Sri Lanka and The Danger from China’s Debt Traps

Colombo is the largest city in Sri Lanka, an island nation in the Indian Ocean on the tip of the Indian subcontinent. In 2011, a large-scale development project called the “Port City Colombo” was initiated with Chinese investments. The project includes plans to create a 269-hectare reclaimed land area adjacent to Colombo Port as a special economic zone. Financial centers would be built there, along with commercial districts and casinos. 

Near the construction site is a lineup with huge photographic panels displaying images of China’s high-ranking officials. Xi Jinping and others are shown in photos taken during their visit. 

Sri Lankans call the port city “mini China” with a sense of irony.

Reclaimed Misery

About 40% of the reclaimed land has been leased to a Chinese company for 99 years. Some fear it could become a second Hambantota. Hambantota port is located in southern Sri Lanka and is operated by another Chinese firm named China Merchants Port Holdings Company. 

As Sri Lanka had not been able to repay one of its loans from China in time, in 2017, it agreed to allow the Chinese company to manage the Hambantota port and simultaneously granted it a 99-year lease. 

Here and elsewhere, loan traps are visible in the wake of China advancing the maritime aspects of its Belt and Road initiative. Debt and incremental advances in political control make the Sri Lankan port a typical case of Chinese loan trapping.

In recent years China has aggressively increased investments in Sri Lanka, which is located at a particularly strategic point in the Indian Ocean. Gotabaya Rajapaksa, who was elected as the nation’s president in 2019, allowed the country’s dependence on China to grow while asking for adjustments to the repayment schedule of his country’s increasingly burdensome debt. 

Rajapaksa’s actions have triggered widespread protests against the Sri Lankan government. In response, the government has declared a state of emergency.

Pradeep Jayewardene (age 62), a member of the Colombo Municipal Council, has been frustrated by the nation’s plight. He said, “If my grandfather had been president, he would not have been so close to China. He kept balance in mind.”

His grandfather is former president Junius Richard Jayewardene, who represented Sri Lanka (Ceylon at that time) at the San Francisco Peace Conference in September 1951. He was also one of the participants who helped restore sovereignty to Japan.

Sri Lanka waived the right to claim compensation

In the San Francisco Peace Treaty, the Allied Powers technically renounced the right to claim compensation from Japan and limited future claims to “service compensation” in technology transfers and labor rather than currency. This shift coincided with the beginning of the Cold War, including the outbreak of the Korean conflict in 1950. 

As Japan was strategically important to the United States, the US emphasized Japan’s stability and reduced its reparations burden. However, some Asian countries occupied by Japan during the war were not happy.

Hatred Ceases Not by Hatred but by Love.

Citing the message of the Buddha at the San Francisco Peace Conference, J.R. Jayewardene declared that negotiators should waive the right for Asians to claim compensation from Japan. He explained that the independence of Japan would be beneficial to Asia. 

His passionate speech affected attendees at the conference. It is said that Japan’s representative, then- prime minister Shigeru Yoshida, took off his glasses and wiped his tears.

Japan made reparations to Asian countries in the postwar era by supporting their infrastructure construction through its Official Development Assistance (ODA) program. Various grants and loans were offered to these nations in part to make amends. 

Sri Lanka received a total of ￥1.1 trillion yen ($8.55 billion USD today). Images of infrastructure built with Japanese assistance are still used as design motifs in local banknotes.

The Colombo port, which is not like a mini China, is one such basic infrastructure. Pradeep said, “Everyone understands Japan’s assistance has contributed to the development of our nation. In contrast, I regret that Chinese assistance seems harmful.”

According to AidData Research Lab in the US, Chinese government institutions and state-owned entities financed projects across 165 countries. Among them, 42 countries received various forms of loans, including so-called “hidden debt” from the Chinese government that exceeds 10% of their national GDPs as of 2017. Sri Lanka’s debt, for one, is 12.1% of its GDP, while Laos owes 64.8% of its GDP. 

China provided an average of $85.4 million USD (about ￥10 billion JPY) (about $78 million USD) per year in development funding from 2013 to 2017. While Japan has supported these countries in the past, the debt accumulation from China’s loans exceeds the sum of money lent by both Japan and the United States.

Tied Aid and Lax Screening

“The problem is the lack of project vetting,” observes Waseda University professor of Science and Engineering Naohiro Kitano. He explains the causes of countries becoming “soaked in debt” by China, which is becoming apparent in various regions. 

China’s aid is mainly tied to its own companies, meaning that the recipients of projects are limited to Chinese companies. The Chinese government often supports their local companies to expand their business overseas under governmental credit. Government funds flow to projects with little competition and low economic potential. 

Also, political factors come into consideration. 

Loan terms from these Chinese firms, including interest rates and repayment periods, are stricter than those of Japan and other developed countries. However, it is easier for developing countries to borrow from China because it does not set conditions on its loans, such as compliance with environmental standards and women’s participation, as developed countries require.

Japan’s ODA arrangements with China ended in March 2022. However, China says it learned this tied aid system from its experience in receiving development funding from Japan. It is said that Japan had faced similar criticism, prompting improvements to its overseas financial programs. 

In recent years, China has shifted the jurisdiction of foreign aid from the Ministry of Commerce to a newly established agency directly under the State Council. The new entity, responsible for implementing the policies of the Chinese Communist Party, has increased the focus on the debt of the borrowing country and the economic viability of projects.

