Sri Lanka’s financial crisis was brought to light when the Sri Lankan government declared a national economic emergency on August 30, 2021, following a sharp fall in the country’s currency, which resulted in a jump in food costs. In addition, Sri Lanka has been struggling with twin deficits, meaning fiscal and trade deficits, indicating structural economic imbalances in recent years. Sri Lanka’s foreign debt has increased steadily since 2014 (30 percent of GDP), reaching 41.3 percent of GDP in 2019, and this, in turn, has put a severe load on the country’s debt service.
Given the country’s unfavorable economic and budgetary conditions, credit rating agencies such as Standard & Poor’s, Moody’s and Fitch have lowered the country’s long-term sovereign ratings to CCC+/C from B-/B in 2020. Due to this downgrade, the government became ineligible for funding through international sovereign bonds. Furthermore, Standard & Poor’s recently downgraded Sri Lanka to ‘CCC’ from ‘CCC+. Further, the country’s low growth rate has acted as a fuel in this crisis as it stands at the rate of 4 percent.
The country’s foreign reserves are also depleting significantly faster and stand around $1.6 billion, barely enough for a few weeks of imports. It also has foreign debt obligations exceeding $7 billion in 2022, including repayment of bonds worth $500 million in January and $1 billion in July 2022. Households are experiencing significant shortages as a result of the crisis. There are long queues to purchase essentials such as milk powder, cooking gas, and kerosene. According to the Central Bank, prices have risen dramatically, with the inflation rate rising to 12.1 percent at the end of December from 9.9 percent in November 2021. During the same time frame, food inflation soared to almost 22 percent. Expatriate remittances have also decreased due to the government’s mandated foreign currency conversion and exchange rate regulations. Since the island country is cash-strapped, it is becoming difficult not only for importers to clear cargo containing essential items, but manufacturers are also unable to acquire fresh raw materials. Furthermore, the effect of the COVID-19 crisis, the loss of tourists, high government expenditure and tax cuts depleting state revenues, and the use of money for initiatives with minimal returns have all contributed to Sri Lanka’s economic meltdown.
Sri Lanka is commonly described as a country that has fallen into debt due to public investment projects sponsored by China as part of its Belt and Road Initiative, a long-term effort to fund and construct infrastructure linking China to the rest of the world. After disbursing billions of dollars in soft loans, China has become Sri Lanka’s fourth-largest lender. International financial markets, the Asian Development Bank, and Japan are Sri Lanka’s three major lenders. However, its infrastructure development projects have sparked a lot of debate. The Rajapaksa government’s endeavor to draw too close to Beijing has resulted in decisions where the principal benefactor has been China; as a result, Sri Lankan interests have been harmed. Some critics attribute the decline in foreign reserves in part to infrastructure projects financed with Chinese loans that are not profitable. Furthermore, China is present in Sri Lanka for its own benefit rather than Colombo’s.
The Hambantota port is a prime example. Developed with significant Chinese funding, the port had no commercial viability, but China persuaded Sri Lanka to proceed with the project. As the port struggled to gain momentum, Beijing wanted it as collateral, compelling the Sri Lankan government to hand over management to a Chinese corporation on a 99-year lease in 2017. Despite this, the Sri Lankan government has further awarded the contract to the state-owned China Harbour Engineering Company to build Colombo’s eastern cargo terminal. Beijing now owns 88 hectares of Colombo Port City on a 99-year lease.
Several nations, particularly the United States, its allies, and India, have vehemently criticized these projects as part of the debt trap that frequently follows Chinese investments throughout the world. China uses its checkbook diplomacy to lure underprivileged nations such as those in Africa and South Asia. It then loads them with large loans, forcing the recipient country to slip into an economic trap. As can be seen from the above, Sri Lanka successfully fell into this trap when it had to sacrifice the Hambantota port.
Another massive development project financed by Chinese funds is Sri Lanka’s second international airport, Mattala International Airport, known as the “World’s Emptiest Airport.” However, Mattala Airport, like many other developments, has fallen short of expectations.
Additionally, Sri Lanka owes China more than $5 billion in debt and received an additional loan of $1 billion from Beijing last year to help it recover from its catastrophic financial crisis, which is being paid back in installments. As per the Ceylon government data of April 2021, China accounts for 10 percent of its USD 35 billion foreign debt. Other estimates suggest that China’s overall lending might be significantly higher when loans to state-owned firms and the central bank are factored in.
The next issue is the decreasing number of tourists in Sri Lanka. The pandemic, which began in Wuhan, China, has significantly impacted tourism. The tourism industry, which typically contributes about 10.4 percent of the island nation’s GDP, was severely affected by the pandemic, with a cascading effect. According to the World Travel and Tourism Council, more than 200,000 individuals have lost their employment in the travel and tourism industries since the pandemic began. Before the pandemic, China was one of Sri Lanka’s most significant sources of tourism. Recently, the Sri Lankan President urged China to allow its citizens to tour Sri Lanka, but this is unlikely to happen because COVID-19 is still reeling over there, and China is quite concerned.
Another critical issue is Sri Lanka’s reliance on China, as evidenced by the fact that it imports more goods from China than any other country globally. In Sri Lanka, Chinese infrastructure has depended primarily on imported capital goods and intermediate products from China. The Southern Expressway, for example, was developed using large imported Chinese road-building equipment and materials, demonstrating that there is a shortage of the capital goods sector in Sri Lanka. Since 2006, China’s imports of capital goods and intermediate products have gone up, pointing to an increase in Chinese infrastructure expenditure. Before the launch of the BRI, Sri Lanka’s capital imports from China accounted for around 17 percent of total capital goods imports in 2006-12, rising to 27 percent in 2013-17. Meanwhile, over the same time, Sri Lanka’s intermediate goods imports from China increased from 58 percent to 62 percent of total intermediate goods imports. The spike in imports intended for Chinese infrastructure projects in Sri Lanka, combined with a tiny base of Sri Lankan exports to China, results in an expanding trade deficit between the two nations.
Recently, Sri Lankan President Gotabaya Rajapaksa asked China to restructure the island nation’s massive debt to Beijing. He conveyed his proposal to the visiting Chinese Foreign Minister Wang Yi, who met with the President in his office in Colombo on January 9, 2022. Later, Mr. Wang Yi stated that Sri Lanka would receive a grant of 800 million yuan ($ 125 million). The money will be channeled through the China International Development Cooperation Agency, which will be sent through an economic and technical cooperation agency. However, such funds can only give short-term assistance because this island country’s financial problems are deep-rooted and have been worsened by its close relationship with China.
Sri Lanka is attempting to engage in infrastructure projects that are useless, time-consuming, and costly. It has spent a lot of money and borrowed a lot of money during the last few years, but it has not produced anything. Sri Lanka has to rethink seriously to save its economy from the debt-trap policy of the dragon. First and foremost, President Rajapaksa must reconsider his policies to offer security to his own country by seeking the assistance of neighboring countries such as India, which can work as a balancing wheel against China.