China biggest roadblock, time running out for Sri Lanka to deliver on IMF commitment

What are the reasons for the delay, will Wickremesinghe be able to meet this deadline, and what could be the consequences of not doing so?

Why no creditors’ agreement yet

“Financing assurances to restore debt sustainability from Sri Lanka’s official creditors and making a good faith effort to reach a collaborative agreement with private creditors are crucial before the IMF can provide financial support to Sri Lanka,” the September 1 statement from the IMF had said.

What this means is that financing assurances have to be given by the bilateral creditors, resulting in “a sufficient level of comfort to the IMF that bilateral creditors will support Sri Lanka’s efforts to restore public debt sustainability,” the Sri Lankan government said, briefing its creditors on September 24.

Sri Lanka held a second meeting with bilateral donors on November 3, but there was not enough progress for the country to clinch an agreement and meet its December deadline.

While private creditors only have to be given an assurance of a “good faith effort”, the debt restructuring commitment from bilateral or “official” donors was always going to be the difficult part.

China, Japan, and India are Sri Lanka’s main bilateral creditors. Of the total bilateral debt, that is the amount owed to foreign governments, China’s share is 52 per cent, Japan’s share is 19.5 per cent and India’s is 12 per cent, going by what the government has said in its briefing for bilateral creditors.

What China, and to a lesser extent India, do is important to how Sri Lanka’s debt restructuring talks progress and get resolved. No bilateral creditor wants any other country or group to get preferential treatment — if there has to be a haircut, it must be evenly distributed among all creditors. For this reason, creditors prefer to negotiate with the debtor country from a common platform.

Creditors from the OECD group, which includes Japan and South Korea, work through a common platform called the Paris Group. For Sri Lanka’s debt restructuring, the Paris Group wants China and India to come on board.

China is the main concern; it has the biggest share of Sri Lanka’s bilateral debt. And its past record suggests that it prefers bilateral negotiations, with confidential terms. China has not said it will join the Paris Club negotiations with Sri Lanka.

India, which has said that any agreement must reflect “creditors equitability and transparency”, has concerns about joining a common platform that does not have China: one is that it leaves China to enter into its own custom-made bilateral agreement; second, the Sri Lankan side has conveyed that this year’s emergency assistance from India amounting to $ 4 bn should be included in the restructuring, which is not how New Delhi sees it.

New Delhi is now engaged in separate bilateral talks with Colombo.

Earlier this month, Wickremesinghe said the talks with India had “succeeded”. Officials were more tempered in their assessment, and said the two sides were making “good progress”.

That leaves China, whose apparent reluctance to enter into debt restructuring talks with Sri Lanka even bilaterally gave rise to a rare public rebuke of Beijing.

In parliament, Shanakiyan Rasamanickam of the Tamil National Alliance accused China of trying to scuttle Sri Lanka’s IMF deal, breaking an earlier political narrative that the Chinese leadership was preoccupied with the October Party Congress, and had insufficient time for the talks.

“If China is truly Sri Lanka’s friend, ask the Chinese to help with the [debt] restructuring and the IMF programme,” he said. He accused China of paying bribes to finance unproductive infrastructure projects, and said “this is China not being Sri Lanka’s friend, that is China being Mahinda Rajapaksa’s friend”.

How much does Sri Lanka owe China?

Earlier, Sri Lanka’s debt to China was calculated at 10 per cent of the total of the country’s external debt, about the same as to Japan.

However, new research by the China-Africa Research Initiative at Johns Hopkins University School of Advanced International Studies shows it is as high at 20 per cent. For their paper published November 29, ‘Evolution of Chinese Lending to Sri Lanka Since the mid-2000s: Separating Myth from Reality’, Umesh Moramudali and Thilina Panduwawala show that Chinese loans were $ 7.4 billion at the end of 2021. Almost all of this owed not to the Chinese government but to state-owned banks, China Exim Bank and China Development Bank ($ 4.3 bn and $ 3 bn respectively). And this constitutes 19.6 per cent of Sri Lanka’s debt. The authors of the report said this debt was duly reported to the World Bank’s International Debt Statistics department.

“China will have to play a major role in Sri Lanka’s debt restructuring process, with US$ 7.4 billion or 19.6 per cent of outstanding public debt owed to China at the end of 2021 (out of a total of US$ 37.6 billion in total public external debt excluding central bank debt), and it will be the first time a major Asian Belt and Road Initiative borrower is going through the process. But given the severe balance of payments (BOP) and debt distress being experienced by most developing countries, this will definitely not be the last Chinese debt restructuring. China’s approach to Sri Lanka’s debt restructuring and the extent of debt relief offered will set a precedent for China’s role and behavior in other countries as well,” the authors note.

That Sri Lanka’s debt restructuring could become a precedent for other failing borrowers from China may be one reason that Beijing is holding out. Delegations of the two banks have visited Colombo. So far it does not appear that government level talks have been held. And there is no indication yet from China that it is ready for bilateral restructuring talks or that it will join the proposed Paris Club committee.

What happens if Sri Lanka does not reach an agreement with creditors?

A stalemate over restructuring debt is not unknown. Zambia, also a heavy borrower from China, struggled with its debt restructuring for two years due to stalemated discussions with China. Last month, Zambia said that it was actively engaged with China for a breakthrough, but the matter has not yet reached resolution.

The Paris Club is believed to be ready with its creditors committee, but if Sri Lanka’s stalemate with its biggest creditor continues, it could have a knock-on effect on other creditors.

At the moment, better management of the shortages have partially reduced people’s day-to-day difficulties. The foreign exchange crisis has also partly eased due to strict import restrictions, combined with an increase in remittances plus the pick-up in tourist arrivals.

But this “low level equilibrium”, as some are describing it, has come at the cost of the economy contracting by a projected 6 per cent this year, and perhaps by over 8 per cent next year. This impact on the real economy may in turn have social and political costs.

One way to cut through the impasse, according to experts, is for Sri Lanka to resort to a “most favoured creditors” clause, under which the sovereign debtor promises that if any bilateral creditor — say China in this case — manages to swing advantageous terms for itself, those same terms will be applicable to all other creditors in the first movers’ group.

In effect, this is designed to dissuade outlier creditors from demanding preferential terms, as giving all creditors the same preferential treatment would be impossible.