplomacy. In 2020, it received a line of $3 billion in easy credit from China to help in the repayment of its existing debts. Sri Lanka opted for this path rather than taking the more painful steps of restructuring its debts in dialogue with the IMF and pushing through austerity measures to appease the Paris Club, the grouping of 22 rich nations that are the world’s major creditors. (China is not a member, a reflection of its own geopolitical ambitions and distaste for rules set by other powers.)

That appears to have been a mistake. “Instead of making use of the limited reserves we had and restructuring the debt in advance, we continued to make debt payments until we ran out of all of our reserves,” said Ali Sabry, Sri Lanka’s caretaker finance minister from April to May. “If you had been realistic, we should have gone [to the IMF] at least 12 months before we did.”

Chinese loans loom large in other debt-ravaged countries, too. China accounts for some 30 percent of Zambia’s external debt. Billions of dollars in Chinese funding for a hydropower facility and rail infrastructure are now edging Laos toward defaulting on its debt.

Chinese officials and state commentators resent Western criticism of their methods, arguing that it smacks of a kind of colonial paternalism.

“It is simply another typical case reviewing the sour-grapes mentality of the U.S.-led Western world, unwilling to see any beneficial co-operation between China and others, and they know clearly that they have lost advantages in pursuing such kinds of collaboration,” declared the state-controlled Global Times in reaction to criticism of China’s role in Laos last year.

In Sri Lanka’s case, China is hardly the only creditor. India and Japan, among other nations, account for a considerable portion of Sri Lankan debt and are also enmeshed in complicated talks over further repayment and aid. But China’s engagement with the country has been more conspicuous and problematic.