Sri Lanka - analysing the China mirage!


By C.R. de Silva

Retired World Bank Professional



In the late 2014, when the present coalition group was canvassing votes for the presidential election, a major plank of its election platform on foreign policy issues, focused on the financing and supportive role that China had played in extending loans to the last government, amounting to a total of about eight billion dollars, denominated in various interest rates, as well as terms and conditions. This huge amount of bilateral aid from China was roundly criticised, combined with allegations of overpricing and corruption, never yet proved. These loans were mostly utilised for upgrading Sri Lanka's infrastructure, mainly ports, highways and the proposed Colombo Port City.

In January 2015, when a regime change took place as a result of the election and a new President was inaugurated, the current government adopted a clearly anti-China political stance, suspended work on the Port City project, and looked to the West for its external financing needs, in the context of an overtly western political tilt. However, there is no indication that the expected massive transfers of funds took place from any of these western countries during 20116, but that the prominent stamp of western support seems confined to what has now become known as ‘human rights colonialism’, pursued through the UNHRC and other UN agencies, dominated by western countries, and largely condoned by the current regime in Sri Lanka.

This critical economic impasse led the Prime Minister to visit China to mend bilateral fences and re-establish the political relationship with the Chinese at the highest level, leading to re-negotiation of the terms of the Colombo Port City project as well as a reported resumption of a Chinese government financing as well as the earlier private sector investment role in various large infrastructure projects, especially connected with the Chinese-built Mattala airport and port at Hambantota.

While the public has seen no formal Chinese confirmation of these developments, or public evidence of the spirit and letter of international agreements testifying to these recent understandings, resumption of Chinese financial support has been unilaterally confirmed by top government policy makers.

The outcome of these recent developments is that aside from the so-called IMF three-year instalment loan under the Extended Fund Facility amounting to a total $ 1.5 billion, where total funding will, nevertheless, be transferred only by 2018, only in half-yearly $220 million tranches and upon prior satisfaction of various onerous economic and financial reform conditions, the only other substantial funding source for the government appears, in some sense of reality, to be China.

The well established World Bank and Asian Development Bank loan programs will, of course, continue on a project basis as before, disbursing funds generally over a five- year period, as also various bilateral aid programs financing project and program aid, finally amounting to about another $ 650 million, but not in the large amounts urgently required by the government to meet huge billion dollar debt servicing obligations falling due, and local financing for needed domestic project counterpart expenditures. These financing needs will largely be met from bond issues.

The significant issue whether China as a very major, virtually only, source of foreign exchange funds to meet Sri Lanka's large external financing needs is a realistic assumption, both for debt servicing as well as for development funds, over the short as well as medium terms, depends on the prevailing and projected economic situation in the world, given a high degree of globalization and international trading today, and in the larger countries of Asia, as well as, obviously in China, which is itself influenced by global events.

The analysis that follows seeks to shed light on these important considerations, which will directly impinge on the reliability of China as a virtually guaranteed external financing source for Sri Lanka, and clarifies the realistic prospects for stabilising the country's economy and for the sustainable development of Sri Lanka in the coming months and years.


An IMF Report (World Economic Outlook) in April 2016 on the subject,characterises the situation as follows: "Global recovery continues (i. e. following the 2007-8 depression), but at an ever-slowing and increasingly fragile pace ... we have seen a renewed episode of global as set market volatility, some loss of growth in the advanced economies, and continuing headwinds for emerging market economies and lower-income countries (like Sri Lanka). In addition, several stresses of non-economic origin threaten economic activity ... leading us to a further broad-based reduction in our baseline projections for economic growth in 2016 and 2017... although slightly higher than in 2015. Yet that outcome is far from assured. Significant downside risks remain and events that make those risks more salient may well trigger renewed financial turbulence". Economics is sometimes derisively described as an inexact science, and the message the reader may get from the above is that the IMF is hedging its bets, because the global economic outlook is uncertain.

