China’s Herd of Sri Lankan White Elephants

Chinese investment in Sri Lanka is causing major problems for Sri Lanka’s President Mathripala Sirisena and has become a point of tension in Sri Lanka–China relations.

Before taking office, Sirisena promised that he would look into alleged corruption, stating he would investigate how Sri Lanka is “being obtained by foreigners by paying ransom to a handful of persons.” His election manifesto simultaneously acknowledged Sri Lanka’s economic difficulties. It reads: “Sri Lanka is a country with excessive state debt and a dangerous ratio with regard to loan payment and state revenue.”

During the previous regime, led by former president Mahinda Rajapaksa, Sri Lanka borrowed billions from China to develop mega-projects that many thought were economically unviable. Critics also feared that Sri Lanka would not be able to pay back the loans and as a result China may take control of these vital infrastructure projects, providing it with a strategic presence in the country.

At the time, no information was available in the public domain regarding interest rates on the loans. There were also allegations of corruption and bribery, which may have allowed Chinese companies to secure these projects without open bidding process. As a result, the incoming Sirisena government promised that it would reassess all mega-projects undertaken by the previous government.

One especially controversial project is the Colombo Port City project, being built by China Communication Construction Company (CCCC), a subsidiary of China Harbor Engineering Company, in cooperation with the Sri Lanka Port Authority. The project amounts to a US$1.4 billion investment, but – according to Sri Lanka Government Spokesperson Rajith Senaratne – the project was awarded “without relevant approvals.” Interestingly, the World Bank has barred CCCC on charges of corruption until 2017.

During his visit to Beijing after being elected president, Sirisena assured China that “the current problems facing the Colombo Port City are temporary and the problems do not lie with China.” Chinese President Xi Jinping in return expressed his hope that “Sri Lanka could ensure the legitimate rights and interests of Chinese enterprises.”

But in an interview with CNN Money, Sri Lanka’s Finance Minister Ravi Karunanayake said, “the Chinese companies used the opportunity of a corrupt regime to crowd out other companies coming in … There was no even playing field.”

Other Chinese projects have also drawn criticism for being unproductive investments and are considered bad loans. Chinese companies built the Hambantota Port, Mahinda Rajapaksa International Airport (MRIA) and a cricket stadium in the former president Rajapaksa’s political constituency, Hambantota. These are now incurring losses because they are not commercially viable. In September 2013, the interest rate for MRIA, which cost US$209 million to build, was increased from 1.3 per cent to 6.3 per cent.

Rajapaksa’s government took several steps to make the airport commercially viable. For example, according to Civil Aviation Authority 2014 Annual Report, the Rajapaksa government implemented an “open skies” policy for granting third, fourth and fifth freedom traffic rights out of MRIA to foreign airlines. It also provided concessional landing and parking facilities. But MRIA attracted only 20,474 international passengers and 2984 flights according to this report. In the same year, it incurred a loss of LKR2.75 billion (approximately US$20 million).

The Hambantota Port has also not been able to return the economic dividend it promised. The port was built with a US$306 million loan, 85 percent of which was provided by China’s Exim bank with a fixed interest rate of 6.3 percent. In September 2014, Sri Lanka reportedly granted Chinese state-owned companies, China Merchants Holdings International and CCCC, operating rights to four berths at the Hambantota Port, providing it with nearly 65 percent share in the project as per the agreement reached with China in 2010. But Hambantota is yet to attract investment despite being declared a “free port,” alongside Colombo Port, in July 2013.

The Sri Lankan government has also declared that Katunayake Export Processing Zone, Koggala EPZ and MRIA are bonded areas in an attempt to attract investors. According to the Minister of Port and Shipping the loss from the Hambantota Port in 2012 was LKR678 million (approximately US$5 million). The Hambantota Port was maintained from the profits made by the Colombo Port. The Sri Lanka Port Authority, which was earlier providing bunkering services, has now asked private companies to takeover or develop a joint venture for bunkering operations.

China has invested around US$5 billion in Sri Lanka. The Sirisena government faces a dilemma. While the government is not in a position to spurn Chinese investment or to repay the huge loans, it also does not know how to ensure these mega infrastructure project make profits that would help pay back the loans. It is under tremendous pressure from China on the Colombo Port City project, where CCCC is reportedly claiming to be losing US$380,000 a day. It would be financially difficult for the Sri Lankan government to provide such huge compensation in case it decides to cancel the project.

At the same time, there is enormous domestic pressure to abandon the project because it has no environmental clearance and is likely to provide China a strategic foothold in the Indian Ocean, which could draw the wrath of India and the US. The Chinese Foreign Ministry spokeswoman Hua Chunying said it expects Colombo to “preserve Chinese companies’ confidence to invest in Sri Lanka in the overall interests of China–Sri Lanka friendliness and the fundamental interests of Sri Lanka’s national development.”

Sri Lanka has always tried to leverage its ties with Beijing in its relations with India and the West. But the previous Rajapaksa government went too far in courting China and did not consider the strategic consequences. It would be difficult for Sri Lanka to withstand Chinese pressure. But it is likely that China won’t be in a hurry to take punitive action if the Colombo Port City project does not materialize. After all, Colombo continues to be a major lynchpin in China’s Maritime Silk Route and is an important partner in the larger geopolitical game.

Dr. Smruti S. Pattanaik is a research fellow at the Institute for Defence Studies and Analyses, New Delhi.This was written for the East Asia Forum, a platform for analysis and research on politics, economics, business, law, security, international relations and society centered on the Asia Pacific region. It is based out of the Crawford School of Public Policy at the Australian National University.