COLOMBO: Sri Lanka is routinely criticized by Western countries and the pro-Western media for foolishly taking out “massive” and “unproductive” Chinese loans and falling into a “debt trap” that only impoverishes it and puts it under China’s tutelage.

But the truth is that: (a) China is not the largest lender and (2) if Sri Lanka is increasingly taking on Chinese loans, there are good reasons for it, points out Sri Lankan economist Umesh Moramudali in a detailed post by the advisory and analytics division of The Diplomat on October 23rd.

According to the Ministry of Foreign Affairs of the Sri Lankan Government, Sri Lanka’s external debt at the end of 2019 was: China -10%; Asian Development Bank-13%; Japan 10%; World Bank – 9%; India – 2%; International Market Bonds-47%; and others – 9%.

In 2012, when the first government bond matured, Sri Lanka’s external debt was 31.7% of GDP, up from 42.6% by the end of 2019.

According to Moramudali, Chinese loans are increasingly becoming a natural option for a number of reasons: (a) There is an urgent need to build much-needed infrastructure in a country devastated by three decades of war (2) Lack of domestic funding due to poor and inadequate exports Tax collection and (3) the balance of payments (BOP) position is dangerous. These conditions seem persistent.

Moramudali outlines the changes in Sri Lankan debt from before 2015 to the present day and explains why these changes had to take place.

Prior to 2015, almost all of the Chinese loans were “project loans,” most of which were obtained from China’s EXIM bank for heavy infrastructure construction projects such as Hambantota Port, Colombo-Katunayake Expressway and Mattala Airport.

However, the money gained through these “project loans” was not allowed to be used for other purposes. The government did not have financial autonomy in relation to these project loans (or any project loans received from the World Bank, the Asian Development Bank, or the Japan International Cooperation Agency), he said.

Project loans have not provided much support in overcoming the balance of payments crises (BOP), which are an ongoing problem in Sri Lanka. The BOP crisis is caused by insufficient export revenues and poor tax collection, both persistent features of the Sri Lankan economy.

In view of the BOP crises, Sri Lanka has been forced to go beyond project loans and seek other tools that would help it deal with BOP crises and short-term public finance issues. Sri Lanka began issuing International Sovereign Bonds (ISB), which were used to raise dollar denominated loans from the international capital markets.

The ISBs granted financial autonomy. But high interest rates and short repayment periods were limiting factors.

However, the Sri Lankan government has not faced any restrictions on the use of funds lent by ISBs. The government was free to use the money on whatever project it wanted.

This financial autonomy and the reduction in concessional loans granted to Sri Lanka after its promotion to middle-income status made ISBs a widely used method by successive Lankan governments to obtain foreign loans. Sri Lanka issued its first ISB in 2007, and at the end of 2019 around 47 percent of its total foreign loans were ISBs.

However, the IM’s short-term maturity structure and the obligation to repay the amortization immediately put the country’s balance of payments status under pressure.

With this in mind, Sri Lanka began looking for alternative methods of foreign funding to ease the pressure on its BOP. One option has been to obtain a foreign currency credit facility (also known as a “syndicated loan”). In 2018, the Sri Lankan government received a $ 1 billion syndicated loan from the China Development Bank (CDB). This loan was taken out at the USD LIBOR 6-month interest rate (a global benchmark) plus a margin of 2.56 percent pa and a payback period of eight years (with a grace period of three years).

This loan was topped up in March 2020 and another syndicated loan of $ 500 million was obtained from the CDB, including an extension of the payback period to 10 years. The interest rate also improved compared to 2018, with the USD LIBOR 6-month rate in 2020 being lower than in 2018.

This development could lead to some results, predicts Moramudali. Government bond repayments would amount to $ 6.3 billion over the next three years. With this in mind, the Sri Lankan government could get more syndicated loans from China to fill its foreign funding gap and manage the currency reserves to address its BOP challenges.

In this context, it is possible that syndicated loans from China are used as an alternative to borrowing via the issue of government bonds. Over the next five years, the Sri Lankan government is likely to use Chinese syndicated loans, or those from other lenders, to fund some of the large debt payments, rather than relying entirely on government bonds. With the potentially high interest rates on government bonds due to the downgraded country ratings, syndicated loans would be an attractive alternative to the state, says Moramudali.

According to Moramudali, it is also clear that the Sri Lankan government sees syndicated loans from China as an alternative to IMF loans to solve BOP problems. The loan, due to be negotiated during the Chinese delegation’s visit in October, would help the country manage its currency reserves in the short term, avoiding the use of conditional support from the IMF.

This potential scenario is likely to lead to an increase in the Chinese proportion of Sri Lanka’s external debt with a possible reduction in the proportion of government bonds, he predicts.

As a result of the visit by Yang Jiechi, a political bureau member of the Chinese Communist Party earlier this month, China provided 600 million renminbi (US $ 90 million or Sri Lankan rupees 16.5 billion) as grant aid to one of chairman Wang Xiaotao , signed agreement available to the China International Development Cooperation Agency (CIDCA). Local newspapers reported that there was discussion of a “syndicated loan” of $ 500 million from the China Development Bank (CDB).

“When Sri Lanka receives the last syndicated loan from China, it increases the syndicated loan to more than 25 percent of the total Chinese debt. That number is likely to increase given the opportunities to get more syndicated loans in the future. It is likely that some of the future repayments of Sri Lankan government bonds will be funded by Chinese syndicated loans without relying on the issuance of any more government bonds, ”Moramudali said.