Sunday Times 2
Unprecedented economic crisis: Is China the problem or part of the solution?
View(s):By Prof. H.M.W. Ariyaratna Herath and Luxman Siriwardena
Sri Lanka’s External debt issue, which often leads to serious balance of payment (BOP) and budgetary constraints, is more than its massive borrowings from various external sources. The root causes of the continuing crisis are found in structural weaknesses such as the contraction of export income, low-tax revenue, lack of foreign direct investments (FDI), and diversified export destinations, products, and sectors. Failure to provide comprehensive, consistent, sustainable solutions to address such weaknesses has resulted in the country running into serious BOP and fiscal crises.
Meanwhile, some analysts say the causes of Sri Lanka’s economic crisis are many. China is criticised for being at least partially responsible for Sri Lanka’s ballooning external debt and for its predatory behaviour, as has been seen in the 99-year lease of the Hambantota Port. Many Western media called the Hambantota Port a “debt trap” set by China. However, the real picture of the affiliation with China in terms of external debt is not monstrous as the widespread criticism. Sri Lanka owes only 10% of its external debt to China. Of this amount, only US$1 billion has to be settled during this year.
The major lending source is market borrowings, which constitute 47% of the total borrowings. The second largest lender is the Asian Development Bank which accounts for 13% of the total external debt.
Commercial Loans or Market Borrowings
Since 2014, external debt levels have been on the increase. In 2019, external debts amounted to 42.6% of GDP. This was a result of Sri Lanka’s low economic growth and the issuance of International Sovereign Bonds (ISBs). Unlike concessionary loans, ISBs, which come under the category of commercial borrowings, have a short payback period, high-interest rates, and are without grace periods. ISBs have a payback period of 5-10 years with an annual interest rate above 6% to be paid biannually. Also, the total borrowed amount of an ISB should be settled at the maturity date.
With exports falling from roughly 33% of the GDP in 2000 to 13% in 2019, forex earnings have become stagnant. On the other hand, FDI inflows remain low and successive governments failed to reach annual FDI targets. Sri Lanka’s external reserves ran dry due to this, and successive governments issued more ISBs.
The scarcity of foreign currency reserves in Sri Lanka led to a BOP crisis in 2015, when the government obtained support from the IMF through an Extended Fund Facility of $1.5 billion. In such critical junctures, Sri Lanka has recourse to a few temporary fixes for its external debt crisis. One way is to issue ISBs and roll over external loans. This is costly but has no conditions. Another option is to seek IMF assistance or bail-out packages to increase the foreign currency reserves and thereby avoiding a BOP crisis. Sri Lanka has also sought financial assistance from China, largely through Foreign Currency Term Facilities. Moreover, Sri Lanka has used currency swap facilities, largely from India and also from Bangladesh.
Problems surfaced in 2021 due to the pandemic
Sri Lanka’s external debt situation in 2021 was particularly worrying due to a few factors. The stance of the then government was that it did not intend to recourse to IMF. IMF support was key but temporary with regard to the BOP crises encountered in 2009 and 2015. Another concern is the extreme difficulty for Sri Lanka to raise money through international capital markets though this was a method preferred for settling ISB maturities until 2015. With Sri Lanka’s low sovereign credit ratings and the ongoing Covid 19 pandemic, issuing ISBs did not seem an easy option for the Sri Lankan government.
During the recent past (2020-2021), the government’s strategies to manage the external debt problem have focused on import restrictions, export promotion, currency swaps, and funds from IMF. In 2020, imports were reduced by about $3.9 billion (a 20% reduction in comparison to 2019) resulting in a roughly $2 billion drop in the trade deficit. This gave the government temporary breathing room to manage external debt repayments in 2020. Nevertheless, the reduction of foreign currency outflows to purchase fuel, largely influenced by the low oil prices in the international market and restricted travel due to lockdowns, was the largest factor in the decline of the trade deficit. In 2020, fuel imports were reduced by $1.35 billion, accounting for more than 60% of the downward trend in the trade deficit. The strategy of managing external debt through restricting imports is not a sustainable solution for a country like Sri Lanka when more than half of imports are intermediary and capital goods. The continuous restriction of imports will restrain economic growth and Sri Lanka can afford this under any circumstance.
