The rule of the Rajapaksas ends again
It was quite remarkable: in the 21st century, no Asian country had defaulted on its sovereign debt. So far.
Over the past few months, Sri Lanka, a small island nation off India’s southern coast straddling the region’s crucial waterways, has been embroiled in economic and political crisis. It reached a crescendo in July, when street protests forced the resignation and hasty departure of President Gotabaya Rajapaksa.
The crisis was born out of many problems. Among them highlighted by Akhil Bery from the Asia Society Policy Institute are: spiraling debt; protectionist trade policies; spiraling fiscal and trade deficits; unhealthy vanity infrastructure projects; nepotism and corruption; lower tax revenues; galloping inflation; commodity price spikes; and a crippling blow to vital income from tourism and remittances from COVID-19.
These daunting problems were compounded by a disastrous decision taken by President Rajapaksa last April when, “without warning and without any attempt to teach farmers how to cope with change, [he] announced a ban on all synthetic fertilizers and pesticides. Rice production and tea exports fell. Food prices have soared. The government was forced to reverse its decision months later, emptying government coffers to compensate affected farmers.
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The perfect storm started hitting the Sri Lankan economy earlier this year. In March, Sri Lanka’s sovereign debt was downgraded to a “waste” evaluation. In April, Colombo suspended external debt payments. Amid supply shortages, power cuts and runaway inflation, Sri Lankans have taken to the streets. Several government ministers, including some named after Rajapaksa, have resigned.
In May, Sri Lanka defaulted on its foreign debt and Prime Minister Mahinda Rajapaksa, brother of Gotabaya and former president of the country, resigned. Gotabaya continued as president for two more months before abruptly departing the country on a military plane, announcing his resignation afterwards.
After winning a special election in parliament, the moderate former prime minister (six times) Ranil Wickremesing will, for the time being, be president. He inherits a difficult situation. Year-on-year inflation is nearly 60%. The country no longer has hard currencies and the World Bank will not offer new financing to Sri Lanka until Colombo implements adequate macroeconomic policy reforms. Wickremesinghe has placed his hopes in the IMF: in a few weeks, he intends to file a debt restructuring and a funding plan to secure the billions of dollars Sri Lanka needs to stay afloat.
The crisis has refocused attention on China’s growing role in Sri Lanka. During Mahinda Rajapaksa’s reign as President (2005-2015), China made headlines with several splashes, controversial, multi-billion dollar investments in Sri Lanka, including the $1.5 billion port and airport in the remote district of Hambantota, the ancestral home of the Rajapaksas. Both operate at a loss. The $200 million airport was double “The emptiest international airport in the world.”
Unable to repay Chinese loans, in 2017 Sri Lanka leased the port to Chinese state entities for 99 years. The case was suspicious. The Sri Lankan government later forced the deletion of the sovereignty-infringing provisions from the agreement. The Sri Lankan government is also responsible for the $1.5 billion funded by China Port City of Colombo project, a significant portion of which is also on a 99-year lease to Chinese state-owned entities.
Is the Chinese “debt trap” responsible for the current crisis in Sri Lanka? Yes and no. China has certainly made Sri Lanka’s economic woes worse through irresponsible lending. But he is not solely responsible. International sovereign bonds purchased on the open market are the main source of Sri Lanka’s external debt. Mismanagement by the Sri Lankan government is largely to blame, as are the pandemic and inflationary pressures largely beyond its control.
Yet China is far from blameless. First, many of the concerns expressed about China’s growing footprint in Sri Lanka go beyond macro-economic misconduct. He has been accused of fueling corruption and nepotism, illegally funneling money to pro-China politicians, bolstering the anti-democratic instincts of the Rajapaksa and inserting sovereignty-violating provisions into agreements of a billion dollars traded in secret.
Second, China is Sri Lanka’s largest bilateral creditor, and it has lent the country billions of dollars for vain projects that other bilateral and international lenders had rejected for a reason. It is also consuming an ever larger share of Sri Lanka’s debt profile. Most reports suggest that China accounts for around 11% of Sri Lanka’s external debt, but new estimates approximate the figure to 20-26% taking into account Chinese commercial loans to the Sri Lankan government and state-owned enterprises.
IMF insists Colombo must talk to china on restructuring its debt, but so far Beijing is playing hardball. Faced with its own economic and pandemic-related problems at home, China has been reluctant to bail out its drowning partners in the developing world. This spring, Beijing turned down a request from Sri Lanka for a $2.5 billion credit support facility and canceled Sri Lanka’s access to a $1.5 billion swap line.
India has stepped up its efforts, providing Sri Lanka with over $4 billion in economic aid this year, including currency swaps and credit lines. India has watched China’s growing footprint in Sri Lanka with concern.
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Like his brother Mahinda, President Gotabaya Rajapaksa looked to China early in his term, taking billions of dollars in new Chinese loans in 2020 to pay off old Chinese loans. In 2021, the president discarded an existing agreement to offer Indian and Japanese firms a development contract for the East Container Terminal at the Port of Colombo, awarding the deal to a Chinese firm instead.
The pendulum may be swinging back in India’s direction. Last March, India and Sri Lanka signed an agreement to create a Maritime Rescue Coordination Center in Colombo, with a second site in Hambantota. President Wickremesinghe will likely be keen to strike a more delicate balance, strengthening cooperation with the United States and the West while allaying Indian security concerns over China’s rising profile on the island.
This month, news emerged that a Chineseinvestigation and spy ship was on his way to Hambantota. The government of Wickremesinghe insisted that the visit had beenerasedby President Gotabaya Rajapaksa a day before he fled the country and the Chinese ship was only coming to refuel. The Indian government nevertheless expressed its displeasure, hinting that it was monitoring the situation and would protect its security and economic interests. Sri Lanka then asked China toreportthe visit, prompting a protest from Beijing. In a second about-face, Colombo then re-approvedthe port makes a stopover for the Chinese ship, and the showdown continues.
Over the past 15 years, Sri Lanka has arguably been South Asia’s hottest battleground state, a microcosm of a broader regional struggle for influence and access underway between China and India. Moving forward, New Delhi and Washington should work together, and in partnership with international lenders, to provide Sri Lanka with the debt relief it needs to avoid a catastrophic disintegration of its economy. At the same time, they must encourage the Sri Lankan government to undertake the difficult reforms necessary to put the country on a sustainable path as a sovereign, democratic and economically vibrant member of the Indo-Pacific community.