Why did Sri Lanka ask China to restructure debt repayments?

Sri Lanka has been facing a deepening economic crisis, exposing the country to the threat of bankruptcy. 

With high inflation causing an unprecedented food price hike, the country has now pleaded before China, asking Chinese Foreign Minister Wang Yi to consider restructuring the debt repayments and help them sail through the ongoing economic crisis. 

"The president pointed out that it would be a great relief to the country if attention could be paid to restructuring the debt repayments as a solution to the economic crisis that has arisen in the face of the Covid-19 pandemic," Sri Lanka’s President Gotabaya Rajapaksa's office said after he met Wang Yi in Colombo on Sunday. 

As the fourth-biggest lender of Sri Lanka, China has given billions of dollars in loans to the small island nation. 

So, how did Sri Lanka come to the verge of bankruptcy?

The pandemic has battered Sri Lanka's tourism economy, which was one of the main drivers of the country's national income. 

In 2019, the contribution of tourism to Gross Domestic Product (GDP) for the country was 12.6 percent, which was six percent in 2000.

Along with the devastating pandemic effect on tourism, high government expenditures, loss of revenues due to tax cuts, and vast debt payments are the main factors of the economy's meltdown.

Amidst the looming economic crisis, foreign exchange reserves declined to their lowest levels in a decade.

On the other hand, high inflation forces the government to print more money to pay domestic loans; however, this situation creates a vicious circle for the country’s economy.

According to the World Bank estimation, nearly half a million people have fallen below the poverty line since the pandemic, which caused a loss of jobs for many people.

Consumer prices in the South Asian country jumped 12.1 percent year-on-year in December 2021, which made the essential goods unaffordable for many of those who were previously well-off, struggling to feed their families.

On the other hand, Sri Lanka's food prices rose by a record 22.1 percent in December.

The census and statistics department said food inflation hit an all-time high last month on a year-on-year basis since the Colombo Consumer Price Index (CCPI) was launched in 2013.

The price increased in December compared to 17.5 percent in November, the previous record, the department said. 

"I am confident that the new year will provide an opportunity to further the steps taken by the government to pursue and overcome challenges and strengthen the people-centric economy," the president said.

He gave the power to ensure the essential foods, like rice and sugar, were sold at specific prices set by the government.

Foreign debts

International rating agency Fitch downgraded Sri Lanka’s long-term Foreign-Currency Issuer Default Rating (IDR) last month to “CC”.

Mounting fears of sovereign default on its $26 billion foreign debt was the main reason for Fitch’s decision.

Last month, the central bank said that its foreign currency reserves had almost doubled to $3.1 billion from $1.6 billion last month, a level that was only sufficient to pay for a month’s imports.

However, the government drew down a $1.5 billion Chinese loan and claimed reserves had nearly doubled.

"We have high debt from three countries — China, Japan and India. The total outstanding for this year would be USD 6.9 billion," FM Rajapaksa, the younger brother of President Rajapaksa and Prime Minister Mahinda Rajapaksa, said.

Debt repayment to China in 2022 is likely to be smaller than its International Sovereign Bond (ISB) commitments of $1.54 billion, at about $400 million- $500 million.

The Chinese share of the debt is more than $5 billion, which makes China so crucial for the Sri Lanka economy.

Before the pandemic, China was Sri Lanka's primary source of tourists, and the island imports more goods from China than any other country.

Sri Lanka is a crucial part of China's Belt and Road Initiative (BRI), a long-term plan to fund and build infrastructure linking China to the rest of the world. Still, others, including the United States, have labelled it a "debt trap" for smaller nations.

In December 2017, Sri Lanka handed control of the newly built port of Hambantota to a Chinese operator to satisfy part of its significant debt to Chinese lenders. 

Sri Lanka’s Hambantota port is being leased out to China, mainly due to the persistent balance of payment crises which resulted from the reduction of trade over the years. However, many Western and Chinese sources have been conflicted on whether it is a part of China’s “debt trap strategy” or not.