Sri Lanka has secured swap facilities from India, China and Bangladesh. It is clear that these debt troubles cannot be solved using short-term fixes. The only sustainable solution lies in addressing the structural weaknesses of the economy, expanding the export sector, and continuous attraction of foreign direct investments. As Sri Lanka will have ISBs reaching maturity every year up to 2030, the country will have to spend a significant amount of foreign currency earnings to honour these obligations. That certainly is not going to be a walk in the park.
Debt restructuring issue and the role of China
There are many misinterpretations and fake news being generated in western and Indian media about the Chinese loans and financial assistance to Sri Lanka. But be in no doubt that all kinds of debts could become a form of trap provided the receiving country fails to manage the economy right and is unable to repay in time. In the battle of the debt traps, be aware that our choice here is whether a western debt trap or a China debt trap or an Indian debt trap. For instance, many western media and a few local media outlets also called the Hambantota Port a “debt trap” of China. This is a gross falsification without proper analysis of the transaction between the two countries. The funding received from the Chinese lessee of the port was not used to repay the loans from China, but was used to repay other more expensive facilities obtained from western lenders. Therefore, there are not many facts or any acceptable justifications behind the so-called “debt trap” allegations.
As mentioned earlier, Sri Lanka’s external debt to China is 10% of the total. As of 2021, a staggering 81% of Sri Lanka’s foreign debt was owned by the US, European financial institutions, and Western allies such as Japan and India. No matter where our borrowings have come from, any debt that becomes overdue pushes the country into a bad situation at the end of the day. Most importantly, the major lending source of Sri Lanka is the market borrowings: 47% out of the total borrowings. ISBs raised during 2007-2019 are crucial in this connection. The top holders of the Sri Lankan government’s foreign debt in the form of ISBs are BlackRock (USA), Ashmore Group (Britain), Allianz (Germany), UBS (Switzerland), HSBC (Britain), JPMorgan Chase (USA), and Prudent (USA). Also, it is well known that the Asian Development Bank and the World Bank which is mainly dominated by the US, own 13% and 9% of Sri Lanka’s foreign debt, respectively. The media, the west-funded institutions, and many Sri Lankan analysts reporting on Sri Lanka’s forex crisis, however, ignore these facts and give a deeply misleading impression that Beijing is responsible for a large part of the chaos.
Given this critical situation, what the IMF is suggesting is to immediately start negotiations with the lenders towards restructuring the debt. In this case, the west and India appear to be keener about the Chinese bilateral debt to Sri Lanka rather than its commercial lending and the sources thereof. If this results in rescheduling repayment without a haircut we can probably achieve that ourselves, by speaking to the lenders directly.
The IMF is not the only solution to the issues Sri Lanka is facing. The root causes are macroeconomic mismanagement over several decades and the insufficient growth of the export sector. Though the IMF can provide us with short-term relief, it will not fix our long-term problem. Since Sri Lanka has a history of struggling with western debt burdens, having gone through 16 economic stabilisation programmes with the IMF, do our leaders hope to go back on the same pilgrimage which results in aggravating the debt crisis?
Is China the problem or part of the solution?
China has achieved sustainable economic growth and eliminated absolute poverty. China is the world’s second-largest economy. It is also the largest export destination for almost all the major economies in the world. More importantly for Sri Lanka, China is the world’s largest exporter of investment capital. During the past two decades, Chinese enterprises have become the largest global direct investor in the history of mankind.
Sri Lanka’s immediate requirement is to increase export earnings, attract FDIs and increase tourist arrivals. In this context strengthening China-Sri Lanka economic, cultural and people-to-people relations is a sine qua non for Sri Lanka’s development. Of course, if any other country or group of countries provides us with similar assurances in export market investments and tourist arrivals, we should proactively and warmly welcome them.
(Prof Herath is attached to the Department of Economics and Statistics, University of Peradeniya. Mr. Siriwardena is the Managing Director of Veemansa Initiatives, Colombo)