Will multilateral development banks step up to meet Sri Lanka’s funding gap?

After the outbreak of Covid-19 earlier this year, some predicted that the pandemic’s economic reverberations in Sri Lanka would lead China to increase its already considerable funding to the island state. Indeed, as early as mid-March 2020, the China Development Bank agreed to lend Sri Lanka US$500 million when it upsized an existing facility signed in 2018. More recently, the CDB agreed to lend a further US$140 million to the state-owned Bank of Ceylon.

Predictions of Sri Lanka’s closer ties with China have redoubled since the sweeping electoral victory of the Sri Lanka Podujana Peramuna—the party of President Gotabaya Rajapaksa and Prime Minister Mahinda Rajapaksa—in the country’s legislative elections on 5 August.

Several factors could propel Sri Lanka and China to forge closer relations, but there are also some countervailing pull factors that may limit the extent of China’s funding and influence. An underappreciated pull factor is the contribution of multilateral development banks (MDBs) to alleviating the country’s economic burdens. During the Covid-19 pandemic, MDBs like the Asian Development Bank have contributed far less to Sri Lanka than they have to other South Asian countries. This in turn has amplified China’s bilateral role in the country. Increased funding from MDBs could reduce the depth of China’s future footprint in Sri Lanka.

A recent paper by Chatham House, which I co-authored with other Sri Lankan colleagues, challenged the narrative that Sri Lanka is mired in a Chinese debt trap—noting that debt to China amounted to less than 6% of GDP in 2018. Nevertheless, it also recognised the risk of a debt trap in the future, and critics have pointed out that loans from China come with fewer procedural safeguards than those from MDBs.

The predicted negative economic growth in Sri Lanka this year as a result of the global pandemic will add pressure to the country’s debt-to-GDP ratio, which stood at 87% last year, and to its ability to service that debt with limited dollar reserves. These concerns are despite Sri Lanka’s success in containing the pandemic due to early and decisive steps like closing its borders in March and an active contact tracing system. At the end of July 2020, there were fewer than 2,900 cases and 11 deaths.

Sri Lanka’s challenging economic reality is among the strongest push factors towards its greater dependence on Chinese bilateral aid. This is particularly because of China’s reliably swift responses—a speed that was also evident after the devastating terrorist attacks on Easter Sunday last year, when China was the first country to relax its travel advisory about Sri Lanka.

Further push factors include the new government’s need to garner global support to defend Sri Lanka’s human rights record in international forums, increase foreign investment, modernise its technological capabilities and meet its significant infrastructure gap (at an estimated cost of US$24 billion based on a 2014 World Bank study) through existing projects under the Belt and Road Initiative and new development projects. An additional push factor is the growth of China’s public diplomacy, including with Sri Lanka’s majority Buddhist community.

On the other hand, the logistical difficulties faced during the pandemic by many construction and other companies in Sri Lanka point to the country’s need to diversify its supply chains from China. Other pull factors that sustain Sri Lanka’s non-China relationships, and can thereby limit China’s influence, include Sri Lanka’s need for economic assistance from diverse sources and its multifaceted security relationships with India and other partners. More generally, pull factors encompass Sri Lanka’s need to give visible contours to a non-aligned foreign policy that it has pledged to continue, particularly in view of spiralling US–China tensions.

One pull factor that warrants special mention is the extent to which international financial institutions are aiding, or could aid, Sri Lanka. After the outbreak of Covid-19, Sri Lanka sought US$300 million from the Asian Development Bank and an additional amount from the Asian Infrastructure Investment Bank, and renewed its discussions with the International Monetary Fund. Sri Lanka is yet to receive substantial funding from MDBs, relative to its neighbours. As of the end of July, MDBs had committed US$386 million to Sri Lanka, compared to, for example, the over US$1 billion allocated to Nepal.

Although media reports have highlighted Chinese assistance to Sri Lanka, these reports neglect a comparative perspective. In effect, Chinese loans in this pandemic year are helping Sri Lanka to close its funding gap from MDBs. The role of multilateral aid in shaping China’s post-Covid footprint in Sri Lanka is particularly significant because of opposition in some quarters to bilateral assistance, particularly from the US—which has offered a compelling US$500 million grant for transport and land administration projects—and India, from which Sri Lanka has nevertheless accepted a US$400 million swap facility that contributed markedly to Sri Lanka’s foreign reserves.

In this context, middle powers like Australia—which partnered with the World Health Organization to commit A$600,000 to Sri Lanka’s Covid-19 response—would do well to continue to support MDBs and other multilateral initiatives. Australia should likewise continue to back multilateral institutions like the Indian Ocean Rim Association that help to maintain a rules-based, peaceful Indian Ocean—an objective that Sri Lankan policymakers know is indispensable to the country’s future and will require the cooperation of many nations beyond China.

China has established itself as an enduring partner of Sri Lanka. During the Cold War, Sri Lanka turned alternately to the West and the Soviet Union, depending on its leaders in power. There is little such local vacillation in the ‘new cold war’ between the US and China; even the presumed pro-Western government between 2015 and 2019 relied heavily on Chinese assistance.

That China will solidify its partnership with Sri Lanka appears a given, but the extent to which it does so will depend on multiple factors that link Sri Lanka to its non-Chinese partners. International financial institutions have a key role to play in diversifying Sri Lanka’s international partnerships and engagement, a role that that middle powers can also support in different ways.

This post is part of an ASPI research project on the vulnerability of Indo-Pacific island states in the age of Covid-19 being undertaken with the support of the Embassy of Japan in Australia.