Debt Diplomacy in Sri Lanka: Towards a New Era

By W.M. Piyumi Udayakanthi Bandara*

Published on November 15, 2024

The 2024 Sri Lankan presidential election in September was a pivotal point in the nation’s political and economic history. Traditional electoral narratives of nationalism and ethnic divide are becoming less relevant as Sri Lanka grapples with the fallout from an economic and political crisis. Having experienced economic imbalances, people of Sri Lanka seek for a system change and wants the newly appointed government to relook at Sri Lanka’s relationships with China, India and other major partners.

Harsh economic challenges started to unravel in the country with the debt crisis in 2022, entangling it in a severe debt-trap. Sri Lanka’s growing debts, mostly from foreign-financed infrastructure projects, have forced it to carefully manage its ties with important countries like China, India, and the Western financial institutions. The island nation’s history of borrowing, particularly from China, has raised concerns about the consequences for debt-trap diplomacy and its impact on Sri Lanka’s sovereignty. This article examines the complexities of Sri Lanka’s debt diplomacy, contemporary governance issues, and the path forward for regaining sustainable sovereignty.

Diplomacy Driven by Debt

The goal of Sri Lanka’s early 2000s infrastructure boom, which was primarily financed by loans from nations like China, was to modernize its economy. Projects like the Colombo Lotus Tower, Mattala Rajapaksa International Airport, and Hambantota Port were meant to serve as markers of development and entryways to financial success. But these initiatives soon came to represent a greater burden: unmanageable debt. The incapacity to produce enough income to pay back these debts has consequently raised geopolitical issues since debt has turned into a diplomatic weapon in the hands of lenders.

The Role of China and Debt-Equity Exchanges

The relationship between Sri Lanka and China is among the most controversial facets of its debt diplomacy. China made billions of dollars in infrastructure investments in Sri Lanka as part of its Belt and Road Initiative (BRI). But these initiatives frequently included high-interest loans, which led to a recurrent pattern of reliance. Fears of “debt-trap diplomacy” emerged when Sri Lanka was compelled to lease the Hambantota Port to China for 99 years as part of a debt-equity swap because it was unable to fulfil its repayment obligations.

China’s impact in Sri Lanka extends beyond its financial assistance. Concerns about security are raised by Hambantota’s geostrategic location close to important shipping lanes, particularly for India and Western nations leery of China’s expanding regional influence. For Sri Lanka, striking a balance between strategic autonomy and Chinese economic assistance is a sensitive and an increasingly difficult task.

 The Counterbalance of India

India, Sri Lanka’s nearest neighbour, has not watched quietly as China’s power has increased.  Although it has historically taken a cautious stance, the geopolitical consequences have forced it to get increasingly involved in Sri Lanka’s growth. India is a significant partner for Sri Lanka, offering projects with fewer conditions than China, from sponsoring infrastructure projects to granting credit lines. Many Sri Lankans identify with India’s focus on people-centred initiatives like housing, healthcare, and education, plus New Delhi’s cooperation with foreign partners contrasts with China’s more unilateral strategy. But despite their shared history and culture, Sri Lankan officials are careful to maintain their independence and avoid being unduly dependent on any one partner.

Debt Restructuring and Western Financial Institutions

Western organizations like the World Bank and the International Monetary Fund (IMF) have been crucial to Sri Lanka’s debt restructuring efforts as the financial crisis has gotten worse in recent years. In an effort to restore budgetary stability, these institutions have implemented austerity measures such as tax reforms, reductions in subsidies, and restructuring of the public sector. However, the working class is particularly impacted by these prescriptions, which frequently have a societal cost. These austerity measures have drawn a lot of criticism because Sri Lanka’s poverty rate is rising and its residents are finding it difficult to acquire necessities like healthcare and education. Thus, the Sri Lankan government’s balancing act now consists of enacting the required reforms while maintaining social stability and justice.

 The Challenges of Current Governance

Steering the country out of an economic crisis while preserving political legitimacy and social cohesion is a difficult assignment for Sri Lanka’s current leadership. In addition to an effective bureaucracy, modern Sri Lankan administration calls for openness, responsibility, and inclusive decision-making. Corruption is a widespread problem as it erodes public confidence and impedes efficient government. Concerns regarding the responsible handling of foreign finances are raised by Transparency International’s findings, which regularly place Sri Lanka poorly on the Corruption Perceptions Index. Gaining the trust of both locals and foreign investors requires reforms that focus on corruption, bolster democratic institutions, and guarantee accountability.

Navigating a New Era

Although Sri Lanka's financial problem is a major obstacle, it also presents a chance for the nation to move toward good governance and sustainable development. Sri Lanka may overcome this crisis with more strength and resilience if it learns from its past mistakes and makes the required reforms.

Accountability and Transparency: Establish policies in place to guarantee openness in public spending and decision-making.

Debt Sustainability: To prevent future crises, create a sustainable debt management plan.

Economic Diversification: Encourage environmentally friendly businesses and lessen dependency on debt-financed infrastructure.

Good Governance: To increase public trust, fortify institutions and encourage accountability.

Regional Cooperation: To promote economic cooperation and lessen reliance on any one creditor, interact with regional partners.

To conclude, the financial issue in Sri Lanka should serve as a warning signal to other emerging nations. Sri Lanka can successfully negotiate the difficulties of the 21^st century and create a prosperous future for its citizens by comprehending the dangers of debt diplomacy and putting good governance principles into place.

*The Author is a Research Intern at the Kalinga Institute of Indo-Pacific Studies (KIIPS). She is Pursuing MA in Diaspora and Migration Studies at Gujarat University, Ahmedabad.

Disclaimer: The Views in the Article are of the Author.