China has become Sri Lanka’s largest foreign creditor, foreign investor, and top importing source in just two decades. After Sri Lanka’s sovereign default, China remained crucial to Sri Lanka’s economic recovery and External Debt Restructuring (EDR) process.
Sri Lanka currently owes around $ 4 billion and $ 3 billion to the two main Chinese creditors, China EXIM Bank (ChEXIM) and China Development Bank (CDB). This means that EDR negotiations with China involve negotiations with these entities in addition to the bilateral discussions with the Chinese Government.
The progress towards debt restructuring agreements with these two Chinese policy banks have coincided with official bilateral visits to China. President Ranil Wickremesinghe’s October 2023 visit coincided with ChEXIM Bank providing its Agreement in Principle (AIP). Prime Minister Dinesh Gunawardena’s March 2024 visit involved discussions on the next steps in the process ahead of the upcoming International Monetary Fund (IMF) review.
Chinese debt restructuring
Understanding China’s role and significance in Sri Lanka’s debt restructuring process requires demystifying Chinese lending to Sri Lanka.
Most of the Chinese lending to Sri Lanka came through two State-owned policy banks: ChEXIM Bank and CDB. The former accounts for ~10% of Sri Lanka’s foreign debt (as at end-2023) and all the loans were obtained for various Government development projects (eg: Hambantota Port, Mattala Airport). The latter accounts for ~7% of Sri Lanka’s foreign debt (as at end-2023), which was obtained for development projects and to bridge foreign currency gaps.
Furthermore, loans provided by ChEXIM Bank had much lower interest rates compared to the loans from CDB. These differences resulted in ChEXIM Bank being categorised as an official creditor alongside other official creditors such as Japan and India. CDB was categorised as a commercial creditor and thus will be negotiated alongside International Sovereign Bond (ISB) holders.
Much of the Chinese lending to the Global South has been provided through these policy banks, rather than directly by the Government. Consequently, outstanding debts of most countries are owned by these different Chinese creditors. This scenario, referred to as a fragmentation of creditors, makes sovereign debt restructuring harder.
When Sri Lanka requested an Extended Fund Facility (EFF) from the IMF in 2022, it required all official creditors agreeing to be in arrears and to provide debt relief in line with IMF targets (financing assurances), including from China. In January 2023, ChEXIM Bank provided a two-year moratorium for the loans Sri Lanka had borrowed and provided financing assurances in March 2023. This led the IMF Executive Board to approve the first instalment of the $ 3 billion EFF programme.
On 27 March, Chinese Prime Minister Li Qiang assured continuous support for Sri Lanka’s debt restructuring process during Prime Minister Gunawardena’s recent official visit to China. Additionally, according to State Minister of Finance Shehan Semasinghe, China will continue its positive engagements with the IMF to strengthen economic stability and restore debt sustainability in Sri Lanka.
China also must work towards finalising other ongoing debt restructuring negotiations. Zambia’s restructuring is the closest to finalising, with China being a deciding factor in approving the AIP with bondholders in March. As reported by Bloomberg, further discussions seemed to have taken place during the Spring Meetings of the IMF and World Bank Group regarding the role of Chinese creditors in the debt restructuring process.
Accordingly, China expressed a desire for creditors to agree on an approach to meet the comparability principle in debt negotiations, while the IMF introduced amendments to its Lending Into Official Arrears (LIOA) policy to make it easier to lend to a country in default.
China trade and investment
China remains an important trading partner for Sri Lanka and most of the inputs for apparel exports are imported from China. In the past, India was Sri Lanka’s top import source, accounting for ~20% of total imports. In 2015, Chinese imports for the first time accounted for 20% of total imports and in 2016 imports from China marginally surpassed India. China topped the import source list again in 2019 and 2020.
However, as Sri Lanka started to face economic issues and sovereign default in 2022, Chinese imports reduced significantly. At the height of the economic crisis, Indian credit lines – including ones to import fuel – supported the Sri Lankan economy. This made India Sri Lanka’s top source of imports in 2022 and 2023.
From 2024 onwards the trend has changed again, with a significant rise in Chinese imports. Such imports are largely driven by yarn and fabric for apparel exports, household consumption and electrical items, and coal.
The post-default period marks a very interesting period for Sri Lanka-China investment relations. After 2021, China has not committed any new loans to Sri Lanka. Due to Sri Lanka’s decision to halt many infrastructure projects, disbursements of already committed Chinese loans have also stopped.
Chinese State-Owned Enterprises (SOEs) are expanding their businesses with Sri Lanka through investments, as opposed to loans. Such investment engagements include Sinopec starting fuel distribution in Sri Lanka and the Sri Lankan Government awarding a $ 4.5 billion oil refinery project in Hambantota to Sinopec.
Future outlook
China will continue to play a vital role in Sri Lanka’s economic recovery. Its relationship affects not only Sri Lanka’s debt dynamics, but also its economy as a whole.
It is evident that the nature of China’s economic ties with Sri Lanka are changing after the sovereign default. It is likely that China-Sri Lanka economic ties will largely revolve around investment from Chinese SOEs as opposed to loans from China EXIM Bank or CDB. These investments are likely to be more cautious compared to reckless lending decisions of Chinese banks in the past.
Although the nature of bilateral economic ties is changing, China will remain a key economic partner through trade, investment, and debt.
(This article summarises the findings of the first issue of the ‘Sri Lanka-China Economic Brief’ published by Arutha)
(Arutha is a Colombo-based policy think tank focused on economic research and communication with a special interest in public debt and taxation. Its economic civic education initiative, Default LK, was established during Sri Lanka’s first ever sovereign default in 2022. For more information visit: https://arutharesearch.org)
Diversification of Chinese loans over time (amount outstanding in USD m)
Note: Does not include accrued interest arrears. Other SOE loans are by ICBC and ChemChina
Source: RTI requests from External Resources Department, Ministry of Finance, Sri lanka
Rise in Chinese imports as share of total imports to Sri Lanka
Source: Author calculations based on CBSL data
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