The Trap: China’s Debt Restructuring and Strategic Manipulation in Sri Lanka

China’s Belt and Road Initiative (BRI) isn’t quite as lucrative as often advertised. Ten projects found in six nations – Vanuatu, Indonesia, Myanmar, Tajikistan, Pakistan, and Hungary – could not generate sufficient revenue to justify the cost. Projects in Mongolia and Azerbaijan face the same problem, despite gross gains. It falls on these countries to pay the difference.

Several of the would-be BRI beneficiaries have found themselves forced to transfer resources to service their debt. Experts such as Nicholas Casey and Clifford Krauss explains the double-facet behind the BRI logic, and notes that ‘China gets to keep 80 percent of Ecuador’s most valuable export- oil- because many of the contracts are repaid in petroleum, not dollars’. In Zambia, where Chinese creditors hold a third of the national debt, China has taken over mining assets as collateral.

Sri Lanka’s Fall and the Trap

Sri Lanka was an even more dramatic case. As Elizabeth C. Economy described in her book The World According to China, “the country could not service its debt and instead granted China a 99-year lease on its Hambantota port.” It was a senseless decision. Sri Lanka’s political elites had only their political survival in mind; China saw, in this fragile and corrupt political culture, a historic opportunity. The newly elected prime minister, Dinesh Gunawardena, understands this as well as anyone. As foreign minister, he had warned that the 99-year Hambantota deal “can extend for a further period. Which means it can go on for any number of years after 99 years or for another 99 years.” Even today, as prime minister, he knows he could never revisit this agreement nor investigate any Chinese project for corruption, as his predecessor Ranil Wickremasinghe had tried to do in 2015.

At the Aspen Security Forum, CIA chief Bill Burns assesses, “Sri Lanka today is heavily indebted to China” having “made some really dumb bets about their economic future and… suffering pretty catastrophic, both economic and political, consequences as a result.”

“The Chinese have a lot of weight to throw around and they can make a very appealing case for their investments,” says Burns. He further views, “That, I think, ought to be an object lesson to a lot of other players – not just in the Middle East or South Asia, but around the world – about having your eyes wide open about those kinds of dealings.”

It’s a timely warning for many other nations in BRI with largely unsustainable borrowing and China as their major creditor. Field research in Sri Lanka in 2021 made it clear that China has effectively laid two traps in the country, the classic debt trap and a strategic trap. The now-disgraced president Gotabaya Rajapaksa, who fled public anger to the safety of Singapore, contributed to the latter trap, tilting the formerly balanced foreign policy of Sri Lanka towards China. The trap has three levels: a political party level with the Chinese Communist Party; a human rights stance dictated by China; and Chinese military assistance. All three dimensions have worsened significantly during Gotabaya Rajapaksa’s regime. Today, several other South Asian nations follow the same trajectory, with heavy borrowings and supporting China’s policies.

Ignoring the Early Warning

It should come as no surprise that Aid Data’s finding suggest that “the most corrupt governments among Chinese borrowers seem to leave office shortly after the onset of an IMF program.” Will the Chinese loans the underlying reason for the Rajapaksa regime’s end? After all, multiple IMF warnings had gone unheeded in government; the conditions of Chinese loans, and their link to kickback schemes that directly benefited Rajapaksa and the political elites in Sri Lanka.

Sri Lanka’s new president Ranil Wickremesinghe (appointed by lawmakers, not by the public) is now in an awkward spot. He cannot negotiate with the IMF without his opaque major creditor looming over him like a ghost, rattling its promissory notes like chains. After its default of $51 billion of international debt in May, Sri Lanka will need restructuring if it wants IMF funding.

Negotiations with China, however, have made no progress. China’s loans are opaque. According to Sri Lankan Central Bank figures, Chinese debt stands at 10 percent of the country’s $35.1 billion in external debt. But some economists argue that China’s share totaled 20 percent at the end of last year, between public and publicly guaranteed debt, commercial lending, and loans to Sri Lankan state-owned enterprises. Umesh Moramudali, a Sri Lankan researcher, says that “Sri Lanka’s [debt] to Chinese creditors comes to about 20 percent, not 10 percent. So, all the 20 percent will have to be restructured. That means you’ll have to look at how the China Development Bank and China’s Exim Bank will deal with restructuring.”

Behind the Figures and China

Speaking at the G20 finance officials meeting in Indonesia, US Treasury Secretary Janet Yellen said, “Sri Lanka is clearly unable to repay that debt, and it’s my hope that China will be willing to work with Sri Lanka to restructure the debt.” Zambia, Ethiopia, and Chad have applied for help on their debt too; but their efforts have stalled, “largely due to foot-dragging by China”; it was “quite frustrating” that China was not stepping up on the debt issues, explained Yellen. 

This push for G20 creditors (including China) to finalize debt restructurings is likely to prove the most important goal to stabilize nations like Sri Lanka and other developing countries facing debt distress. IMF Managing Director Kristalina Georgieva explained that “strong global leadership is also needed to tackle the scourge of high debt, which has reached multiyear highs.” More than 30 percent of emerging and developing countries are in or near debt distress; for low-income countries that number rises to 60 percent. With the tightening financial conditions and exchange rate depreciation, the debt service burden is a harsh, sometimes unbearable burden, says Georgieva. Sri Lanka’s high inflation rate is unbearable, not only for the low-income earners but also for the middle class. The lack of essential food and medicine, in an import-driven economy like Sri Lanka, means that people have no recourse at all but the kindness of strangers.

India, for one, has spent close to $4 billion on swaps and aid to stabilize its neighbour. China, on the other hand, has delayed. It has not offered any specific response, according to Palitha Kohonna, the Sri Lankan ambassador to China, except to offer a new loan to settle the existing debt. Sri Lanka has requested China for a loan of $1 billion to repay an equivalent amount of Chinese debt coming due this year; a $1.5 billion credit line to pay for Chinese imports; and activation of a $1.5 billion swap. This amounts to a total of $4 billion.

Sri Lanka’s creditors will want the IMF to treat all of Sri Lanka’s creditors on par, including China. This is no mere provincial squabble. Sri Lankan economists Anushka Wijesinha and Aquilah Latiff argue, ‘what Sri Lanka could feasibly expect and indeed push for is that China joins a multilateral creditor committee and supports a harmonized effort for debt restructuring talks’. Samantha Power, the Administrator of United States Agency for International Development (USAID), posited the “biggest question of all is whether Beijing will restructure debt to the same extent as other bilateral creditors”. Sri Lanka is just one among many other developing countries where, between 2000-2017, debt to China increased tenfold, from $500 billion to over $5 trillion.

If more nations like Sri Lanka default, China would have to inculcate this extra burden and re-evaluate its BRI strategy. The consequences of such a shift could redefine the future of BRI nations.