Lankan Economist Explains why Sri Lanka Goes in for Chinese Loans

COLOMBO: Sri Lanka is routinely criticized by the Western countries and the pro-West media that the country is foolishly going in for “massive” and “unproductive” Chinese loans and getting into a “debt trap” which will only impoverish it and bring it under China’s tutelage.

But the truth is that: (a) China is not the biggest lender and (2) If Sri Lanka is going for Chinese loans increasingly, it has good reasons to do so, points out Sri Lankan economist Umesh Moramudali in a detailed piece presented by the Consulting and Analysis Division of The Diplomat on October 23.

According to the External Resources Department of the Sri Lankan government, Sri Lanka’s external debt, as of 2019 end, was to: China -10%; Asian Development Bank-13%; Japan 10%; World Bank – 9%; India – 2%; International Market Borrowings-47%; and others- 9%.

In 2012, when the first sovereign bond maturity was due, Sri Lanka’s foreign debt stock amounted to 31.7 % of the GDP but by the end of 2019, it had risen to 42.6%.

According to Moramudali, Chinese loans are increasingly becoming a natural option and that is for a number of reasons: (a) there is an urgency about building much-needed infrastructure in a country damaged by three decades of war (2) there is a severe lack of domestic financial resources due to poor exports and inadequate tax collection and (3) the Balance of Payments (BOP) position is perilous. These conditions appear to be persistent.

Moramudali outlines the changes in Sri Lankan debt from the pre-2015 era to the present and explains why these changes have had to take place.

Prior to 2015, almost all Chinese loans were “project loans”, the majority of which were obtained from the Chinese EXIM Bank for heavy infrastructure construction projects such as the Hambantota port, Colombo-Katunayake Expressway, and the Mattala Airport.

However, the money obtained through these “project loans” was not permitted to be used for other purposes. The government did not have financial autonomy pertaining to these project loans (or, for that matter, any project loan obtained from the World Bank, Asian Development Bank, or Japan International Cooperation Agency), he points out.

Project loans did not provide much support to overcome the Balance of Payments (BOP) crises, which have been a persistent issue faced by Sri Lanka. The BOP crisis is created by inadequate export earnings and poor tax collection, both persistent features of the Sri Lankan economy.

Given the BOP crises, Sri Lanka was compelled to go beyond project loans and look at other instruments that would assist it in managing BOP crises and short-term public finance issues. Sri Lanka began to issue International Sovereign Bonds (ISB) through which dollar-denominated loans were obtained from international capital markets.

The ISBs provided financial autonomy. But high interest rates and short repayment periods were constraining factors.

However, the Sri Lankan government faced no restrictions on how it spent money lent through ISBs. The government had freedom to use the money to carry out any project it wanted.

This financial autonomy, and the reduction of concessionary loans provided to Sri Lanka after its upgrade to middle income status, made ISBs a widely adopted method by successive Lankan governments to obtain foreign loans. Sri Lanka issued its first ISB in 2007 and, as of the end of 2019, approximately 47 percent of its total foreign loans had been ISBs.

However, the short-term maturity structure of ISBs and the requirement to repay the principal payment at once, put pressure on the Balance of Payment status of the country.

Against this backdrop, Sri Lanka started to look at alternative methods of foreign financing in order to reduce the pressure on its BOP. Obtaining a Foreign Currency Term Facility (also known as a “syndicated loan”) was one option. In 2018, the Sri Lankan government obtained a $1 billion syndicated loan from the China Development Bank (CDB). This loan was obtained at the USD LIBOR 6 month interest rate (a global benchmark), plus a margin of 2.56 percent per annum and a payback period of eight years (with a grace period of three years).

This loan was upsized in March 2020, and another $500 million syndicated loan was obtained from the CDB, including an extension of the payback period to 10 years. The interest rate too was an improvement over 2018, with the USD LIBOR 6 month rate in 2020 being less than that of 2018.

This development could result in a few outcomes, Moramudali predicts. In the next three years, sovereign bond repayments would amount to $6.3 billion. In light of this, the Sri Lankan government might obtain more syndicated loans from China to bridge its foreign financing gap and manage foreign reserves, thereby tackling its BOP challenges.

In that context, it is possible that syndicated loans from China will be used as an alternative to raising money through issuing sovereign bonds. Within the next five years the Sri Lankan government is likely to use Chinese syndicated loans or such loans obtained from other lenders to finance a portion of large debt repayments instead of entirely relying on sovereign bonds. With the potential high interest to be paid on sovereign bonds due to the downgraded country ratings, syndicated loans would be an attractive alternative to the government, Moramudali avers.

According to Moramudali, it is also clear that the Sri Lankan government sees syndicated loans from China as an alternative to IMF loans to tackle BOP issues. The loan said to be negotiated during the visit of the Chinese delegation in October would assist the country to manage foreign reserves in the short term, thereby allowing it to avoid seeking the support of the IMF, which comes with conditions.

This potential scenario is likely to result in an increase in the Chinese portion of Sri Lanka’s foreign debt, with a potential reduction of the share of sovereign bonds, he predicts.

As a result of the visit of Yang Jiechi, a politburo member of the Chinese Communist Party earlier this month, China provided 600 million renminbi ($90 million, or 16.5 billion Sri Lankan rupees) in grant assistance in an agreement signed by Wang Xiaotao, chairman of the China International Development Cooperation Agency (CIDCA). Local newspapers reported that there were discussions about obtaining a $500 million “syndicated loan” from China Development Bank (CDB).

“If Sri Lanka obtains the latest syndicated loan from China, that will increase the syndicated loan portion up to more than 25 percent of total Chinese debt. This figure is likely to increase given the possibilities of obtaining more syndicated loans in the future. It is likely that some Sri Lanka’s future sovereign bond repayments will be financed by Chinese syndicated loans, without relying on issuing still more sovereign bonds,” Moramudali says.