Sri Lanka has deployed troops at fuel stations as protests have erupted across the island nation over shortages. Motorists have had to deal with long queues daily in order to fill their tanks as the country has been facing a severe fuel shortage. And this is just one of the many issues plaguing the country. Sri Lanka is in the grip of a full-scale economic breakdown.

Rising prices and the nation’s debt crisis have turned the situation extremely grim. There have been extreme food shortages as private banks have run out of foreign exchange to finance imports.

Why is Sri Lanka’s economy in such a bad state?

Sri Lanka’s economic woes stem from its lack of foreign currency. Without adequate foreign currency reserves, the country has been unable to import fuel, food and other key goods.

The COVID-19 pandemic struck one of the major sources of foreign income for Sri Lanka -- tourism. Not only did foreign tourist numbers dwindle, remittances from Sri Lankan expatriates also shrunk, worsening the situation.

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Sri Lanka’s decision to completely ban all non-organic fertiliser around the time meant that farmers were forced to pay nearly double for organic fertilisers, passing off the cost to consumers. Fertiliser prices have been highly volatile over the past year and have been shooting upwards due to increasing crude and natural gas prices, which means that food items have become more expensive.

Hoarding of food items like rice and sugar is making matters worse.

Where does Sri Lanka’s debt come in?

Sri Lanka has extensive foreign debts that it had secured for infrastructure projects. The country accrued foreign debt of $35 billion in 2021. While a significant part of this debt is owed to other countries in the form of concessionary loans, the largest sum of borrowing for Sri Lanka is in the form of international sovereign bonds. These bonds amounted to 39 percent of the total foreign debt for Sri Lanka in 2017.

What about the Chinese debt trap?

China accounts for nearly 10 percent of Sri Lanka’s total foreign debt in the form of concessionary loans, though additional commercial loans through Chinese state banks have also been procured by Sri Lanka.

As a result of its deteriorating financial situation, Sri Lanka had to hand over control of the Hambantota port constructed in the southern part of the country to China for 99 years as part of the loan repayment process. The port was constructed using Chinese money and was seen as an unnecessary expense, especially given the dire straits of the Sri Lankan economy.

Sri Lanka had at various points also considered leasing other infrastructure projects to other countries apart from China to make up for losses and to reduce financial burden on its beleaguered exchequer.

The country has been seen as a prime example of the Chinese ‘debt trap’ narrative, where China aggressively pushes developing countries into building large infrastructure projects using Chinese loans. When these nations are unable to pay back their loans, they have to hand over the infrastructure projects to Chinese authorities.

While China has been a major financier of infrastructure projects in countries like Sri Lanka, Kenya, Djibouti, Laos, Zambia, Malaysia and Kyrgyzstan, the notion of ‘debt trap’ diplomacy has been challenged by many experts, especially in the case of Sri Lanka.

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“Sri Lanka would have encountered concerns pertaining to external debt sustainability and persistent balance of payment (BOP) issues even in the absence of Chinese debt. Of course, there were serious concerns regarding the economic sustainability and the necessity of the projects financed by the Chinese at the time those were initiated. Yet the bigger issue behind Sri Lanka’s debt crisis was the choice to borrow from international capital markets at commercial rates at a time when the country’s exports were going down even while the government consistently failed to fix structural issues such as the reduction of trade, rising protectionism, and reduction of government revenue,” explained Umesh Moramudali, economic researcher focusing on public debt dynamics in Sri Lanka and international trade, University of Warwick, for The Diplomat.

The lease of the Hambantota port is also often portrayed wrongly. While the port was constructed using loans from China Eximbank and built by China Harbor, it was only done so after Sri Lanka was snubbed by both the US and India, reported the Atlantic.

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Sri Lanka engineered a bailout with the help of the International Monetary Fund (IMF) and leased the underperforming port to China Merchants for $1.12 billion in cash in exchange for being the majority shareholder in a 99-year lease. This money was not used to repay Eximbank, but to bolster foreign exchange reserves. Sri Lanka still owes its debt to China Eximbank.

Political upheaval, dwindling economic conditions and poor planning led to the port being unsuccessful and being leased out.

India playing a good neighbour

The seizure of the port raised concerns for India as has the steadily deteriorating situation in its southern neighbour. India has already extended a $912-million loan in addition to $1.5 billion split across two credit lines for the purchase of food and fuel from India.

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“Neighborhood first. India stands with Sri Lanka. US$ 1 billion credit line signed for supply of essential commodities. Key element of the package of support extended by India,” tweeted S. Jaishankar, Minister of External Affairs of India.

India is also working with Sri Lanka for its negotiations with the IMF for an additional bailout, reported the Indian Express. India would also be taking up a stronger role in helping Sri Lanka develop its renewable energy, ports, logistics, infrastructure and connectivity structure through investments.

(Edited by : Shoma Bhattacharjee)