China’s Role in Sri Lanka’s Debt Restructuring

For instance, in certain countries, such as Sri Lanka, China may seek preferential treatment and negotiations in a more tailored manner. Both China and Sri Lanka should avoid this. As Sri Lanka prepares to negotiate with its major creditors, including the International Monetary Fund, it is important to consider the role of China in the country's debt restructuring. China's participation in the restructuring of Zambia's debt could be an encouraging sign for the country's efforts.

An IMF Bailout

As the foreign reserves of Sri Lanka dwindled to just days of import cover, the government announced a debt standstill. It exempted payments to MDBs from its foreign debt servicing. Since then, negotiations with the International Monetary Fund have been progressing, but a staff-level agreement regarding a bailout is yet to be concluded.

Even if an agreement is reached, the Executive Board of the IMF would still need to approve a program and disbursement after it has sufficient financing assurances. Other multilaterals, such as the Asian Development Bank and the World Bank, will not lend new money to Sri Lanka until the country's creditors are satisfied with its treatment. Given the current economic situation, it is important that Sri Lanka makes progress on its debt restructuring efforts quickly. Besides its private creditors, such as China and Japan, the country's other bilateral creditors, such as India and India, also need to be involved in the negotiations. The government appointed Clifford and Lazard as legal and financial advisers to help resolve the country's various creditors' issues. The conditions for the approval of a bailout by the IMF are also dependent on the country's creditors' willingness to negotiate in a more transparent and expeditious manner.

Significance of China in Sri Lanka’s Debt Profile

The country's central government debt, which includes both foreign and domestic currency, was estimated to be around $81 billion at the end of 2020. Its interest payments bill is also among the highest in the world, at around 7 percent of the country's GDP. This figure could be undercounted due to the lack of reliable data on the various types of debt that the country has. The country's foreign debt servicing has increased significantly over the past couple of years. In 2020, it was estimated that Sri Lanka owes around $12.3 billion to its private creditors, which include some of the country's major external credit sources. In addition to its private creditors, Sri Lanka also owes about $9 billion to multilaterals and $5 billion to its bilateral creditors, excluding China. Although India and Japan are among the Paris Club's creditors, China is not a member of the organization. While as a member of the G-20, China has signed up to a common framework for debt treatment. This agreement will help improve the country's debt management.

China holds about 6.2 percent of Sri Lanka's total government debt. Some of this is as central government debt, while the rest is through state-owned banks, such as China EXIM Bank and the China Development Bank. These loans have been used to fund various projects, such as the construction of airports and ports, the extension of the Southern Expressway, and the development of telecom towers. Since the terms of the loans were initially agreed upon, questions about the value Sri Lanka received from China have been raised over the years. Some of the foreign commercial creditors of Sri Lanka are worried about the potential impact of the country's growing debt burden on their investments in China. For instance, they would not want to see their ISBs get reduced to help the government pay off Chinese loans. It is important to note that China is yet to commit to participating in the debt negotiations of the G-20. Its stance on this issue has been mixed.

Despite China's efforts to help Sri Lanka avoid a debt default, the country decided to go to the International Monetary Fund instead. This resulted in the country's default on its loans. Other countries that have colonized Sri Lanka have also been asked to help. In March 2022, China rejected the Sri Lankan government's request to reschedule its loans. The country was open to helping the country with its financial problems. He also noted that China would like to encourage the IMF to consider Sri Lanka's position.

In response to the country's financial troubles, China urged Sri Lanka to step up its efforts to protect the interests of its investors and ensure that its financing environment is stable. It also noted that it is ready to work with other countries to help the country overcome its current difficulties. The positive statements by China's authorities could indicate a shift in the country's attitude toward engaging in a cooperative process. They also might encourage Sri Lanka to adopt a more multilateral approach to addressing its financial problems. However, it is still important to note that China's experience with debt restructuring in other countries could provide valuable insight into the country's future path.

China’s Approaches to Debt Relief and Restructure

As the world's largest bilateral lender, China has been carrying out various reforms and restructurings on its loans to developing countries. According to reports, over $118 billion worth of Chinese loans have been affected by these changes. This is around 1 in 4 of the loans that China has made to these countries.