This analysis, replete with jargon, seems to get even more ambiguous and inconclusive, as follows: "What are the risks? Important among purely economic risks is a return of financial turmoil itself, impairing confidence and demand in a self-confirming negative feedback loop. Despite the recent pullback in asset (meaning stock/bonds) prices, financial conditions in the United States, Europe and Japan, have been ona tightening trend since mid-2014...Yet financial conditions have tightened even more outside the advanced economies. Increased net capital outflows from emerging markets (like Sri Lanka), could lead to further depreciation of their currencies, eventually triggering adverse balance sheet effects. Market perceptions of constrained economic policy space have added tothe recent bout of pessimism. These worries remain and arespecially relevant for emerging market and developing economies" (again, like Sri Lanka). From the above IMF analysis, this writer's assessment is that the earlier cautionary uncertaintyabout the global outlook is now tilting towards the negative!


Since Asia has been riding the crest of seemingly unstoppable growth, this Continent's rise in the last three decades hascaptured the world's popular imagination, surprising Americaand Europe with its progress. This has led some analysts of the emerging global scenario to have dubbed the twenty firstcentury as "The Asian Century".

Sri Lanka, occupies a very geo-strategic location in Asia, at the very centre of the shipping lanes between Europe and theMiddle East on one hand, and the Far East on the other, which is the gateway to China and Japan and the smaller 'miraclee conomies'. But globalization and the increasing sophisticationof technology has contributed to tectonic global shifts, which occur periodically without warning. There is now concern that influenced by the global economic slowdown just discussed, one such shift may be on the horizon.

On Asian countries, a recent IMF Report's conclusion is that while the Region "remains the most dynamic part of the global economy, Asia is facing severe headwinds from a weak globalrecovery, slowing global trade and the short-term impact of China's growth transition (from a mostly export to a consumerdemand economy) ... High debt poses a significant risk in Asia, especially because debt levels have increased markedly (like in Sri Lanka, and including China and Japan) ... Overall, the Asia Region has become more sensitive to the Chinese economy", where its economic re-balancing "will have short-term adverse effects". This important point, very meaningful for Sri Lanka deserves analysis here later, China being its premier funding source.

The IMF also refers to the Asia-wide need for structural economic reforms, including gradual fiscal consolidation; adjustments to composition of spending; more inclusive growth by reducing income inequality, which has risen in most of Asia; addressing inequality of opportunities, particularly broadening access to better health and education; expanding coverage of social spending; improving tax progressivity; addressing near-term risks from large exchange rate depreciations, and managing risks associated with high leverage (meaning debt) and financial volatility; and lastly, state-owned enterprise reform in China. Sri Lankan policymakers would do well to focus on all the above-mentioned critical development issues identified by the IMF for Asian countries, which have particular relevance for Sri Lanka.

This next IMF argument is even more important for the subject under analysis here: "China, now the world's largest economy on a purchasing-power-parity basis, is navigating a momentous but complex transition towards more sustainable growth on consumption and services. Ultimately, this process will benefit both China and the world. Given China'simportant role in global trade, however, bumps along the way could have considerable spillover effects, especially on emerging market and developing economies". (The IMF is again referring to China's ongoing transition from an export-oriented to a consumer-demand driven economy).

"Adding to these headwinds are concerns about the global impact of the unwinding of prior excesses on China's economy, as it transitions to a more balanced growth path after a decade of strong credit and investment growth, along with signs of distress in other large emerging markets .... The re-balancing process in China may be less smooth than assumed. A sharper slowdown in China ... could have strong international spillovers through trade,commodity prices and confidence and lead to a more generalized slowdown in the world economy".

The IMF finally concludes that "consecutive downgrades of future economic prospects carry the risks of a world economy that reaches stalling speed and falls into widespread secular stagnation".

To be continued tomorrow

animated gif
Processing Request
Please Wait...