However, Sri Lanka’s Lower House member Vijitha Herath says, “Did Japan ever seize a port? There is a difference in the ambition lurking at China’s back.”

Postwar Japan’s Asian Supporters

What about Japan’s treatment of poorer Asian countries that supported its return to the international community? 

Indonesia’s population of 270 million is the largest in Southeast Asia. In its capital city of Jakarta, the country’s first subway opened in Japanese style in 2019, bringing along with it features familiar to many in Japan. Passengers wave their contactless IC cards over the turnstile gate to enter. Lines are painted on the platform floor to guide passengers to board in an orderly manner. 

A female passenger says, “I like it that the trains run as scheduled. It reminds me that Japan’s technological level is high.” 

Jakarta’s Metropolitan Rapid Transit (MRT) was planned to solve the problem of chronic road traffic congestion. Japan provided a ￥12.5 million JPY (about $100 million USD) loan through its Official Development Assistance (ODA) program. It also assisted the “all Japan-style” development approach, from delivery of comprehensive system manuals to detailed operation plans, and thorough training of vehicle drivers and maintenance personnel.

By the end of 2021, Japan had also developed the Patimban port terminal in the metropolitan area using yen loans. In contrast, there is a delay in the Chinese project of the Jakarta–Bandung high-speed railway. China won the contract in 2015, winning in the competition with Japan.

Southeast Asia is the main economic battleground where Japan, the United States, and other countries compete with China under the Free and Open Indo-Pacific (FOIP) concept. In addition to infrastructure development, Japan has also assisted with the distribution of COVID-19 vaccines. 

Thus, the importance of ODA becomes clear. It has been an effective diplomatic tool for postwar Japan, while the use of military force was restricted.

Japan’s ODA budget now about half of its peak level 

The importance of ODA was not limited to providing a means for Japan’s postwar reparations. Its significance goes beyond making amends, and reflects Japan’s progress in the international community after the war. 

Developing and expanding the economies of Southeast Asian countries through the ODA has been important in helping to secure new markets and resources after Japan lost its markets and suppliers in Korea and China in the last war. In this way, ODA has also enabled the Japanese economy to recover and grow.

Japan’s financial support in the region was also part of the US strategy to prevent the spread of communism in Southeast Asian countries as the Cold War spilled over into other parts of the world. Washington wanted to see social and economic stability in these countries that had just gained independence from colonial rule. Japan provided aid, gradually gaining trust without military power behind it.

Japan has also contributed to human resource development and technology transfer in the region. Mitsuya Araki, chief editor of the International Development Journal, which has focused on ODA policies for about half a century, feels that “the Japanese model” is taking root in the social and economic foundations of the local communities.

Through the institution of ODA, Japan has shared its values, cultivated pro-Japanese sentiments, achieved friendship with people and nations, and restored its sovereignty in the war’s aftermath.

But then came what Araki terms as the “years of confusion.” In the 1990s, Japan increased its contributions to fend off criticism from the West over its massive trade surplus. Its contributions to ODA were highest in those years.

When poverty and environmental problems in developing countries became issues, Tokyo diversified its support with an emphasis on “international contributions.” This in turn led policies to lose direction and focus.

Furthermore, the government has since reduced its ODA budget due to sluggish economic growth and deteriorating fiscal conditions so that it is now about half of its peak level.

Comprehensive strength required for Japan

The 2015 revision of the Development Cooperation Charter describes the role of ODA for the first time, as “Helping to secure the national interests.” Some involved in the revising process strongly resisted the use of the phrase “national interests.” Araki, who was involved in the discussion, took a different approach and prevailed, saying: “We are using taxpayer money, so unless we say it is necessary for the survival of Japan, we will not gain the public’s understanding.”

The Charter sets development cooperation policies based on the strategic importance of the recipient country as one of its principles. As a result, Japan will focus on FOIP-related (“free and open Indo-Pacific) projects.

The Towering Great Economic Wall of China

China surpassed Japan in trade volume with the Association of Southeast Asian Nations (ASEAN) in 2009, and its trade volume is now more than twice the size of Japan’s. Yet, in a survey of ASEAN scholars and researchers conducted by a Singaporean policy research institute, “trust” in Japan was high, but China led the pack in “regional influence.”

Due to financial constraints, Japan cannot match China in terms of the volume. Instead, Japan’s focus is on quality. Here, Araki believes the key is to channel resources to higher-level technology transfer and human resource development, including research and development support. Influencing nation-building in the recipient countries is equally important, in his view, through the development of good policies and design of institutions.

He also emphasizes establishing an independent central authority to oversee aid policy, like those in the United States and United Kingdom, to ensure consistency in long-term aid strategies.

However, for that to happen Japan must continue to be needed by Southeast Asian countries aspiring to build their own know-how and join the ranks of advanced nations. And as Araki has said, one lesson learned through the ODA program is, “the more you do it, the more it tests your overall strength as a country.”

Japan’s National Security Strategy defines its national interests as maintaining its sovereignty and protecting an international order based on rules and universal values. 

It stipulated that the goal of diplomacy is to promote Japan’s claims and gather support in the international community to advance its national interests. 

The “Japanese model” fostered through ODA is a strategic connection that enables this goal. And if it is undermined, Japan will not be able to survive.

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(Read the article in Japanese here.)

Author: The Sankei Shimbun