Sri Lanka ‘can’t get out of crisis without China,’ analyst says

Sri Lanka won’t be able to resolve its debt restructuring problems without help from China as the country teeters on the brink of economic collapse, according to analysts.

Sri Lanka has defaulted on its debt, plunging the island nation into its worst financial crisis since independence in 1948. In addition to fuel shortage, the country also faces the prospect of running out of food, staples and medicines.

Public frustration over the deepening economic crisis has spilled over to raging street protests in recent months. President Gotabaya Rajapaksa, who has been blamed for the economic mismanagement, was forced to resign and fled overseas last week as anger toward his government spiraled.

Acting President Ranil Wickremesinghe declared a state of emergency on Sunday, in an effort to quell protests ahead of a vote in parliament on Wednesday to elect a new leader.

China’s willingness to provide substantial debt relief to Sri Lanka will be vital to accelerate the debt restructuring and in helping the country get out of its current situation, said Umesh Moramudali, lecturer at University of Colombo.

“You can’t get out of this crisis without China,” Moramudali, told CNBC’s “Streets Signs Asia” on Tuesday. “China needs to agree to restructure its debt, which is not their usual path to take.”

China has invested billions in Sri Lanka under its Belt and Road Initiative. The massive infrastructure program was launched in 2013 and aims to build ports, roads, railways and pipelines across Asia, Europe and Africa.

“Sri Lanka needs to come to a common framework and what the international community is insisting is that China also agrees to a common framework for a debt restructure,” Moramudali added. “It’s not quite clear yet, what level of negotiation we are in, particularly with China.”

At a regular press briefing last week, China’s foreign ministry spokesperson Wang Wenbin said that “shortly after the Sri Lankan government announced to suspend international debt payments, Chinese financial institutions reached out to the Sri Lankan side and expressed their readiness to find a proper way to handle the matured debts related to China and help Sri Lanka to overcome the current difficulties.”

In a high-profile case, Beijing took over a strategic port in 2017 when Sri Lanka failed to service its debt.

Critics have accused Beijing of what they call a “debt trap,” saying countries that owe money to China may be forced to sign over national territory or make steep concessions if they can’t pay up. China denies those allegations.

Sri Lanka said that as of April last year, China accounted for about 10% of its total debt, but Moramudali said in reality that’s probably not the case. 

“I mean this 10% is also an underestimate,” he said, underlining that further research provided a more accurate picture of China’s lending to Sri Lanka. 

“Sri Lanka’s [debt] to Chinese creditors comes about 20%, not really 10%. So all these 20% will have to be restructured. That means you’ll have to look at how China Development bank will deal with restructuring and China’s Exim bank will deal with restructuring,” he added.

Sri Lanka couldn’t tap a $1.5 billion credit line from China and has yet to hear back on the request to China for a $1 billion loan, former president Rajapaksa said in June, according to a Bloomberg report.

At last week’s Group of 20 meeting, U.S. Treasury secretary Janet Yellen said it is in China’s interest to restructure Sri Lanka’s debt.

“China is, of course, a very important creditor of Sri Lanka. Sri Lanka is clearly unable to repay that debt. And it’s my hope that China will be willing to work with Sri Lanka to restructure the debt — it would likely be both in China and Sri Lanka’s interest,” Yellen told a press conference.

Political observers underline Sri Lanka is currently in a tough spot over debt owed to China.

“One of Sri Lanka’s tragic mistakes was in 2020 when the pandemic hit, it did not engage in restructuring negotiations with its creditors,” Akhil Bery, the director of South Asia Initiatives at the Asia Society Policy Institute, told CNBC’s “Squawk Box Asia” on Tuesday.

He said it was known at that point the debt was unsustainable.

“The other hubris that came on behalf of Sri Lanka politicians is believing that China would come to their help and restructure their loans,” Bery added.

“While China is willing to perhaps engage in a rollover of debt or refinancing of the debt, it’s not willing to take on restructuring because of the precedent it will set.”

According to central bank data obtained by Reuters, Sri Lanka currently has about $2 billion in foreign exchange reserves against $7 billion in total debt due this year, including $1 billion worth of notes maturing in July.

Acting president Wickremesinghe said on Monday that the country had almost concluded talks with the International Monetary Fund for a possible debt relief.

Negotiations with the IMF “are nearing conclusion, and discussions with donor countries are also progressing,” Wickremesinghe’s office said in a twitter post.

“The [IMF] negotiations will resume once there is a new government. It’s not going to be concluded as quickly as the acting president says. I think we all need to acknowledge that because it’s going to take maybe a couple of months to finalize the agreement,” Moramudali said.

In June, the IMF ended talks with Sri Lanka after failing to conclude a deal for a bailout package.

“The IMF was lenient during the pandemic,” said Bery. “It’s going to look for some stringent measures, including raising taxes, including anti-corruption measures and even possibly central bank independence.”