HAS SRI LANKA BEEN CAUGHT IN A CHINESE DEBT TRAP? PART 1
Posted on November 13th, 2020

BY EDWARD THEOPHILUS

What is a debt trap, is a question to ordinary people in the country, because many people have no understanding of the debt trap issue, and access to related statistics? People know what is a trap, and how to use a trap for various purposes.  A trap is used to catch animals, and popularly, a trap uses in houses to catch rats and mice. Is Sri Lanka a country like a rat looking for debt?   There is no doubt that debt management in the country has been weakened since the 1990s, and the demand for money on account of various development projects forced the country to borrow funds from outside.

According to experience in the country, traps are used to protect various agricultural produces from thefts, destruction, and waste by animals and insects. It seems that traps in some instances were used to punish enemies who didn’t steal, but to get revenge, and is this usage of a trap a legally approved punishment system? No, it is, China doesn’t want to treat Sri Lanka as an enemy to punish, as it has been maintaining a consensus with Sri Lanka that could be traced back to centuries, and the relationship has renewed after the visit of Mr. Xi Jinping in 2014.

 People who have a general understanding of criminal law know that punishing people using a trap is not in terms of the Penal Code, and the punishment system is not associated with the court system of the country, or it is not a civilized method of punishing the country.  Therefore, a trap is neither a legally valid punishment method nor a generally implied method of punishment. The concept of debt is appeared to be a warning signal to the country.

Does China want to catch Sri Lanka in a debt trap? Is the debt trap being a poetic term reasonable to describe the current debt crisis in the country, as many countries have relegated to the debt problems in the COVID 19 Pandemic era? Why does China want to catch Sri Lanka in a debt trap in the crisis? From the point of view of the west or sometimes, Indian foreign policymakers, China wants to trap Sri Lanka to use for the success of its trade root concept, Silk Road considering the strategic situation. The differences and hostile situation between the western countries and India with China are not valid reasons to discredit the relationship between China and Sri Lanka.  The countries where have relationships with Sri Lanka have not attempted to abase foreign relationships.      

In economics, the term trap was used by John Maynard Keynes in his book, titled General Theory”, and the term used to interpret the liquidity preference, which is a broader concept of the motives of demanding money. Later, the idea was used to make economic policies. According to Keynes, the rate of interest is a defending factor in demanding money for speculation, the rate of interest is a leg of the demand curve for the speculative motive. The expected changes in the rate of interest would be a factor for demanding money for the speculative motive, and the concept is used to interpret the debt market behavior too. 

Economic theory assumes that whilst borrowing is depending on the rate of interest, and the theory is applied to the credit market. The borrowing may lower when the price of debt is higher, and the borrowing may lower when the price of debt or the rate of interest is higher. This is working with the assumption that other influencing factors for borrowing are not changing.  This theoretical aspect may relevant to developed countries, and respecting developing countries like Sri Lanka, the theory is applied distinctly because the government needs to borrow money for various purposes. 

In the current dynamic environment, the total revenue of the government is not equal to total expenses (Y is not Equal to C), and the government has to borrow money to settle the expenditure in the fiscal process which is current, recurrent, and investment purposes.  

The volume of debt in any country should be related to the rate of interest, it is the theoretical assumption, the reality differs from the theory as in many countries the volume debt determines considering other factors such as loan conditions. For example, Sri Lanka obtains loans from China as other international credit suppliers failed and reluctant to support the country. In the current dynamic environment, the government cannot manage borrowing consistent with the theoretical assumption as explained above. In a situation that the rate of interest is higher the total debt of the government should be lowered, however, the idea may relevant to developed countries like America, Japan, or Germany, or the UK.  It is not practically the truth in developing countries like Sri Lanka.

In a totalitarian country, the leader can stop borrowing by force, however, in a democratic country, the government should respect the voice of the people and may need to borrow more than the capacity to repay. It is the situation that appears in Sri Lanka.  The government is compelled by the wishes of the people or forced by the election promises to borrow more money for general spending and investments. In some instances, developed countries offer credit lines to developing countries with conditions to buy their productions and services. It is a complicated factor of foreign help that uses debts as help to own business than supporting developing countries. For example, many people in Sri Lanka doubt the Kalani Valley light-rail project under JICA assistance is helping Japanese firms than helping Sri Lanka. 

As explained above, the rate of interest is a determining factor for borrowing and Keynes assumed that the rate of interest will not be lower than 5%, and if it happens so, it would become a liquidity trap, because the country can borrow more and more if the suppliers of debt agree to provide credits. The idea of Keynes was the demand for money for speculative purposes.  The liquidity trap indirectly advises that not to demand more money for speculative motive, it may be negatively affected the aggregate demand in the economy that reduce employment and national income.  He did not explain what would be a negative result, later, his fellow economists such as Alvin Hanson, L.R Khan precisely described the situation.

If a country borrows too much at a lower rate of interest it would get caught in a liquidity trap that is the lesson that should understand from the idea of Keynes or trap theory.  In Sri Lanka, there is no standard of the volume of debt that could be easily regarded as a limit to evaluate the country, and the borrowing more than the limit may be caught in a debt trap.

No standard has been set by the monetary authority for borrowing, and the limit should be published for people to understand. Many countries have determined the standard borrowing limit as a percentage of the Gross Domestic Product. The current foreign debt in Sri Lanka as a percentage of GDP is 69.64%, and if it takes together domestic and foreign debt the ratio might be very higher. 

The value of foreign debt in 2019 was US $ 55916 Million (Rs 10156 240 Million), and the value of GDP was Rs.14583892 Million. It is difficult to find the volume of total debt borrowed from China.

It is clear that debt to GDP 69.64% is at a higher level but it cannot define as in a trap.  My feeling is foreign debt should stay less than 35% of GDP, and the current ratio of 69.64% is at a higher level, and this ratio should be further reduced before more borrowing. It is a gigantic policy task for the government. If the government reduces the foreign debt level to 35% of GDP the volume of foreign debt stays at the US $ 30 billion limits at the current level of GDP.  The calculation based on the current higher value of Sri Lanka rupees to a US dollar and if the foreign value of Sri Lanka’s monetary unit could be increased then the debt burden of the country could be reduced.

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