The Sri Lankan government has signed a US$500mn deal with China Development Bank to help the country better mitigate the financial impact of Covid-19, as it continues to struggle with fiscal debt.

The facility has “concessional terms on both interest and tenure”, says a statement issued by the Chinese foreign ministry. The loan has a tenor of 10 years and a three-year grace period, along with interest rates linked to the US dollar-Libor rate.

The funding is set to be disbursed by the end of March, with the aim of increasing the official foreign reserves of Sri Lanka to enable it to better manage the financial effects Covid-19 is having on the country.

As part of its response, the Sri Lankan government has imposed a nationwide curfew and closed all international commercial flights into the country.

Despite criticism that Sri Lanka has depended too heavily on Chinese loans in the past, particularly for infrastructure projects relating to China’s Belt and Road Initiative (BRI) and as such has seen its sovereign debt spiral, the loan was “urgently requested”, says the statement.

Countries which depend on China, the country where Covid-19 originated, could suffer the most economically at the hand of the novel coronavirus. “Countries that are most dependent on China stand to be hit the hardest; these include countries in Asia and the Pacific, due to their economic relations with China. Sri Lanka is no exception, given its close links to China in terms of trade, investment, and the movement of people over the past decade,” says Talking Economics, a Sri Lanka-focused socio-economic policy think tank.

China’s BRI project was launched in 2013 by Chinese President Xi Jinping. With the goods trade volume between China and countries involved in the initiative surpassing US$6tn from 2013 to 2018, it has been criticised for creating ‘debt traps’ by burdening fiscally weak countries with unsustainable debt. Another country with high sovereign debt and many BRI projects underway is Pakistan, which turned to the International Monetary Fund (IMF) for a US$6bn bailout in July 2019.

According to IMF data Sri Lanka’s debt-to-GDP ratio is 82.7% (see figure 1), one of the highest ratios in South and Southeast Asia.

Figure 1: Sri Lanka’s debt-to-GDP ratio (%)

Concerns over the sustainability of Sri Lanka’s debt to China peaked when the government was unable to pay back loans issued by China to build its Hambantota Port, which subsequently saw Beijing take control of the port under a 99-year lease at the end of 2017.

There are worries that Covid-19 will trigger more problems for countries already battling debt problems, as public spending increases and fiscal revenues decrease. Earlier this month, Sri Lanka’s President Gotabaya Rajapaksa revealed a six-month debt moratorium for tourism, apparel and SME businesses.