What has Happened:

In our May 2022 ATW, we addressed the devastating economic crisis in Sri Lanka and some of the underlying factors including the high cost of debt capital associated with Chinese loans.

• The government owes $51 billion in total and is currently in default as it cannot make interest payments (it had previously reached out to China, India, and the IMF for assistance).
• High inflation brought on by the war in Ukraine and other factors, including a government ban on chemical fertilizers, have driven up the costs of food and fuel nationwide (inflation was near 40% and food prices were up nearly 60% in May).
• The 2019 Easter suicide bombings at churches and hotels killed more than 260 people and decimated the tourism industry in the country.
• In late June, the Prime Minister announced that the economy had “collapsed” and the country was running out of money to pay for necessities.
• While India’s $4 billion credit line is helping and a preliminary bailout plan from the IMF should be ready before the end of the summer, the situation is dire for many.
• Last weekend, President Gotabaya Rajapaksa and Prime Minister Ranil Wickremesinghe (who just took office in May) announced that they would resign as protestors stormed both of their residences.
• On July 13^th, President Rajapaksa fled the country and appointed Prime Minister Wickremesinghe as acting president.

Why it Matters:

“China will continue to gain influence through its Belt and Road Initiative and debt diplomacy. A Chinese company has already taken over Sri Lanka’s southern Hambantota port (which could provide potential military opportunities) and is located on a key shipping route. India is warning Sri Lanka not to do the same with its Colombo port. The U.S. needs to counter China’s regional influence operations wherever it can.”

 –  General Robert Walsh

“China has a dilemma now with Sri Lanka as it would like to maintain the friendship it has established with the previous government (along with the commercial opportunities). However, China does not want to be associated with a floundering economy and set a precedent by restructuring their debt, which could allow other distressed countries that have received large Chinese loans to change terms. China will not use a bilateral approach and will steer Sri Lanka to the IMF. With a new government in place, an IMF bailout package will be reached. India and the U.S. must step forward now and support Sri Lanka as it seeks to maintain the balance of power in the region. India is the resident Indian Ocean power, but China has been steadily increasing its economic and military footprint in the region. China became a sea threat to India with the 99-year lease on the Hambantota port in Sri Lanka which is just off the coast of India. This lease agreement (coupled with Chinese border skirmishes) make it imperative that India should not allow China to gain a larger maritime foothold. The U.S. and India need to compete against China for influence in the Indian Ocean and the small island nations (Sri Lanka, Maldives, Mauritius, Seychelles, Madagascar, Comoros) in the region need to be our allies. India, as part of the QUAD, shares our vision of a free and open Indo-Pacific.” – General K.K. Chinn

“This issue fits into India’s sphere. India will assert a leadership role to contain the political chaos and avert a catastrophe that could migrate into bloodshed. This is a chance for Modi to exercise soft diplomacy, but if India offers forces either through the UN or independently, he may step too far and rely on his autocratic leanings. This could be a chance for the U.S. to improve its regional influence with India.” – General Spider Marks

In addition, please see below for a few thoughts from our Head of Macro Strategy, Peter Tchir.

“I think the events in Sri Lanka, unfortunately, highlight the need to re-iterate two of our ongoing themes:

1. Economic Colonization. While some call China’s lending Debt Diplomacy, I view it as a form of Economic Colonization. China will be in the driver’s seat of any restructuring. They will likely, and should, angle for control of underlying assets. It’s all complicated with other countries and the IMF involved, but the underlying assets (like ports) have important implications for global trade and naval power projection.
2. Supply chains and shifting away from Asia to Central and South America. At the very least, the political situation and potential disruptions in the country will make companies think twice about setting up (or keeping) operations in Sri Lanka. What I don’t know is whether re-thinking supply chains already impacted Sri Lanka’s economy. I continue to think that supply chain security is an increasingly important part of the “Governance” component of the G in ESG. Closeness, whether politically, morally, or simply geographic proximity will impact corporate behavior – creating opportunities and risks. 

While it may seem like a non-sequitur, I can’t help but mention Brazil signing up to buy Russian diesel. There is a global competition for trade routes and resources, and I’m concerned that we are playing tic- tac-toe, getting ready to try checkers, while our competitors have been setting up a chess board skewed heavily in their favor.” – Peter Tchir