Via STRATFOR (subscription required), a look at Sri Lanka’s economic challenges ahead:

Sri Lanka’s increasing reliance on China and India for financial aid and investment will risk triggering domestic pushback and social unrest, forcing the government to make concessions that could ultimately threaten its economic strategy. China and India are heavily involved in Sri Lanka’s economy, often competing for projects and influence. Both countries are also the two largest importers of Sri Lankan goods, and both have the potential to provide the debt-ridden island nation with large credit lines in the future. As part of its Belt and Road Initiative (BRI), China has invested heavily in Sri Lanka’s infrastructure, including the ports in Hambantota and Colombo. Beijing also supplies crucial developmental aid for Sri Lanka. India, meanwhile, has provided concessional financing amounting to $1.8 billion since the early 2000s, and has funded various projects in Sri Lanka’s rail sector. But between the two, China remains Sri Lanka’s largest patron — accounting for roughly 23% of the country’s overall foreign direct investment over the past decade  (2010-2020) compared with India’s 10%.

Sri Lanka’s debt and liquidity crisis are poised to worsen. Sri Lanka’s economic woes began in 2019 and have only been further compounded by the fallout from the COVID-19 pandemic. The country’s tourism sector, which accounts for over 12% of GDP, took a hit after jihadists attacked three churches and four hotels on Easter Sunday in 2019 — only to be hit again by the onset of the COVID-19 crisis, with tourism rates declining by 70% in March 2020 compared with the previous year. Sri Lanka has imposed import restrictions amid a growing foreign currency shortage, with its central bank’s foreign exchange reserves dropping from $7.5 billion in November 2019 to $2.8 billion in July 2021. Increasing global oil prices combined with the domestic liquidity crisis have also led to rising inflation and the depreciation of the Sri Lankan rupee, making imports all the more expensive.

• The Sri Lankan rupee’s exchange rate against the U.S. dollar has fallen by at least 20% since 2019.
• Sri Lanka has a $1.5 billion external debt payment due in 2022, followed by another $1.2 billion payment in 2023. 
• Fitch Ratings estimated Sri Lanka’s debt will increase to $29 billion over the next five years and downgraded the country’s credit rating in August 2021, indicating a potential default. 

Colombo will seek to maintain relations with both India and China to avoid having to turn to the International Monetary Fund (IMF) for support, which would require imposing unpopular austerity measures. Sri Lanka has requested an IMF bailout 16 times over the past 55 years, and has only completed nine of the programs due to difficult reform requirements. To avoid having to request yet another bailout from the international lender, Sri Lanka has chosen to fund its deficit through new loan agreements with China and India. 

• Sri Lanka received a $1 billion loan from China in 2018.
• Colombo is also seeking a $500 million loan from India to finance its oil payments under the India-Sri Lanka Comprehensive Economic Partnership Agreement. 

Sri Lanka’s growing economic dependence on India and China will lead to local opposition and disruptive social unrest, which in extreme cases could force the government to alter or potentially even cancel its investment deals with Beijing and New Delhi. Opposition parties, unions and religious leaders in Sri Lanka have all expressed their dissatisfaction with the government awarding big infrastructure projects to foreign entities through protests and legal action, fearing Sri Lanka would effectively lose its sovereignty in the future. Over the past couple of years, new projects financed by either a foreign state or private entity have faced increasing scrutiny in the island nation. Some have even triggered protests, with demonstrators threatening strikes and demanding that the projects be canceled. Amid this growing social pressure, it’s possible that protest-related disruptions will become severe enough that the government will need to consider concessions.

• China built and currently operates the Port of Colombo’s South Container Terminal. In April 2021, a bill to facilitate the implementation of the China-backed port project was challenged in court by opposition groups. 

• In February, the Sri Lankan government also scrapped a deal with India to develop the Colombo port’s East Container Terminal following fierce opposition.

• The Sri Lankan government’s recent deal with a U.S. firm to supply liquified natural gas has spurred demonstrations that may intensify in the coming weeks. The contract mandates a 40% share in a major thermal power plant in Colombo, which protesters argue would give the U.S firm a monopoly.