Through its various initiatives, China has been able to provide debt relief to over 20 countries. It has also been able to contribute to the development of a debt relief fund operated by the Fund for China-Africa Cooperation. Through the Debt Service Suspension Initiative, which was established by the G-20, China has been able to suspend the debt service of over $1.3 billion in these countries. Also a study revealed that between 2000 and 2019, China had canceled over $3.3 billion worth of loans to African countries. Almost all of these were zero-interest loans. On an ad-hoc basis, China also provided debt relief to other countries such as Venezuela and Ecuador. These countries were able to extend their grace periods and refinance their oil-backed loans.

Although China has been able to provide debt relief to other countries, it has been reluctant to offer debt restructuring on loans that are interest-bearing. This is because it believes that doing so could cause moral hazard. Instead, China has suggested that these countries should adopt multiple strategies to reduce their debt burden. In Kenya, China agreed to reduce the interest rate on a loan for a railway project and extend its maturity. However, it imposed additional interest charges on the country. In Pakistan, it also agreed to extend the maturity of a loan for energy projects.

China Development Bank and China Exim bank, which are state-owned, treat debt restructuring as a case-by-case procedure. These two banks are profitable, despite being under the Chinese government's geopolitical strategy. Since they are part of the People's Bank of China, which is the largest shareholder of these institutions, they will most likely suffer the biggest losses from any restructuring. This means that the resolution process is still under the control of the PBOC. And due to the nature of the confidentiality undertakings that are part of the debt restructuring process, it can be hard for creditors, including other financial institutions, to monitor the financial position of the country's debt. This could also affect the debt renegotiation process. The policies and procedures that China has adopted regarding debt restructuring are widely known. One of these is its insistence on having closed-off discussions regarding the restructuring process. Also, Chinese entities use opaque contracts, which can vary depending on the type of loan and the lender. This issue was raised by Samantha Power, the US Agency for International Development's administrator, during a speech in India. Despite being rejected by Chinese authorities, she was still able to raise this issue.

Conclusion

Unless Sri Lanka is reclassified as a low-income country, it is not eligible to participate in the G-20's debt relief program. This means that it will not be able to participate in the G-20's debt restructuring efforts. China can still provide an ad hoc approach to debt relief, as some Latin American countries have done. However, Sri Lanka's context is different from that of other countries such as Venezuela and Ecuador. Despite the various initiatives that have been launched to improve the efficiency of the debt restructuring process, the common frameworks still remain ambitious and have weaknesses. The International Monetary Fund recently stated that the G-20 Common Framework's progress has been slow. China's approach to debt restructuring is different from that of other countries. It prefers to negotiate with other countries on a bilateral basis instead of through multilateral discussions, and it has a clear preference for taking on debt restructuring terms that are tailored to its specific needs. This makes it difficult for other countries to follow through with their debt restructuring efforts.

If Sri Lanka were to offer China preferential treatment in its debt restructuring efforts, it would not only affect the other countries' efforts to restructure their debts, but it would also delay the overall process. Although the various issues that are involved in the debt restructuring process can be very challenging, Sri Lanka should be handled in a tactful manner. It can't afford to reduce the flow of Chinese capital into the country to finance its development. It can also rely on China's diplomatic support. Sri Lanka should be proactive in its efforts to engage with China on its debt restructuring efforts. This country should be able to negotiate with its Chinese counterparts with the highest level of representation. This will allow it to avoid waiting for the Chinese authorities to respond to its requests. In addition to being able to negotiate with its Chinese counterparts with the highest level of representation, Sri Lanka should also expect China to participate in a multilateral debt restructuring committee. This could be similar to its efforts in Zambia.

China should also participate in a comprehensive international debt restructuring process. It should avoid seeking preferential terms and ensure that the process is conducted in a manner that is transparent and efficient. Doing so will allow Sri Lanka to avoid further complications and delays in the debt restructuring process. The way China approaches Sri Lanka's debt restructuring will set the tone for the relationship between the two countries in the years to come. It will also have a significant impact on other developing countries' debt restructuring efforts.

Pic Courtsey-Sheetal Nyalpelly at unsplash.com

(The views expressed are those of thE author and do not represent views of CESCUBE.)