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China's Global Image Under Strain as Sri Lanka Faces Debt Trap

Sri Lankan university students push down police barricades during a protest over the country’s worst economic crisis in decades outside the residence of prime minister Mahinda Rajapaksa in Colombo, Sri Lanka, April 24, 2022.
Sri Lankan university students push down police barricades during a protest over the country’s worst economic crisis in decades outside the residence of prime minister Mahinda Rajapaksa in Colombo, Sri Lanka, April 24, 2022.

Faced with a grave financial crisis, Sri Lanka sought urgent assistance from China amounting to $2.5 billion. Chinese authorities responded Friday, weeks after Sri Lanka made the request for financial support, saying it would extend $31 million in "urgent emergency humanitarian aid."

Sri Lanka has also been seeking to delay the repayment of $11 billion in Chinese loans since January 10 when Chinese Foreign Minister Wang Yi visited the country's capital, Colombo. China has not responded to the request.

For years, China has tried to create a global image of being a dependable friend to developing countries. But Sri Lankan leaders, including President Gotabaya Rajapaksa, have tested that image by consistently and publicly asking for bail-out funding.

Image matters a lot to China because it is trying to persuade dozens of governments to adopt its infrastructure building program, the Belt and Road Initiative. Beijing has poured more than $800 billion into BRI projects since 2013. BRI is an essential tool for China's quest to sell more goods and obtain contracts for its construction companies — in addition to challenging what it refers to as "American hegemony."

On the other hand, China has been accused by some, including the U.S., of pursuing a kind of "debt-trap diplomacy" meant to bring economically weak countries to their knees, dependent on China for support. Chinese diplomats deny such accusations.

China's reluctance to roll over BRI loans comes as a surprise among analysts and diplomats.

"China has hesitated from granting Sri Lanka moratoria or debt restructuring," Ganeshan Wignaraja, a senior fellow at the National University of Singapore, told VOA.

"China worries that this would create a new precedent in its lending practices. It seems reluctant to initiate similar negotiations with other indebted countries that have received large Chinese Belt and Road loans," he said.

Among the reasons cited for Sri Lanka’s debt crisis: deep tax cuts enacted before the COVID pandemic shut down tourism and reduced remittances from Sri Lankans working overseas as well a move to organic farming that did not yield enough rice, forcing the country to import it, sometimes at inflated prices.

Under the pressure of $51 billion in foreign debt, Sri Lanka is asking for help from the International Monetary Fund. That includes $11 billion from China’s BRI projects. This includes $11 billion spent by Chinese lenders on BRI projects in Sri Lanka.

Gulbin Sultana, an associate fellow at the Manohar Parrikar Institute for Defense Studies and Analyses in New Delhi, believes China has a hidden agenda for refusing to reschedule its loans to Sri Lanka.

"China wants to take advantage of Sri Lanka's inability to repay loans in time. Beijing is waiting for a good time to enter into a debt-to-equity swap and acquire land in Sri Lanka," she said. Such a swap would turn past loans into equity, giving China ownership of the project in Sri Lanka.

Sultana cited the precedent of the Chinese-funded Hambantota port project, which was put through the swap mechanism in 2017 after Sri Lanka failed to repay the debt on time. China acquired 70% ownership after converting loans to equity in the port.

Sri Lanka is in a difficult position regarding ongoing Chinese-funded projects. "If Sri Lanka suspends work on the projects to avoid taking more loans, it will be forced to pay compensation to the Chinese for the work stoppage," Sultana said.
Beijing is not worried that the loss of image in Sri Lanka would harm BRI projects in other countries.

"Different countries opt for Chinese loans because they do not have the necessary funds for new projects. They do not always consider China's global image in making decisions. They consider their local situation and whether other countries are coming forward with offers of assistance," Sultana said.

Taking a somewhat different view, Colombo-based think tank Verite Research said China is not entirely responsible for Sri Lanka’s predicament. China has contributed just 15 per cent of Sri Lanka's foreign debt, it said pointing out that a big part is the country's borrowings through sovereign bonds sold in several countries.

"While Sri Lanka is being made the poster child of falling into the Chinese debt trap, where it is largely perceived that the nation’s sovereignty and geo-political space is compromised, the latest insights by Verité Research narrate a different story," the think tank said in an article posted on its website. "Of Sri Lanka’s total external debt, Verité Research identifies that less than 15 percent is from China."