AsianInvester
Advertisement

Sri Lanka diversifies from China to India amid debt crisis

Some have accused Sri Lanka of falling into China’s “debt trap", but the South Asian nation refuses to put all of its eggs in China’s basket.
Sri Lanka diversifies from China to India amid debt crisis

A version of this article was first published on FinanceAsia.

Amid increasing geopolitical tension between China and India, Sri Lanka is turning to both Asian giants for financial assistance on the back of its recent sovereign downgrade by global credit rating agencies for its debt-ridden woes.

Sri Lanka’s friendly relations with China have generated unease for its Indian neighbour, which fought border skirmishes with China across 2020 and 2021. Last December for example, the Chinese government cancelled an energy project in Sri Lanka to be built by a Chinese company, Sino Solar Hybrid Technology, after India lodged a protest against this project, according to media reports.

“The Sri Lankan government wants to stay neutral between India and the US on one side, and China on the other,” Michael Hammond, a partner of Shard Capital, a UK financial services firm, told FinanceAsia.

Sri Lanka would benefit greatly from financial help from both countries.

On January 12, S&P Global Ratings downgraded its credit rating of Sri Lanka to CCC from CCC+, with a negative outlook. The rating indicates the country’s increasing financial vulnerability.

“Sri Lanka's external position continues to weaken owing to elevated external obligations and uneven access to financing,” S&P said.

“These developments indicate a rising probability of sovereign default scenarios playing out over the next 12 months in the absence of an unforeseen positive development,” the ratings agency warned.

The Sri Lankan government retaliated in protest to such harsh predictions, stating, “The Government of Sri Lanka (GOSL) is perturbed over today’s announcement…at a time when the GOSL has diligently lined up adequate funds to repay its maturing foreign debt liabilities and its repeated assurances over the strong commitment to oblige its debt service payments, including the International Sovereign Bond (ISB) maturing on 18 January 2022.”

Three weeks prior, Fitch Ratings downgraded Sri Lanka from CCC to CC, suggesting imminent default. A report by Fitch in the same month detailed apparent difficulty for the Sri Lankan government to meet its external debt obligations in 2022 and 2023 in the absence of new external financing sources. The country’s obligations include two international sovereign bonds of $500 million due January 18 and $1 billion due in July, it revealed.

The Sri Lankan government faces foreign-currency debt service payments, including principal and interest, amounting to $6.9 billion in 2022, equivalent to nearly 430% of its official gross international reserves as of November 2021, Fitch added.

Help

The Sri Lankan government has historically sought support from China and India with its financial troubles, and the current case is no different. After being accused by some of being too cosy with China, Sri Lanka is engaging India.

On January 13, the Indian High Commission in Colombo, Sri Lanka, tweeted that the Reserve Bank of India (RBI) had extended more than $900 million in credit facilities to Sri Lanka, in the past seven days.

The country has also offered funds elsewhere. India recently supplied trains for a service between Mount Lavinia and Kankesanthurai in Sri Lanka. Marked by a local ceremony on the island nation, the Indian High Commission offered to finance the project through a loan facility, one of several within India’s extensive Sri Lankan development portfolio, which exceeds $3.5 billion in capex, the Indian High Commission added.

While being friendly with India, Sri Lanka continues to maintain its warm ties with China. On January 9 Sri Lankan President Gotabaya Rajapaksa received Chinese Foreign Minister Wang Yi, recalling the nation’s historic close relationship between the two countries.

Conveying a sense of desperation, a release on the website of the Presidential Secretariat detailed, “It would be a great relief to the country if the attention could be paid on restructuring the debt repayments as a solution to the economic crisis that has arisen in the face of the Covid-19 pandemic.”

At a press conference at the Chinese Foreign Ministry on January 12, Sri Lankan central bank governor, Ajith Nivard Cabraal expressed hopes that his country might negotiate a new loan from China, to ease its debt obligations. In response, Chinese Foreign Ministry spokesman Wang Wenbin expressed, “China has always been doing its utmost to provide help for Sri Lanka’s economic and social development and will continue to do so in the future.”

Faint of heart?

But while Sri Lanka requested flexibility from China in terms of being able to renegotiate its outstanding loans, it should not expect too much, Matthew Mingey, a senior analyst of Rhodium Group, a US consultancy, warned, in conversation with FinanceAsia.

Based on prior debt discussions, Chinese banks are typically willing only to reschedule or defer payments, almost never taking haircuts, he shared.

While in previous years, Sri Lanka’s government perhaps could have been described as “drunk” with Chinese funds, the country realised that in order to move from a tourist-based economy, it would have to move away from China, said Andrew Wheeler, chief executive officer of Australian consulting firm, Asia Pacific Connex. Further, Sri Lanka is delicately re-engaging economically with India by allowing investment by Indian conglomerate Adani Group, into Colombo Port, he added.

On September 30, 2021, India’s Adani Group, as well as Sri Lankan firm, John Keells Holdings and the Sri Lanka Ports Authority (SLPA), signed an agreement to jointly develop the Colombo West International Container Terminal off Port of Colombo. The 35-year Build-Operate-Transfer (BOT) agreement, worth more than $700 million in development costs, marks the largest foreign investment ever in the country’s port sector, the SLPA noted.

In 2017, while in the throes of another debt crisis, a development at the Sri Lankan port in Hambantota sparked accusations of nefarious dealings and entangling ties with an alleged Chinese “debt-trap”, when a Chinese state-owned enterprise, China Merchant Port Holdings, secured its lease.

In fact, on October 4, 2018, US Vice President Michael Pence said in a speech at the Hudson Institute, a US think tank, “China uses so-called “debt diplomacy” to expand its influence… Just ask Sri Lanka, which took on massive debt to let Chinese state companies build a port of questionable commercial value.”

Pence was referring to China’s Belt and Road Initiative (BRI) – its overseas infrastructure mega-scheme, through which China aims to connect with other countries and take ownership and influence across nationally-critical projects such as railway and ports, through funding by state-owned banks and participation by Chinese developers.

But Mingey warned, “Whether looking at Sri Lanka specifically, or other countries, the idea that Chinese lenders deliberately seek to create debt distress and purposely extended unsustainable loans is not really credible.”

When Chinese investors took their stake in Hambantota Port around 2017, acute pressure simultaneously hit Sri Lanka’s economy, but this largely came from dollar bonds, not Chinese loans, Mingey pointed out.

In fact, Sri Lanka’s current crisis may seem somewhat similar, since the biggest source of debt pressure are dollar bond payments, he shared, adding, “But Sri Lanka’s current crisis is not totally of China’s making.”

This a more complex matter than a simple “debt-trap”, said Wheeler. “With China under-delivering on its BRI promises in terms of investment, community growth and upgrade, Sri Lanka appears to be taking a more balanced approach, particularly with regards to India.”

¬ Haymarket Media Limited. All rights reserved.
Advertisement