China and the Politics of Investment

Last month, the Sri Lankan government formally handed over control of the port of Hambantota to Chinese interests on a 99-year lease. The price was over one billion dollars, but this came mostly in the form of a reduction in the enormous debt burden to Beijing that is crippling the island nation’s economy. Strategists warn that by giving up control of the port, a strategic asset straddling Indian Ocean shipping lanes, Sri Lanka is sacrificing its sovereignty and succumbing to what one Indian analyst has labelled “creditor imperialism” by China.

If China’s motives are indeed imperialist, is this form of economic diplomacy effective? In a recent article, we explore the sources and impact of Beijing’s financial leverage over Colombo. For more than a decade China has been increasing its use of credit abroad—provided on both concessional and non-concessional terms—to facilitate both the international expansion of Chinese industry and the cultivation of influence with recipient governments. Beijing’s signature international initiatives in recent years—the Belt and Road Initiative and its components such as the Asian Infrastructure Investment Bank—are similarly based on the provision of financing, demonstrating that China has the resources to wield significant power and influence on the world stage. Moreover, they create the perception that Beijing is ready and willing to take an active leadership role.

The Sri Lankan case offers an illustrative instance of how the Chinese model of debt-driven infrastructure financing plays out. Needing to jumpstart economic reconstruction following the end of a brutal civil war, Colombo eagerly accepted close to $15 billion in Chinese money between 2005 and 2017, largely to facilitate the construction (by Chinese companies) of large infrastructure projects including a power plant, an airport, an extension of the existing port at Colombo accompanied by a brand-new financial district called the Colombo Port City, and an entirely new port at Hambantota.

The resulting scenario provides important lessons for governments lured by the promise of China’s famous no-strings attached infrastructure financing. The power plant suffered numerous outages, the airport became the “world’s emptiest,” and the Hambantota port was a “commercial failure, getting hardly any ships.” Commercial failures, meanwhile, meant that insufficient revenue was generated to cover loan repayments, creating distressed assets.

For the debt-addled Sri Lankan government, the prospect of renegotiating these often-onerous loan agreements was hampered by a lack of transparency surrounding the precise terms of the original contracts, which removed the possibility of external checks and balances to hold the government accountable for negotiating good commercial deals. This in turn created the conditions for pork-barrel politics, in which projects were pursued not for the long-term economic benefit of the country but for political or personal benefit—building “bridges where there were not rivers.”

Unsurprisingly, these dynamics generated political tensions, and corruption allegations featured prominently in the 2015 Sri Lankan presidential election. The incumbent Rajapaksa administration was sensationally defeated, with the incoming government promising to extract Sri Lanka from the worst excesses of its China ties. Political will, however, could not overcome economic reality. By themselves, the under-performing projects may have been manageable, but combined with the overarching weaknesses of the Sri Lankan economy they became a crippling burden. A deteriorating balance-of-payments and falling foreign currency reserves were forcing authorities to rely on foreign financing to cover budget shortfalls and achieve economic growth. Amid such fragility and a lack of alternative sources of liquidity, the new government had little choice but to seek accommodation with Beijing, despite its political desires and commitments.

China’s debt-financing has therefore yielded at least two strategic benefits: the Hambantota port itself, and more broadly the willingness of an otherwise skeptical government to maintain and even build upon positive bilateral relations. However, two major countervailing factors make it unlikely that these outcomes will translate into substantial gains on the security front. First, domestic sentiment in Sri Lanka has been increasingly hostile to Chinese finance. As with Chinese investments in many African countries, Sri Lankans have begun to resent Chinese state-owned enterprises for using predominantly Chinese labor and technical skill to build poorly-performing assets. In early 2017, for example, violent protests greeted Colombo’s decision to clear land and resettle communities in the Hambantota port region in order to create an industrial zone for Chinese firms.

Second, Sri Lanka’s neighbor to the north, India—a rising major power and regional competitor to China—plays an outsized role in Colombo’s security calculations. New Delhi has long sought to keep external powers out of South Asia, and although this stance is currently changing, Beijing is not on the guest list. In fact, China is the cause of India’s more active neighborhood diplomacy, including efforts to undermine Chinese influence in Sri Lanka; for example, by offering to buy the virtually defunct Hambantota airport and pushing to invest in the Eastern Container Terminal of the Colombo Port. Given Sri Lanka’s historical, cultural, and social ties to India—there are at least 60 million Tamils in India and four million in Sri Lanka—it is unlikely that Colombo will make policy concessions that are overly prejudicial to New Delhi’s interests.

Instead, we find that the Sri Lankan government has sought to maximize the benefits it can gain from the competition for investment and influence between China and India. Sri Lankan leaders have declared an “omni-directional” foreign policy that seeks to accommodate the interests of both great powers and in the process secure the best deal possible for Colombo’s development plans. While infrastructure projects may struggle or fail and Beijing may lap up a distressed asset or two in the short term, the odds of this type of economic diplomacy successfully driving a wedge between India and Sri Lanka on the security front remain minimal.

Indeed, history shows that imperialism—of the creditor variety or otherwise—is a fraught and often unprofitable enterprise. (The Diplomat)

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