The real cause of SL’s grim debt crisis

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Sri Lanka’s debt crisis, which led to political upheaval and change of Government, is the result of debt accumulation, domestic policy dysfunction and external shocks.

Sri Lanka has long relied on external borrowing to bail itself out of financial crisis. It has entered into 15 loan agreements with the International Monetary Fund in 52 years, with the ratio of its external debt to gross national income being above 50 per cent for years.

Sri Lanka is a country with not only very high debts, but also a very fragile debt structure. Short-term debt and private creditors, which are highly vulnerable to capital flight and interest rate volatility, account for 45 per cent of its total external debt, while official creditors, which have low financing costs, long maturity periods and more stable financial flows, account for only 36 per cent.

Besides, the Covid-19 pandemic and the Russia-Ukraine conflict have had a huge impact on Sri Lanka’s revenue, for they reduced, almost dried up, the flow of tourists to the country, while affecting its tea exports, especially to Russia. That the tourism industry accounted for about 13 per cent of Sri Lanka’s GDP and tea was a very big foreign exchange earner before the pandemic, shows the importance of these industries. In 2020, for example, the number of tourists visiting Sri Lanka was only about 20 per cent of that, in 2018.

Wrong macroeconomic policies too, accelerated Sri Lanka’s economic collapse. After coming to power in 2019, former President Gotabaya Rajapaksa implemented three major policies: tax cuts, printing more currency notes and introducing green agriculture.

While the tax cuts widened the fiscal deficit, with the fiscal revenue to GDP ratio falling from 12.6 per cent to 9.1 per cent in 2019-20, the Government overissued currency notes to fill the funding gap, triggering hyperinflation. As for the green agriculture policy which took effect in 2021, it not only drastically increased farming costs but also halved production, creating an unprecedented food crisis.

As such, Sri Lanka is mired in a debt crisis, economic crisis, and food crisis. To overcome the economic crisis, Sri Lanka must first adopt prudent monetary and fiscal policies, and address the food shortage problem at the domestic level, and to resolve the debt crisis, it should cooperate with the international community.

In 2021, the share of sovereign bondholders in Sri Lanka’s external debt was as high as 47 per cent, with China accounting for 10 per cent, the Asian Development Bank 13 per cent, Japan 10 per cent, the World Bank 9 per cent, and India 2 per cent. Therefore, contrary to some Western politicians’ claim, China is not the largest creditor of Sri Lanka and Sri Lanka’s debt crisis cannot be resolved by China alone, waiving its debt.

Over the years, China has been contributing to Sri Lanka’s economic construction and helping improve its people’s livelihoods. The infrastructure projects China has promoted and built overseas have not only reduced construction costs, but also are suitable to the respective geographical and climate conditions of the host country, and therefore, meet the realistic needs of developing countries.

Moreover, China’s overseas infrastructure projects are accompanied by long-term capital. Accordingly, China’s stable and preferential funds for Sri Lanka’s infrastructure projects were based on the policy of long-term infrastructure investment, high investments, and long payback period, which have helped the country overcome many a financial woe and continue on the road to development.

Although China’s funding for Sri Lanka’s infrastructure projects has increased the latter’s liabilities, it has increased its public assets too, while improving interconnectivity within the country and with the outside world, thereby reducing transportation costs and making the logistics sector more efficient.

China has always pursued an independent foreign policy and follows the Five Principles of Peaceful Co-existence, including non-interference in other country’s internal affairs.

Also, China helped finalise the G20 debt moratorium initiative for least-developed countries in 2020 and the common framework for follow-up after the G20 member States launched a debt service suspension initiative in early 2020, to offer debt referrals to 73 of the world’s poorest countries. In fact, China has suspended the highest number of debt repayments among all G20 members.

The year 2022, marks the 65th anniversary of the establishment of diplomatic relations between Sri Lanka and China. The two sides have always had close and friendly relations, and promoted the spirit of ‘independence and self-reliance, solidarity and mutual assistance’.

Since the Sri Lankan crises broke out, China has sent emergency humanitarian aid worth 500 million yuan
(USD 72.10 million) to Sri Lanka, including medicines, fuel, rice and other urgent necessities, to help the country cope with the crises. And China sincerely hopes Sri Lanka, under the new Government, emerges from the crises, revives its economy and restores peace, stability and prosperity in the country.

The author is Deputy Chief of Staff of the National Institute for Global Strategy.

By Sun Jingying