Why China has assisted Sri Lanka over debt worth $4.2 billion?

What’s in today’s article?

• Why in News?
• Why does Sri Lanka Need Assistance with its Foreign Debt?
• How has Sri Lanka Planned to Tide Over its Economic Crisis?
• What are the Concerns over Sri Lanka’s Debt Negotiations?
• What are the Implications of the Recent Sri Lanka-China Deal?

Why in News?

• More than a year after Sri Lanka plunged into an economic crisis, it has reached an agreement with the Export-Import (EXIM) Bank of China to cover about $4.2 billion of its outstanding debt.
• The indicative terms agreed will provide the necessary fiscal space for Sri Lanka to implement its ambitious reform agenda.

Why does Sri Lanka Need Assistance with its Foreign Debt?

• In (April) 2022, Sri Lanka declared that it had failed to repay its debt of more than $83 billion, with more than half of it owed to foreign creditors. It also decided to approach the International Monetary Fund (IMF).
• The crisis was years in the making and many factors were responsible, such as the -
  • President Gotabaya Rajapaksa’s government pushed through the largest tax cuts in Sri Lankan history, as part of the 2019 elections campaign, impacting the government’s revenue sources.
  • Another blow was dealt by the coronavirus pandemic, which hit the tourism industry. The war in Ukraine further contributed to fuel shortages.
  • Skyrocketing inflation saw many Sri Lankans take to the streets to protest against the government and the then-President Rajapaksa resigned.

How has Sri Lanka Planned to Tide Over its Economic Crisis?

• To increase revenues and signal better governance, it will be important for Sri Lanka to strengthen tax administration, remove tax exemptions and actively eliminate tax evasion.
• In the interim, the then President had sought help from China and India, particularly assistance on fuel from the latter.
• A diesel shipment under a $500 million credit line was signed with India. Later, a $1 billion credit line for importing essentials, including food and medicine was also extended.
• In (September 2022), Sri Lanka qualified for an IMF Extended Fund Facility of $2.9 billion. Its first tranche of $330 million came through in (March) 2023.
  • However, the debt owed to other countries had to be managed through negotiations (called debt restructuring), for the IMF to extend its loan to Sri Lanka.
  • Generally, debt restructuring can lead to reduced loan interest rates or an extension of its repayment date.

What are the Concerns over Sri Lanka’s Debt Negotiations?

• A debt restructuring agreement between Sri Lanka and countries such as Japan, India, and France were expected (in September 2023) but did not materialise.
• Through the Paris Group, which includes countries like Japan and South Korea, there was an attempt from countries to bring China and India on board and negotiate as a whole - to make sure no nation gets preferential terms.
• Of the total bilateral debt Sri Lanka owes to foreign governments, China’s share is the greatest, followed by Japan and India.
• But China has largely gone for bilateral negotiations in the past, with confidential terms.
• India has had two major concerns about joining a common platform that does not have China:
  • It leaves China to enter into its own custom-made bilateral agreement;
  • The Sri Lankan side has indicated that this year's emergency aid from India totalling $4 billion should be included in the restructuring, which New Delhi does not agree with.

What are the Implications of the Recent Sri Lanka-China Deal?

• The agreement with China’s EXIM Bank will assist Sri Lanka in getting past the first review of the IMF programme in the coming weeks and in securing the release of the 2nd IMF tranche of about $334 million.
• For India, China’s assistance to Sri Lanka will be seen as another means through which it is investing in deepening its ties with the island nation.
  • In recent years, Sri Lanka also joined the Chinese infrastructure financing project, the Belt and Road Initiative (BRI), which India opposes.
  • As part of it, China funded the development of Hambantota port in southern Sri Lanka, which falls on the crucial trade routes between Southeast Asia, Africa and West Asia.
  • It was taken over in 2017 after Sri Lanka failed to pay for its costs. This has been termed ‘debt-trap diplomacy’ by many, as a means for China to assert itself and acquire overseas assets through its increased economic heft.
• India has concerns that China’s increasing presence in its immediate neighbourhood could further embolden Chinese military presence, also potentially allowing them to conduct surveillance in the region.

Q.1) What is the IMF's Extended Fund Facility?

The Extended Fund Facility provides financial assistance to countries facing serious medium-term balance of payments problems because of structural weaknesses that require time to address.

Q.2) What do you mean by ‘debt-trap diplomacy’?

Debt-trap diplomacy entails providing projects/loans with too challenging terms for borrowing states to pay back, ultimately forcing them to accept economic or political concessions.

Source: Why China has assisted Sri Lanka over debt worth $4.2 billion