The angry crowds broke through the gates of the president’s palace, brushing past the few ineffectual security guards that remained.
The hungry and desperate protestors swarmed the luxurious rooms and then celebrated by taking a dip in the leader’s private pool.
Across the city, a mob burned down the prime minister’s house.
The scenes from Sri Lanka in recent days have been reminiscent of the storming of the Bastille in 1789 or the Winter Palace in 1917. This was a textbook revolution.
President Rajapaksa, who was not in the palace as the crowds burst in, has resigned and fled the country.
On the face of it, the way is now cleared for this economically shattered nation to rebuild itself, having thrown off the corrupt and incompetent Rajapaksa dynasty. It should be able to restructure its massive foreign debts and begin to restore economic order. Yet, alas, Sri Lanka still faces a major obstacle on the road to economic salvation, in the shape of China and its debts.
Beijing could determine not only Sri Lanka’s future, but also that of dozens of other countries that have borrowed heavily from China over the past decade. Some fear that it could play havoc with the traditional postwar role of the International Monetary Fund (IMF) in rescuing bankrupt nations.
When countries run out of money they call in the IMF, the international lender of last resort to bankrupt sovereign states. In fact, since winning independence from Britain in 1948 Sri Lanka has called in the fund no fewer than 16 times.
This time is different, though, and the prospect of an international financial rescue is deeply uncertain. China is a major creditor of Sri Lanka and the question of how that debt is dealt with is complicating the bailout negotiations, which began in earnest last month when a team from the IMF visited Colombo.
The fund judges Sri Lanka’s total debt — at about 120 per cent of national income — to be unsustainable and in urgent need of being written down to restore order to its finances.
Estimates of the size of the debt to China vary wildly, but Nandalal Weerasinghe, governor of the Sri Lankan central bank, puts it at about 15 per cent of the country’s $50 billion external debt. The Chinese cash has mostly been used to build infrastructure such as new highways, ports and conference centres — many of which analysts argue are destined never to deliver an economic return.
China is not the biggest bilateral lender to Sri Lanka. Japan, for instance, has lent more. And Sri Lanka’s sovereign bonds, issued to international investors, are the biggest tranche of its borrowing. Yet the problem is primarily a Chinese one because Beijing doesn’t seem willing to play by the usual creditor rules when it comes to debt restructuring.
The IMF’s procedures require countries to impose writedowns (or haircuts, in the jargon) on all their creditors equally. It cannot, and does not, allow its emergency bailout cash to be used to pay off external third parties. Will China agree to a haircut on its Sri Lankan loans, unlocking the IMF bailout? Well, it hasn’t yet.
Weeresinghe recently told me he was optimistic that it would. The governor last month described China as a “good friend” of the country and that he was confident Beijing would ultimately offer “similar relief” as other creditors. Yet, as a key participant in the negotiations with the IMF, it’s Weeresinghe’s job to be optimistic.
Others are not so sure. “It’s not clear China would agree to a haircut,” says Umesh Moramudali, an economist at Colombo University. “But you can’t do this restructuring without China. It’s going to be a problem”.
So why might China be hesitating? The problem is that Sri Lanka is part of a much bigger tableau of lending for Beijing.
China has spent hundreds of billions of dollars making loans to developing countries as part of its so-called Belt and Road Initiative, a massive infrastructure lending splurge instigated by President Xi. Among the recipients of these loans it’s by no means only Sri Lanka that is in financial trouble.
The World Bank has warned that up to a dozen other states are at risk of default in the wake of the pandemic, during which they borrowed copiously to stay afloat, and the global food and fuel price rises unleashed by the Russian invasion of Ukraine. On top of this, interest rate rises by the US Federal Reserve are sucking global capital out of developing countries, hammering the value of their currencies against the US dollar and making their debts ever more unsustainable.
The sovereign bonds of 27 states are yielding more than 10 per cent — a benchmark for a high default risk. And many on that list — including Ecuador, Kenya, Venezuela, Tajikistan and Suriname — are heavily in hock to China. Sri Lanka, then, is regarded as a template for a swathe of bankruptcies and restructurings.
“What happens in Sri Lanka will set precedents for what goes on in many other countries. It is the canary in the coalmine,” said Gabriel Sterne, a former IMF analyst, now at Oxford Economics.
In the Chinese embassy in Colombo last month, Qi Zhenhong, the Chinese ambassador, was evasive when I asked him for BBC Newsnight about the possibility that Sri Lanka would be a model for other countries which require debt restructuring. He chose to demur, quoting Tolstoy.
“Happy families are all alike; every unhappy family is unhappy in its own way,” he said. “I think Sri Lanka is unique”.
American politicians, and the head of MI6, accuse China of laying “diplomatic debt traps” to lure countries into over-borrowing and then snapping up their assets, such as strategic ports like Sri Lanka’s Hambantota, on the cheap. The more prosaic reality is that Belt and Road was as much a way of deploying China’s excess domestic savings and spare construction capacity abroad as projecting Chinese power.
And when it comes to debt writedowns it’s more likely that Beijing is, in a phrase from the former Chinese leader Deng Xiaoping, “crossing the river by feeling the stones”. Sterne said: “They’ll drive as hard a bargain as they can. But they don’t have a completely powerful hand. They’re not getting paid at the moment. Getting paid something from any creditor is better than being paid nothing.”
In a Colombo vegetable market Jehan, who runs a local photography business, is agog at prices up 60 per cent on a year earlier. “Very soon a majority of people will be starving if it carries on like this,” he says.
The Sri Lankan people have had their political revolution. But an end to their economic suffering remains some distance away.
This piece was originally published in The Sunday Times on 17 July 2022