By Suren Surendiran –

Suren Surendiran

Facts:

• In the past decade China has been the largest foreign investor in Sri Lanka.
• In the past 24 months China has become the top import partner of Sri Lanka, surpassing India – (in 2020 China $3.58B vs India $3.01B)
• China has been the second-largest foreign lender for Sri Lanka during the last decade.
• Nevertheless, Sri Lanka exported $654.44M worth of goods and services to India compared to only $252.00M worth to China.

In every financial measure or instrument China has an upper hand in Sri Lanka compared to India. Besides these, China also gives blanket cover for Sri Lanka in international forums such as the United Nations and its’ bodies, particularly at the UN Security Council and United Nations Human Rights Council (UNHRC).

India on the other hand has to balance its position at these forums due to its historic involvement in the internal conflicts in Sri Lanka and the large constituency of Tamil Nadu.

In the past decade and a half, Chinese engagement with neighbouring countries of India has increased by multiples. China uses different financial and non-financial instruments to facilitate its engagement. Belt and Road Initiative (BRI) is one mega vehicle China uses to engage. Foreign Direct Investment (FDI), trading partnerships, using its lending capacity to lend for major infrastructure projects, military assistance and in some instances providing diplomatic cover at international forums. With majority of the neighbours of India, in all above avenues, China either leads or is one of the top five countries. Intentions vary but the primary strategic interest is regional domination and tacit intimidation.

Chinese strategic interests in Sri Lanka may be of many folds like in the rest of the neighbours but the approach to Sri Lanka seems different. For example;

* China has given Duty-Free (DF) access to 97 percent of Bangladeshi products which came into force from 1 July 2020. However, with Sri Lanka China doesn’t even have a Free Trade Agreement (FTA).

* In June 2020 China agreed to delay debt repayments for the Maldives. However, being the largest foreign lender to Sri Lanka, no such favourable terms even as a breathing space has been granted to Sri Lanka.

* Chinese assistance to Nepal falls into three categories: Grants (aid gratis), interest free loans and concessional loans. Sri Lanka owes China over USD 6bn and all interest bearing loans of some kind. The only recently recorded grant given to Sri Lanka was in October 2020 of USD 90m when a delegation from Beijing visited Colombo.

If any of these or a combination of these can be offered to Sri Lanka by China, it will give the country a chance to recover from its financial and economic woes.

This difference in treatment could perhaps be conceived as to have sufficient control over Sri Lanka but maintain instability within Sri Lanka to keep India distracted and engaged in multiple fronts.

One of the sustainable ways of maintaining instability is to create a weaker Sri Lankan economy.

“Our country is facing a severe foreign exchange crisis. Data from the Central Bank shows that the country’s net foreign exchange reserves are close to zero, which means almost all of its reserves are borrowed.” – This statement to Parliament by Mr. Basil Rajapaksa, the Finance Minister, on September 7, amplifies the dire situation of the Sri Lankan economy.

On 19 July, just days before sovereign bond settlement of US $1bn on 27 July by Sri Lanka, the global rating agency Moody’s placed the Government of Sri Lanka’s “Caa1” foreign currency long-term issuer and senior unsecured debt ratings under review for downgrade. This immediately triggered a frenzy of panic sell offs at huge discounts.

This was the second time in less than six months Moody’s have given negative assessment of Sri Lanka’s economic conditions. Only a few months ago Fitch Ratings downgraded Sri Lanka to its CCC category, indicating a real possibility of default.

In a recent report, Bloomberg stated “Sri Lanka’s risk premium for a default jumped, reflecting concern that the pandemic is damaging the nation’s ability to fill its foreign-exchange coffers. Early in August, the one-year default probability was at 27.9%, the steepest in Asia, up from around 13% over six months ago, according to a Bloomberg model where a reading above 1.5% signifies high risk of failure to pay.

What these negative indicators and rating agencies’ negative coverage do is, it destroys investor confidence, phenomenally increases borrowing costs and shuts Sri Lanka off from International Capital Markets.

Ministry of Finance of Sri Lanka reacted immediately after Moody’s made the announcement with a statement titled “Statement by Moody’s Investors Service is ill-timed, ill-judged and hence unacceptable”. A senior diplomat based in Colombo commented “when you are sparring with the rating agencies, you have got problems”. And another one commented “the whole concept of independent international rating agencies are there to do exactly this…to advice investors, portfolio managers, agencies and institutions on a timely and accurate fashion”

The foreign currency reserves stood at USD 2.8bn at the end of July and at USD 3.55bn at the end of August.

Last month, then State Minister and currently the Governor of Central Bank of Sri Lanka Mr Ajith Nivard Cabraal listed potential inflows over the next 3 months, which amounts to nearly USD 2,650m as follows:

*SWAP from India – USD 400m

*SWAP from Bangladesh – USD 250m

*Loan from China Development Bank – USD 300m

*Special Drawing Rights allocation from the IMF – USD 800m

*Central Bank purchases from the Forex market in the next 3 months – USD 200m

*Inflow from ISBs held by local banks – USD 300m

*Expected inflows from the utilisation of under-utilized assets – USD 400m

The Central Bank has also negotiated a SWAP with the People’s Bank of China of a sum of USD 1500m, which too, can be accessed and hence could be included as a part of its effective reserves, he added.

Majority of these are interest bearing loans of some form. It cannot be assumed that some or all of these could be rolled over without conditions. For example the USD 400m from India cannot be rolled-over beyond once without Government of Sri Lanka signing up an agreement with the IMF which Sri Lanka vehemently rejects, at least till now.

In January this year the government was of the firm belief that the export income will compensate for some of the depreciating reserves. Unfortunately Sri Lanka’s economic growth recorded its worst performance in the post-independence history with a 3.6 percent contraction, while the budget deficit hit its worst level in 38 years. In 2020, exports of goods fell 15.6 per cent to $10 billion, down from $12 billion in 2019.  Exports of services fell roughly 60 per cent to $3 billion in 2020 down from $7.5 billion in 2019. During the first half of 2021 exports of goods have improved, yet 7% less at USD 5.6bn than what it was during the same period in 2019 (USD 6bn), before the pandemic. Exports of services haven’t recovered significantly since the fall in 2020.

These weak economic indicators have led to a near 10 per cent depreciation of the Sri Lankan rupee against the US dollar over the past one year, making imports more expensive.

President Gotabaya Rajapaksa declared a state of emergency on August 31 to deal with food shortages, as most banks have run out of dollars to finance imports.

Sri Lanka has to repay about $2 billion in foreign debts before the end of the year.

Is China succeeding in creating and maintaining an unstable Sri Lanka just 22 miles off-shore to India?

*Suren Surendiran is an accountant by profession and the Director for Strategic Initiatives and Spokesperson for Global Tamil Forum (GTF).