Will China back out of Sri Lanka’s debt restructuring?

China’s absence from the Sri Lankan debt restructuring meeting in Washington in April signalled growing frustration over Beijing's attitude towards developing world debt woes.

The Chinese delegation had been invited to the meeting to discuss Sri Lanka's Chinese loans but did not attend. This sent a clear signal that China was unwilling to negotiate on its loans. It was frustrated with the slow pace of debt restructuring progress.

The meeting in Washington marked the beginning of restructuring talks with the Paris Club, Japan, and India. The event was intended to inject new momentum into Sri Lanka’s debt talks, which are caught in a standoff between China and other lenders. It also addressed the issues in an effective manner. The meeting ended successfully, with all parties reaching a common understanding.

The negotiations were a step towards a comprehensive agreement between Sri Lanka and its creditors. A timeline was established for the restructuring process to be completed.

Sri Lanka is in a deep debt crisis, and early debt resolution is needed for Sri Lanka to emerge from its crisis, IMF Deputy Managing Director Kenji Okamura said. We hope all official bilateral creditors can participate and negotiations progress smoothly and swiftly. Okamura said.

He believes that the most effective way to address the crisis is for all official creditors to come together and negotiate a resolution that works for both parties. This would allow Sri Lanka to pay off its debt and move forward with its economic development plans.

In addition, this would also benefit creditors, as it would provide them with regular payments and ensure their interests are protected. This could be a win-win situation for both parties and help Sri Lanka get back on its feet.

The launch of the talks came just a day after China agreed to soften some of its demands during a roundtable convened by the IMF and the World Bank. The roundtable was convened to devise broader guidelines for debt relief to low-income countries.

However, those discussions are poised to continue in the months ahead with significant issues unresolved. It is yet to be seen if China's softened stance at the roundtable will secure a debt relief agreement. Nevertheless, the talks are a significant step forward in resolving the debt crisis.

Hanging over those wider talks are concerns about China’s role in negotiations involving countries like Sri Lanka and Zambia. These countries are facing increasing economic strains because of slow debt resolution.
Sri Lanka and other creditors want China to participate. They were quite eager at that stage that China wouldn’t hold up negotiations any further.

Sri Lanka, in any case, was not willing to negotiate a separate debt deal with China, which would concern other creditors. This was because they were concerned that a separate deal would set a precedent. This would mean that other creditors could demand similar deals, disrupting the negotiations and delaying the debt issue resolution.
Japanese finance minister Shunichi Suzuki said China had been invited to the talks but had failed to participate.

The Chinese embassy in Washington was also reluctant to respond to a comment request. The Chinese government has yet to comment on the issue. Meanwhile, Japan has expressed disappointment at the Chinese government’s decision not to attend the talks. Japan has urged China to reconsider its decision and join the negotiations.

Suzuki said the framework for the Sri Lankan talks had been negotiated by Japan, India, and France as the traditional representatives of the Paris Club of rich creditor nations. He hoped that the Sri Lankan talks would become a model for negotiations with other countries.

"We want China to participate in the talks very much," Suzuki told reporters. Talks should take place on an equal footing, with decisions made after negotiations using transparent debt data.

Meanwhile, Sri Lanka’s president has called on China and its other creditors to quickly reach a compromise on its debt restructuring. This is the alternative to creating more economic peril.

Sri Lanka is already facing an economic crisis due to the COVID-19 pandemic and financial mismanagement, especially during Gotabaya Rajapaksa's presidency. He granted an unprecedented tax benefit to big companies soon after the election. As a result, the government lost a lot of revenue due to government coffers. Debt restructuring is seen as a way to help the country recover. Allowing Sri Lanka to restructure its debt in a more sustainable way would be a lifeline for the country.

Sri Lanka Central Bank Governor Dr Nandalal Weerasinghe called for an early resolution of the restructuring talks. Without restructuring, the country would struggle to pay its debt obligations, and this could result in further economic hardship. This could also have a negative impact on the country's credit rating and debt sustainability. Restructuring the debt would help the country manage its debt burden in a more manageable and sustainable way. It would also give it the opportunity to invest in economic recovery.

"It’s in the country's interest for China and Sri Lanka both to complete this process soon, and we can get back to repaying our distressed obligation," Weerasinghe said in an interview in March. "We have to do it as soon as possible."

Paris Club members, including Japan, account for $4.8 billion, or more than 10% of Sri Lanka’s external debt, according to IMF data. That is slightly higher than China, which stands at $4.5 billion, while India owes $1.8 billion.
"Given the relationship between Japan, India, the Paris Club, and China—and that none of them have as much skin in the game—the chances that China would join a group led by them were somewhere between slim and none," said David Loevinger, a sovereign analyst at TCW Group and former U.S. Treasury Department senior coordinator for China affairs.

Beijing "is unlikely to take diktats from smaller creditors," he said, adding that it "will likely follow its own way in dealing with Sri Lanka." China has a history of taking unilateral action when it comes to countries that owe them money, and they are likely to continue that approach in dealing with Sri Lanka. They have the power and influence to do so. This makes it unlikely that smaller creditors will influence Beijing's decisions.

The IMF approved a $3 billion, four-year bailout for Sri Lanka on March 20 and urged a speedy resolution of debt-restructuring talks. China has already rescheduled some Sri Lanka debt repayments and proposed a debt-for-equity swap. Sri Lanka has yet to accept the offer, however, as the swap terms remain unclear.

This is how China uses its economic and political clout to pressure smaller countries to acquire their assets to enhance its influence over them. In that sense, Sri Lanka will be at a disadvantage in an equity swap, as in the case of the Hambantota Port. It is in Sri Lanka's most beneficial interest if China joins other lenders and participates in debt restructuring discussions. In addition, most Chinese projects, such as the Lotus Tower, Mattalal Airport, and Hamabntotoa Port, are liabilities and burden the Sri Lankan economy.

Sri Lanka is hoping to secure an agreement with China to restructure its debt, which could reduce the bailout burden. However, Sri Lanka has yet to finalise the agreement details. Until then, the country will remain dependent on an IMF bailout for its economic recovery.

Emerging-market debt distress and cooperation among creditors were key themes at the IMF and World Bank meetings in Washington in March. Much of the focus has been on China, which in recent years has become the world’s top sovereign creditor.

The Chinese government has been criticised for its lack of transparency and tendency to over-lend to countries with weak economic fundamentals. This has led to growing concerns about debt sustainability and default risk. Countries such as Argentina and Pakistan have already sought IMF assistance due to their unsustainable debt levels. The rescue efforts for Sri Lanka have been a test case of China’s willingness to work with other creditors to provide debt relief.

In February, Paris Club creditors, as well as Hungary and Saudi Arabia, called on China to join the international effort to relieve Sri Lanka's debt. The appeal for financial backing from the world’s second-biggest economy came amid fears that China’s unilateral positioning might delay and even complicate Sri Lanka's rescue, similar to what happened in Zambia.

The rift between Beijing and the Paris Club as well as multilateral institutions has delayed efforts to ease debt burdens on developing economies struggling to recover from the pandemic and repay loans, even as a stronger dollar and higher interest rates increase debt servicing costs.

Sri Lanka last month took a key step towards external bondholder cooperation for restructuring $84 billion in debt. It agreed to include local-currency bonds in the programme. China's adamant attitude towards smaller countries may threaten debt restructuring efforts.