COLOMBO, Sri Lanka—As Sri Lanka’s foreign-exchange reserves began to dwindle under a mountain of debt early in the Covid-19 pandemic, some officials argued it was time to ask for a bailout from the International Monetary Fund, a politically fraught move that traditionally comes with painful austerity measures.
But China, Sri Lanka’s largest single creditor, offered a tempting alternative: Skip the IMF’s bitter medicine for now and just keep adding on new debt to pay off the old, according to current and former Sri Lankan officials. Sri Lanka agreed, and soon $3 billion in new credits poured in from Chinese banks in 2020 and 2021.
Now that plan has blown up, plunging Sri Lanka into chaos. Amid crushing debt and sky-high inflation, the country has run out of U.S. dollars to pay for imports of basic goods, leaving citizens waiting for hours to buy fuel and major cities scrambling to keep the lights on. By the time Sri Lanka finally decided in April to apply for IMF relief, its economy was nosediving toward one of the deepest recessions since the country’s independence in 1948, fueling a popular rebellion that saw the president chased from his home by hordes of demonstrators.
Early Wednesday, President Gotabaya Rajapaksa fled the country on a military aircraft, the same day he was due to resign.
“Instead of making use of the limited reserves we had and restructuring the debt in advance, we continued to make debt payments until we ran out of all of our reserves,” said Ali Sabry, Sri Lanka’s caretaker finance minister from April to May. “If you had been realistic, we should have gone [to the IMF] at least 12 months before we did.”
With around $35 billion in foreign debt, Sri Lanka is the first government in the Asia-Pacific region to default on its international obligations since Pakistan in 1999. Its negotiations with the IMF will pose a test of Beijing’s willingness to help resolve a sovereign-debt crisis in the developing world that critics say China’s own lending policies helped create.
For more than 60 years, sovereign-debt restructurings have been coordinated by the Paris Club, an informal association of 22 major creditor countries, mostly Western and some in Asia, including the U.S., France, Germany, Japan and South Korea. Often working in tandem with the IMF, the Paris Club has signed 433 agreements with 90 countries, restructuring more than $583 billion of sovereign debt since it was created in…
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