How America Can Find Opportunity in Sri Lanka’s Debt Crisis

How America Can Find Opportunity in Sri Lanka’s Debt Crisis

There is a lot at stake in resolving Sri Lanka’s debt crisis.

 

The lesson of the Russo-Ukrainian War is that the world badly needs American leadership in this era of global turmoil and great power rivalry. By contributing billions of dollars worth of military hardware and humanitarian assistance, the United States has been Ukraine’s bulwark in preventing a Russian occupation of Kyiv, preserving the bedrock of the international world order that America’s “Greatest Generation” struggled to create amidst the ashes of World War II.

While war still rages, the United States may have to export that lesson to a different part of the globe, flexing its foreign policy muscles to assist another nation critical to our security interests.

 

In Sri Lanka, the scene is one of complete misery. Years of economic mismanagement by the ruling Rajapaksa family has depleted the country of its foreign currency reserves and created staggering inflation. Lines in the national capital of Colombo stretch for miles with people scrapping for the remaining quantities of food and kerosene cooking oil. Violent protests have become a regular feature outside the president’s house, and without significant foreign assistance and imports of critical supplies like food, gas, and medicine, it is likely that most Sri Lankans will suffer, and many will die.

In Sri Lanka, as in Ukraine, the United States has a chance to reassert its role as the leader of a rules-based international order, and provide a virtuous alternative to the revisionist machinations of autocratic societies like Russia and China.

Sri Lanka, like many other developing countries in the Asia-Pacific, has been a victim of Chinese predatory lending as a part of Xi Jinping’s Belt and Road Initiative (BRI), seeking to expand China’s influence by becoming a friendly creditor for the global south. Over the past decade, Sri Lanka has accumulated over $11 billion in debt from this BRI, largely on unprofitable “white elephant” projects with little upside—most notably the Hambantota Port in the country’s south, which was leased to a Chinese conglomerate for ninety-nine years due to the Sri Lankan government’s inability to service its debt obligations. These loans, unlike those provided by Western governments and institutions, often have predatory repayment structures, with interest rates exceeding 4 percent (compared to around 1 percent from an Organization for Economic Co-operation and Development creditor) and repayment periods of only ten years (OECD creditors average twenty-eight years).

Now, with Sri Lanka in the midst of its worst economic crisis in seventy years, and foreign currency reserves totalling less than $50 million, the country has no choice but to default on all its foreign debt repayments. The government, led by President Gotabaya Rajapaksa of the powerful Rajapaksa family, has reached out to China for $2.5 billion in emergency assistance. Xi, in turn, replied with a curt “no, thank you,” and sent a measly $31 million as emergency humanitarian aid. China’s Ministry of Foreign Affairs has also rejected every request by the Sri Lankan government to restructure its debt obligations.

These are not the actions of a “friendly creditor,” but instead are the hallmark features of China’s “debt trap diplomacy.” With one eye towards its global image, the Chinese Communist Party is wary of making any concessions to the terms of its loans, for the precedent it would set with other developing countries seeking debt forgiveness. Chinese lenders are encircling Sri Lanka like vultures, waiting for the small island nation to crack under the pressure of its economic situation and consent to debt-to-equity swaps, where past loans would be converted into Chinese control of major infrastructure projects—much like the Hambantota Port fiasco. China is using these loans not to enrich the lives of Sri Lankans, but to turn a profit and to gain access to natural resources.

It is important for America to show that there are better options available. Unlike Chinese loans that prioritize profit, bridge loans and rapid aid from international financial institutions and bilateral partners are designed to prioritize the Sri Lankan people. The International Monetary Fund, headquartered in Washington and whose largest voting member is the United States, should expedite the use of funds from its Rapid Financing Instrument (RFI), which would cover short-term balance of payment issues and provide for necessary purchases. The IMF should also make available its larger Extended Fund Facility (EFF) to further aid humanitarian efforts and to ensure that needed structural reforms are implemented. In all, these funds could amount to $600 million in financial assistance, a large step towards completing the $6 billion shortfall needed to cover short-term debt obligations and replete foreign currency reserves.

Beyond the IMF, however, there is much more the United States can do to help the people of Sri Lanka. A starting point would be to reignite the Millennium Challenge Corporation’s (MCC) $480 million Compact with the government of Sri Lanka. The MCC’s Board of Directors approved these funds in April of 2019, but were rejected by the government of Sri Lanka over “sovereignty issues.” These funds would help to reduce poverty through economic growth, by improving transportation and providing secure land titles to Sri Lankan farmers. Displaying a willingness to restart this compact would signal to the Sri Lankan people that America stands ready to assist, and to be a force for good in the long-term improvement of Sri Lankan society.

Congress should also consider passing legislation to provide direct humanitarian assistance to the people of Sri Lanka. This could include direct aid channeled through the U.S. Agency for International Development (USAID), as well as language mandating the Treasury Department to secure debt relief for Sri Lanka—both debt owed to the United States and to its allies. This is important because, while the United States is not a large creditor of Sri Lanka, America’s friend and security partner Japan currently holds 10 percent of Sri Lanka’s debt obligations. Working with Japan to reduce this burden can go a long way to correcting Sri Lanka’s insolvency.

There is a lot at stake in resolving Sri Lanka’s debt crisis. The island nation is strategically located in the center of the Indian Ocean, and over 60,000 ships pass close to its territorial waters each year, accounting for over 24 percent of container traffic in the South Asian region. America and Japan, duly cooperating to create a Free and Open Indo-Pacific (FOIP) strategy, must consider the importance of a stable and economically prosperous Sri Lanka to its larger national security interests. Turning a cold shoulder now would only push the nation further towards China’s sphere of influence, and with it only more debt and despair. It is time for America to resume its role as a global superpower, reassured of its status as the greatest guarantor of peace on Earth, and it can begin by using the institutions it created to aid the people of Sri Lanka.

Harrison Nugent is a JD candidate at Stanford Law School and a Henry Luce Asia Scholar working at the Nakasone Peace Institute in Tokyo.

Image: Reuters.