Sri Lanka’s Debt Crisis and an IMF Bailout
As foreign reserves dwindled down to just days of import cover or less, and facing a looming hard default, on April 12 the Sri Lankan government announced a unilateral debt standstill, suspending its foreign debt servicing with the exception of payments to Multilateral Development Banks (MDBs). Since then, discussions with the IMF on a bailout (an “Extended Fund Facility”) have progressed, but a staff-level agreement is yet to be concluded. Even after it is, the Executive Board would approve a program and disbursement thereafter only once the IMF has “adequate financing assurances” and its major shareholders are confident in Sri Lanka’s fair treatment of its creditors. Until then, other multilaterals like the World Bank and Asian Development Bank will also refrain from lending new money.
Evidently, Sri Lanka must make reasonable progress on sovereign debt restructuring negotiations quickly – with private creditors (holders of International Sovereign Bonds and commercial loans) as well as bilateral creditors like Japan, China, and India. On May 24 the Government of Sri Lanka appointed international financial and legal advisers, Lazard and Clifford Chance respectively, to deal with the country’s various creditors to reach a consensus on the terms of the debt restructuring. Prospective IMF financing is contingent on a fair and expeditious renegotiation process with Sri Lanka’s creditors – bilateral and private – to restore debt sustainability.
Significance of China in Sri Lanka’s Debt Profile
Sri Lanka’s total central government debt was estimated to be over $81 billion at the end 2020 (both domestic and foreign currency), and the government’s interest payments bill is among the highest in the world, nearing 7 percent of GDP. This total debt figure could be an underestimate, given the paucity of properly classified and published data on some types of debt (for instance, foreign loans taken on by state-owned enterprises, and publicly guaranteed debt). Annual foreign debt servicing galloped from $1.3 billion in 2009 to $4.1 billion in 2020 with Sri Lanka owing approximately $12.3 billion to private creditors, the largest external credit source, who hold International Sovereign Bonds (ISBs), Sri Lanka Development Bonds, and some of the syndicated loans. Another $9 billion is owed to multilaterals and $5.6 billion to bilateral creditors excluding China, with a further $5 billion to China, and $3.5 billion to Japan. Notably, among Sri Lanka’s main bilateral lenders, it is only Japan that is a Paris Club creditor – India has observer status, and China is not a member. However, China, as a G-20 country, has signed up to the Common Framework for Debt Treatment beyond the Debt-Service Suspension Initiative.
China holds roughly 6.2 percent of Sri Lanka’s total central government debt – some as central government debt (around $670 million) but mostly as debt through state-owned banks like China EXIM Bank and China Development Bank (CDB), totaling around $7 billion. These loans have financed myriad projects: utilities, roads and highways (parts of the Southern Expressway and Central Expressway), ill-conceived ports and airports, vanity convention centers, and telecom towers. Consequently, questions around the value Sri Lanka received for these Chinese loans have lingered over the last decade.
Low-yielding investments financed with Chinese bilateral debt worry foreign commercial creditors. For instance, they wouldn’t want to take haircuts on their ISBs to Sri Lanka to help the government repay Chinese loans. As such, part of any debt renegotiation depends on the treatment to be meted out to, and requested by, Chinese lenders.
Here, it is vital to recall that China is yet to publicly commit to joining multilateral debt negotiations. Their stance has been ambivalent so far.
China’s Ambivalence
Views taken by Chinese officials have changed over the weeks and months following Sri Lanka’s debt default decision. Immediately after the April 12th announcement, China’s Ambassador to Sri Lanka Qi Zhenhong said that “China has done its best to help Sri Lanka not to default but sadly they went to the IMF and decided to default […] the debt restructuring definitely will have an impact on future bilateral loans.” Qi added – quite controversially – that “[c]ountries that colonized Sri Lanka have more obligations to help at this juncture.” This came on the back of China rejecting a request (made by the Sri Lankan government in March 2022) to reschedule its loans. China instead offered refinancing – a new $1 billion loan to help repay part of the existing loans.
In a sharp U-turn in early May, the ambassador told Sri Lanka’s minister of finance that China is “open to playing an active role in encouraging the IMF to positively consider Sri Lanka’s position.”
At a press conference in June, a Chinese Foreign Ministry spokesperson said that Sri Lanka should “boost its own effort, protect the stability and credibility of the investment and financing partners and ensure the stability and credibility of its investment and financing environment.” That was followed by a Foreign Ministry spokesperson asserting in a press briefing on July 15 that “China is ready to work with relevant countries and international financial institutions to continue to play a positive role in supporting Sri Lanka in overcoming difficulties, easing its debt burden and realizing sustainable development,” and that Chinese banks are “ready to negotiate with Sri Lanka.”
The recent shifts in tone and timbre of statements by Chinese authorities may signal a greater willingness than before to engage in a cooperative process, and a changing attitude toward Sri Lanka’s plans to pursue a harmonized, multilateral approach. Nevertheless, understanding how China has typically dealt with debt renegotiation in other developing economies could provide insights on the likely path for Sri Lanka.
China’s Approaches to Debt Relief and Restructure
China today is the world’s largest bilateral lender, with most of it to developing economies and now a growing share of it coming under renegotiation. Some reports suggest that as much as $118 billion in Chinese overseas loans have come under renegotiation since 2001, and according to some estimates this is 1 in every 4 dollars lent by China.
