HAS SRI LANKA BEEN CAUGHT IN A CHINESE DEBT TRAP? PART 2
Posted on November 13th, 2020

BY EDWARD THEOPHILUS

Sri Lanka has good strategies for debt management and the current debt statistics don’t indicate that Sri Lanka has caught in a Chinese debt trap, and China helped Sri Lanka to expand its GDP base by initiated loan projects, and Sri Lanka needs to expand Chinese sponsored projects in many areas, not only limiting to the infrastructure development but also Chinese involvement in agriculture, building, and industrial areas are needed. For example, the productivity and competitiveness of manufacturing industries could be massively improved when Chinese investors are associated with Sri Lankans, and such a co-operation will cradle the dramatic increase in the volume and pace of annual GDP growth. If it happens the annual growth could be increased to more than 6% and get out of a possible debt trap because Sri Lanka can retire more debt.

When considers the volume of current foreign debt in Sri Lanka it is not in a debt trap, and further borrowing without improvement of the GDP level of the country will involve in a trap.  The debt trap story is a warning signal to the country. The government must concentrate to increase GDP that could be done by two strategies. One is an increase in domestic production, many areas of domestic production have been declined due to various reasons such as ignoring the productivity, competitiveness, innovation, and adding new sources to domestic production.

The government always reiterates that it has not defaulted repayment of debt it is not a valid answer to the question. If it evaluates the way of debt service it is clear that the debt repayment is a heavy burden to the country. The debt repayment has been forced to limit many economic activities such as import controls and investment controls. Farmers in the country have a grave problem with water and no successful projects are initiated to solve the basic problem.        

The rate of interest is a major macroeconomic factor that influences the economy, and Keynes believed that the interest rate will not reduce less than 5% and if it reduces less than 5%, he stated that a country would be in a liquidity trap. In developed countries, the rate of interest has declined to less than 5%, and many people caught in the debt trap as they have borrowed for housing, personal loans, credit card debt, and many others.  The lower growth of economies in developed countries in the COVID 19 environment, the rate of interest has declined to less than 5% and the situation doesn’t look that individuals and firms motivate to borrow more as the revenue of firms, as well as individual, has dramatically declined and in this environment, it shows that liquidity trap theory is not working as it stated by Keynes.   

The meaning of the debt trap to any country is that it borrows more than the affordable limit it will be caught in a debt trap, and when a country is in a debt trap it is difficult to get out of the trap. For example, Sri Lanka has borrowed more than the limit, and many economists believe that it is in a trap. Although this is the simple meaning of the debt trap it should consider many factors that are associated with the reasons for borrowing.  In the case of Sri Lanka, during the past 30 years changes in the consumption pattern of people and the dynamism of the economy, political environment, and international relations have forced Sri Lanka to borrow more and the revenue sources of the country have not been changed consistently to changes (increase) in demand for borrowing.  In this environment what can Sri Lanka do to avoid a debt trap is an issue that needs to debate by economics and come to an agreement.

How to determine the debt trap? It is not an easy task.  Internationally, there is an acceptance that the borrowing of a country should be consistent with the volume of Gross National Product.  It is difficult to exactly say the rate of debt of a country compared to the Gross National Products.  This may change in developed countries as well as in developing countries. Some developed countries allowed to increase the debt level by more than 100% of GDP. Many economists believe that if there is no problem with debt service any country can increase the debt level.  For example, Japan’s debts increased to more than 100% of GDP because the country had a trust that could adjust quickly and the country had a highly positive vision that the level of GDP will increase and debt could be managed without caught in a trap.  This is the difference between Sri Lanka and Japan, although Japan has the confidence to increase the debt Sri Lanka has no such certitude that the country’s GDP will increase to settle the debt.

The volume of debt to China could assume as the US $ 6.0 billion it could be settled within the period of loans if the projects that invested borrowed funds work well.  If it considers in that line Sri Lanka has not been caught in the Chinese debt trap, but the aggregate debt is higher in Sri Lanka than its affordability.  It looks like the prime objective of economic management is to manage debt service than other economic activities.     

In the process of debt management, Sri Lanka could use a variety of strategies, the main strategy is to convert the projects to private hands than keeping them in government ownership.  Although strategically it is possible to show less government debt level the reality should be lower debts to outside and the best strategy should be a genuine attempt to manage the debt level to less than 50% of GDP and this can be done only by increasing the GDP growth more than 7% that is the difficult task the government will ever see.

The debt tap story was a statement of Mr.Mike Pompeo that used to get publicity for his travel, however, it cannot be ignored by Sri Lanka’s government. There is an obvious competition between China and the USA about various matters and the speech of Mr.Pompeo doesn’t warrant that the USA will help to settle Sri Lanka’s debt to China.

The ownership of projects that have been financed by China could be given to China subject to the repurchase of projects by the government and reduce Chinese debt and make efficiency in projects.  If the projects generate a loss in which the owner will be China and it would manage at a profitable level to receive a dividend and considering positive debt management strategies is the best option for Sri Lanka.     

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