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The Sri Lanka – China relationship reminds us of the world of Charles Dickens: Oliver Twist asked for more, everyone was shocked, and he was duly punished. But today the crisis-ridden Sri Lanka knocks at the door of China yet again and asks for a lot more – — “Sri Lanka has asked China to help with trade, investment and tourism to help it grow sustainably,” Palitha Kohona, Colombo’s envoy to Beijing, said as the island nation negotiates for an emergency $4 billion package to help it emerge from an economic meltdown.

No one in Lanka or elsewhere is surprised or objects despite the perception that the endless borrowings from China are a major factor behind the current crisis. “The crisis in Sri Lanka has been in the making for the past two decades. Although a lot of blame has gone on the island state’s domestic developments, Beijing’s contribution to the crisis is inseparable. The story of populist Rajapaksas, unsustainable borrowings, and structural fallacies is essentially incomplete without the China factor,” stresses Aditya Gowdara Shivamurthy of the Observer Research Foundation, India.

In this backdrop approached AidData, a research lab at William and Mary, a US university, for their take on the scenario, and they readily responded. Excerpts from an interview with Bradley C Park, the institute’s Executive Director:

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How fair is the prevalent critique of Chinese debt trap diplomacy? Where does Lanka stand?
That is more of a media myth. The idea that Chinese state-owned lenders prefer to collateralize on physical, illiquid assets – like ports and electricity grids – that can be seized in the event of default is factually inaccurate. Chinese state-owned lenders are savvier than that. They actually prefer to collateralize their debts on liquid assets. Typically, they will require that their borrowers maintain a minimum cash balance in an offshore, lender-controlled bank account. If a borrower falls behind on its repayments, the Chinese state-owned lender can simply debit funds from its bank account without having to deal with the hassle of going before a judge to seize a physical asset.

Bradley C Park, executive director of AidData, a research lab at William and Mary University

(See AidData’s April 2021 study ‘How China Lends’ and AidData’s summary of the study’s topline findings via here, here and here)

But what  if there are forbidding subtexts to the lending terms,  what are the means available for China to enforce the lending terms – specifically in Lanka, declared bankrupt, can China take over any part of the territory? If not what is the point of those terms? Mere empty threats? If China will be seen as helpless, would it not set a precedent, other debtors too becoming cavalier?
Beijing has been operating under the assumption that when BRI borrower countries like Sri Lanka face significant liquidity pressures, the smart move is to keep these countries sufficiently liquid to ‘weather the storm’ — by extending grace periods, spreading out repayments over longer periods of time, and issuing short-term bridge loans. For almost five years, the People’s Bank of China (PBOC) and China Development Bank (CDB) tried to keep the Government of Sri Lanka liquid enough to service its old project debts and avoid sovereign credit rating downgrades. More specifically, between 2018 and early 2022, Beijing pivoted away from project lending and towards balance of payments (BOP) lending (i.e. emergency rescue lending). Between October 2018 and the first half of 2022, Chinese state-owned banks lent approximately $4.8 billion to the Government of Sri Lanka.

The idea that Chinese state-owned lenders prefer to collateralize on physical, illiquid assets – like ports and electricity grids – that can be seized in the event of default is factually inaccurate. Chinese state-owned lenders are savvier than that.

Of that $4.8 billion, only $1 billion supported infrastructure projects. The other $3.8 billion came via five BOP loans from China Development Bank and the People’s Bank of China (PBOC). The BOP carried less generous repayment terms (interest rates between 3.5% and 5.25% and maturities of 1 year to 10 years) than the infrastructure project loans that were contracted between 2000-2017.

And note what we have said in our study of last year – “First, the Chinese contracts contain unusual confidentiality clauses that bar borrowers from revealing the terms or even the existence of the debt. Second, Chinese lenders seek advantage over other creditors, using collateral arrangements such as lender-controlled revenue accounts and promises to keep the debt out of collective restructuring (“no Paris Club” clauses). Third, cancellation, acceleration, and stabilization clauses in Chinese contracts potentially allow the lenders to influence debtors’ domestic and foreign policies. Even if these terms were unenforceable in court, the mix of confidentiality, seniority, and policy influence could limit the sovereign debtor’s crisis management options and complicate debt renegotiation. Overall, the contracts use creative design to manage credit risks and overcome enforcement hurdles, presenting China as a muscular and commercially-savvy lender to the developing world.

…China’s contracts also contain unique provisions, such as broad borrower confidentiality undertakings, the promise to exclude Chinese lenders from Paris Club and other collective restructuring initiatives, and expansive cross-defaults designed to bolster China’s position in the borrowing country.”

What is the importance of Hambantota in the BELT initiative? Should China be worried now?
Hambantota received a lot of media attention and scrutiny since the early-2010’s. Many journal articles have undertaken detailed descriptive analysis of what transpired, but it was the persistent international media coverage that promoted this story as an example of debt trap diplomacy. Please check out this excellent piece by Prof Brautigam on this topic.

(In effect the experts assert Hambantota is not the Chinese monster it is made out to be, just that the world is changing and one has to live with it. No territorial gobbling up, sorry.)

In general, the IMF’s structural adjustment programs aim to put countries’ financial houses in order in order to stabilize their financial structures,

Now looking forward to the possible bailouts, how justified are the apprehensions that those at the lower tiers are set to suffer even worse for the blunders of the rulers?
Ammar A Malik, Senior Research Scientist at AidData, responds:
In general, the IMF’s structural adjustment programs aim to put countries’ financial houses in order in order to stabilize their financial structures, i.e. force them to balance their budgets by raising more revenue and reducing expenses, particularly of the non-developmental variety such as untargeted fuel subsidies. These measures are both politically difficult for governments and incredibly painful for low-income segments of society, i.e., the distributional impacts of tough measures like currency

Ammar Malik, senior research scientist at AidData

devaluations are unequal across segments of society. Having said this, as the IMF would argue, these ‘reforms’ are necessary to make countries more solvent and to get other creditors, including Chinese official sector and Western private sector players, regain confidence in the ability of the recipient country to repay debts. They would further say that this is exactly the role that the IMF is supposed to be playing, i.e., stabilizing the international financial system when it comes under distress. From my own observations, mainly in Pakistan, this is certainly playing out with all official and private creditors waiting on the IMF deal with the country to step forward to renegotiate their own deals.

As for China’s role, as was reported in Bloomberg today with insights from Brad Parks, we have found that China has spent nearly $26 billion in emergency loans in recent years, essentially offering bailouts to developing countries who already had Chinese debt on their books.

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