China provides debt relief and restructure through different ways – as part of the G-20 Debt Service Suspension Initiative (DSSI), through the Forum on China-Africa Cooperation (FOCAC), by way of ad-hoc relief, and contributing to the IMF’s Catastrophe Containment and Relief Trust (CCRT). Through the DSSI, China has given debt service suspensions of around $1.3 billion in 23 countries (16 of which are in Africa). A recent paper by Kevin Acker, Deborah Brautigam, and Yufan Huang found that between 2000 and 2019, China canceled at least $3.4 billion of debt to African countries (under FOCAC), and nearly all were zero-interest loans. On an ad-hoc basis and outside of the DSSI-eligible countries or FOCAC, China has provided debt relief to countries like Ecuador and Venezuela, where it extended grace periods and restructured maturing oil-backed loans.
However, China has been reluctant to offer generous debt restructuring on interest-bearing loans. It worries that allowing such a restructure to any one country could fuel moral hazard. Annual payment deferrals and principal payment rescheduling (by maturity extension) are the most likely strategies that China would adopt to ease the debt burden of recipients. For instance, in Kenya, China agreed to an interest rate cut and maturity extension of a $4 billion loan for a Kenyan railway project, effectively bringing down annual debt service costs. But it imposed a penalty of 20 additional years of interest charges. In Pakistan earlier this year, China agreed to extend the maturity of $4.2 billion in debt taken for energy projects under the China-Pakistan Economic Corridor (CPEC).
Chinese lenders like China Exim bank and China Development Bank typically treat restructuring or cancellation on a case-by-case basis. Despite being state owned and funded, they are profit-making institutions functioning under a geopolitical strategy of the Chinese government and the aegis of the People’s Bank of China (PBOC), which – as the largest shareholder of these banks – will ultimately face the largest losses from any debt restructuring. This means the resolution process is still subject to the scrutiny and control of PBOC.
China’s insistence on closed-off discussions on debt renegotiation and limited coordination with other bilateral lenders is now widely known. Moreover, Chinese entities use rigid and opaque contracts, which appear to vary by the lender and the loan type and reference extensive confidentiality clauses. Contracts after 2014 by China Exim Bank contain such clauses. This was also a point raised by USAID Administrator Samantha Power in a speech during a recent visit to India, even though it was promptly rebuffed by Chinese authorities.
Broad borrower confidentiality undertakings make it hard for all stakeholders, including other creditors, to ascertain the true financial position of the sovereign borrower, to detect preferential payments, and to design crisis response policies. This could complicate the debt renegotiation process as well. Recently, activists in Kenya filed a court petition seeking full transparency of contracts pertaining to the Chinese built Mombasa–Nairobi Standard Gauge Railway (SGR) railway in response to the Kenyan government’s refusal to publicize the contents, on the grounds of Chinese non-disclosure agreements.
Implications for Sri Lanka
Sri Lanka, unless temporarily reclassified as “low-income” (which is highly improbable, even though India has requested it from the IMF on the country’s behalf), is not eligible for having its debt considered under the G-20 DSSI or the G-20 Common Framework beyond DSSI. China still could, as in some Latin American countries that are equally ineligible, adopt an ad hoc approach to debt relief, but Sri Lanka’s context is different to theirs (Ecuador and Venezuela are oil exporters). Meanwhile, common frameworks remain ambitious and an experimental attempt at essentially “unionizing” diverse bilateral creditors under a common goal, and many have pointed out its weaknesses. Even the IMF had said that the G-20 Common Framework’s progress has been slow to yield meaningful results.
Observing how China approaches and deals with other countries in debt distress shows that Beijing prefers to negotiate bilaterally, offer bespoke debt relief terms, and has been ambivalent toward participating in multilateral debt discussions. Their case-by-case approach influenced by geostrategic or resource considerations, coupled with a clear aversion to write off or take haircuts on commercial loans, presents an added challenge. Any attempt by Sri Lanka to offer (or for China to request) highly preferential treatment would not only draw the ire of other bilateral and commercial creditors but entangle and delay the overall debt restructure pathway.
While these issues no doubt complicate a neat restructuring effort, they must be handled tactfully. Realistically, Sri Lanka cannot afford to cut off channels of Chinese capital (debt and investment) to finance future development, and also cannot sour China’s diplomatic support enjoyed in multilateral fora like the United Nations. Knowing the relationship-based lending behavior of the country, Sri Lanka should proactively engage with China on debt restructuring talks now, with the highest-level representation, rather than waiting for foreign financial advisers and lawyers to approach Chinese authorities coldly and clinically.
What Sri Lanka could feasibly expect – and indeed push for – is that China joins a multilateral creditor committee (perhaps even co-chairs it, as it has done in Zambia), and supports a harmonized effort for bilateral debt restructuring talks. China should sincerely and absolutely participate in a structured, international approach to the debt restructuring, avoid the temptation to seek bespoke and preferential terms, and avoid complicating the debt restructuring any more than it already is – considering the immense socioeconomic toll the ongoing crisis is having on Sri Lankan people.
Undoubtedly, the way in which China approaches Sri Lanka’s case will not only set the tone for China-Lanka relations in the decades ahead, but will also have major bearings on China-borrower relations in many other developing countries around the world.
