West Enables China’s Suffocating Embrace of the Sri Lankan Economy

Sirisena government turns to Beijing after being ignored by western capitals

With Sri Lanka still emerging from the ruins of a 26 year civil war that ended in 2009, the government in Colombo is once again turning to China as the only option at its disposal to modernize the economy by introducing sweeping infrastructural development projects.

The story of the Sri Lankan capital’s hopes to transform itself into an “international financial outpost” in the Indian Ocean—and the ups and downs this the country has faced – confirm to a great extent that while China’s role is not necessarily viewed as completely beneficial, the absence of alternate sources of foreign direct investment makes China an inevitable. It is a scenario that is playing itself out in other countries, not least Pakistan, where China is funding vast projects in what amounts of an investment vacuum.

Sri Lanka’s current president, Maithripala Sirisena, was a vocal critic of the policies of the previous president, Mahinda Rajapaksa, and his strategy of using Chinese capital to attempt to modernize the economy while reportedly enriching himself in the process. Sirisena now himself appears to have joined the pro-China bandwagon due to what many in Sri Lanka believe his inability to attract enough foreign investment from other countries as well as to shore up the central bank’s depleting foreign reserves.

In May, Sri Lanka’s reserves fell further to US$5.6 billion from US$6 billion in April, the lowest since February 2012. According to Shiran Fernando, leading economist at Frontier Research, Sri Lanka as a post-conflict nation has not attracted as much as it could in terms of foreign investments.

Fernando told reporters the reserves are falling mainly because of the level of debt repayment which the economy is not accustomed to as well as outflows from local government securities markets and because of a more volatile global outlook.

Domestic opposition to China’s inroads into the country stems from the realization that Beijing regards Sri Lanka as a means establish its strategic foothold , expand its influence in the region and project its own trade routes under its wide-ranging “one-belt, one-road” expansion plans.

During Rajapaksa’s rule, when a number of significant projects got underway that were funded by taking onerous loans from China, many in Sri Lanka feared that the country would not be able to pay them back, allowing China to take control of these vital infrastructure projects and providing it with a strategic presence in the country.

China, by far Colombo’s largest single lender, secured contracts to build roads, railways and ports. But these investments have largely failed to pay dividends and have left the government drowning in debt. Chinese companies built the Hambantota Port, Mahinda Rajapaksa International Airport (MRIA) and a cricket stadium in the former president’s political constituency, Hambantota. These are now incurring losses because they are not commercially viable. In September 2013, the interest rate for MRIA, which cost US$209 million to build, was increased from 1.3 per cent to 6.3 per cent.

Nor has the Hambantota Port been able to return the dividends it promised. The port was built with a US$306 million loan, 85 per cent of which was provided by China’s Exim bank with a fixed interest rate of 6.3 per cent. In September 2014, Sri Lanka reportedly granted Chinese state-owned companies, China Merchants Holdings International and CCCC, operating rights to four berths at the Hambantota Port, providing it with nearly a 65 percent share in the project as per the 2010 agreement reached between the two countries. But Hambantota is yet to attract investment despite being declared a free port, alongside Colombo Port, in July 2013.

The ‘Colombo project’, a legacy of the previous government attracted stiff opposition from domestic political forces However, the fact that China has successfully lulled that opposition into partnerships signifies the extent of political and economic influence China enjoys in island-country and indicates the possible passage of the ‘financial hub’ into Chinese hands in the future.

The financial backing for the project comes via foreign direct investment from China Harbor Engineering Corporation, a subsidy of the World Bank-blacklisted China Communications Construction, a Chinese state-owned enterprise. It is the largest single example of FDI in Sri Lanka ever. Whereas many of China’s other investments in Sri Lanka come in the form of loans, China intends to directly reap the spoils from Colombo Port City. 

This offshore financial center aims at attracting more than US$13 billion in foreign direct investment from investors outside Sri Lanka such as international banking and financial services companies as well as malls, hotels, and apartment complexes, among others.

On the other hand, the reason China continues to strengthen its presence although many of its projects are failing to achieve even their basic most objectives can be traced to the way Sri Lanka has been side-lined by the United States and the European Union. 

As such, both presidential regimes’ proclivity for finding Chinese partners for infrastructure and investment projects owes its existence not to a personal preference but to a reaction to political and economic pressure from the West.

Between 2006 and 2009, the EU and U.S. shut down most economic concessions and sources of aid to Sri Lanka to what they call “war crimes” against the Tamils during the final stages of the country’s decades-long civil war. After the EU’s GSP-Plus trade concessions to Sri Lanka were discontinued and most of the US aid was cut off, China stepped in to fill the vacuum and, as such, has come to dominate the country to the extent of pumping in more than US$4.8 billion in soft loans, leaving minimal room for investment diversification.

Thus that the current president had to return to China and shun his own opposition to it only confirms the rise of China in Sri Lanka as a “vacuum filler.”  That China needed Sri Lanka for the strategic advantages it provides explains why the former continues to flood the latter with loans and investments and, due to the latter’s inability to pay back, continues to establish its own stranglehold as part of what has been dubbed as its “strings of pearls” strategy.  

However, given the many of the previous projects’ failure to yield expected results, the question that is in everyone’s mind is whether the Colombo Project will be yet another addition to the long list of white elephants, or whether it will really help to improve the country’s economy. In any case, Sri Lanka appears to have had little choice as both the west and India have ignored China’s campaign for strategic advantage.

Salman Rafi Sheikh) is a Pakistani academic and regular contributor to Asia Sentinel.