China Demands A Free Trade Agreement For Helping With Sri Lanka’s Economic Problems

Protecting a diminishing domestic market or reaching out to a larger trade world: Sri Lanka’s entrenched, old style trade monopolists need to be moved out for the country to have any chance of revival   

The embattled Sri Lankan Prime Minister, Mahinda Rajapaksa has been casting a financial fishing net around Asia as the country continues its slide into financial and economic chaos. With sovereign defaults looming on the horizon, the country is desperate for new capital. Its two main benefactors, India and China have been offering sympathetic noises, but thus far been reluctant to commit much cash, and certainly not enough to solve Sri Lanka’s growing financial woes.

However, in discussions with Chinese Premier Li Keqiang this week, Rajapaksa was told that while China has empathy for Sri Lanka’s economic plight and is keen on helping it, there ought to be “an early start of the negotiation and signing of a China-Sri Lanka Free Trade Agreement, so as to enhance mutually beneficial cooperation.”

That proposed FTA has been under negotiation since 2015, with the Chinese side increasingly frustrated at a lack of progress. Li though now has specifically linked the FTA to ‘the flow of Chinese aid’. Rajapaksa has said: “Sri Lanka is ready to strengthen cooperation with China in finance, economy, trade and tourism and advance the negotiation of the bilateral free trade agreement.”

There will be resistance, mainly because the Sri Lankan government under the Rajapaksa’s wish to maintain their own policies over domestic trade and imports – multiple businesses under the Rajapaksa’s family portfolio benefit from significant import duties, while the requests from Sri Lankan politicians for fees to provide ‘import permits’ has long been a source of irritation amongst investors in the country. A Sri Lanka-China FTA would eradicate much of these dubious practices.

Another issue is that because of this, Sri Lanka’s domestic manufacturing industry has not been prepared to deal with competitive imports, and remains in several sectors somewhat under invested with at time, antique technologies dating back to the time of the British still being used for manufacturing processes. Chinese competition would put these operations out of business. The Sri Lankan President, Gotabaya Rajapaksa – the Prime Ministers brother has also said: “the Chinese are asking for too much”.

Qi Zhenhong, the Chinese Ambassador to Sri Lanka, had discussed the FTA with Sri Lanka’s Foreign Minister G L Peiris, following which a statement on the meeting said: “Ambassador Qi, while stating that China had signed over 26 FTAs, expressed that finalizing the proposed FTA between Sri Lanka and China would immensely benefit the Sri Lankan local market and products. He also urged the Sri Lankan authorities to resume the 7th round of FTA negotiations at the earliest.” In reply, Minister Peiris said that the 7th round of FTA negotiations will soon commence with the support of the respective line agencies in Sri Lanka.

China has invested billions of dollars in Sri Lanka, building ports, airports, roads and power stations since 2013, as part of its Belt and Road Initiative (BRI). Chinese loans account for 10.5% of Sri Lanka’s foreign debt. However, Beijing feels that there is no appreciation of this in the governmental and political domain. Projects such as the Colombo Port City, Hambantota Port and other BRI investments have been delayed and are not yet ready for cash flow generation – the Colombo Port City development for example remains a flat piece of reclaimed land with no vertical build on it – stymieing Chinese efforts to obtain returns on the investment by building office blocks and other infrastructure.

Beijing has also been critical with Colombo in terms of a lack of responses for two proposals China has made: the formation of a grouping of Indian Ocean Island States with Sri Lanka as the prominent lead, in addition to the formation of a refined and updated dispute-settling mechanism. Colombo has apparently not started any research into these matters either – quite possibly because the Rajapaksa family – which includes several Sri Lankan Ministerial positions – has no experience in dealing with these issues and is reluctant to seek international expertise.

As a result, China has been playing hardball for Sri Lanka to get its act together, a strategy that has some risk as the Rajapaksa’s can also play Beijing off against Delhi.

In January, Foreign Minister Wang Yi rejected President Gotabaya Rajapaksa’s plea for a rescheduling of the repayment of Chinese loans. More recently, China had announced a loan and buyer’s credit totaling US$ 2.5 billion – but has yet to provide this. Last week, China did announce emergency aid of around US$31 million, which is being paid in commodities, not the cash the Government needs. Included were 5,000 tonnes of rice, pharmaceuticals, production materials and other essentials.

Previous FTA talks have failed due to opposition from the entrenched local monopolists, many of them with Rajapaksa ties, who fear foreign competition. China wanted zero tariffs on 90% of the goods sold to each other as soon as the FTA was signed while Sri Lanka wanted it to start with zero tariffs on only half of the products concerned and expand gradually over 20 years.

Free trade would benefit the average Sri Lankan consumer and help the country become export efficient, but not without some initial pain. Domestic companies will need to reinvest, up their game and compete – meaning the current reliance on the highly protected domestic market would be squeezed, with lower profits as capital investment is required for upgrades. However, the revenues of many of Sri Lanka’s companies are already under significant stress due to the economic crisis.

In 2020, China exported US$ 4.01 billion to Sri Lanka. The main products were light rubberized knitted fabric ( US$241 million), broadcasting equipment (US$ 225 million), and refined petroleum (US$127 million). In the same year, Sri Lanka exported US$ 266 million worth of goods to China. The main products were tea (US$ 60.4 million), coconut and other vegetable fibers (US$ 24.2 million) and knit T-shirts (US$ 18.5 million).

When it comes to FTA’s China gives priority to trade in goods and then moves on to trade in services and investments, and is typically committed to eliminating duties on over 95% of tariff lines. That represents a huge market for Sri Lankan manufacturers if they can break out of the mould of purely thinking domestically.

An Institute of Policy Studies (IPS) report in 2015 pointed out that Sri Lanka had a comparative global trade advantage in 566 products, of which, 243 items were or could be exported to China. There were an additional 299 products with trading potential with China, and especially in vegetable products, rubber, and plastics.

There is however regional precedence for Sri Lankan businesses and entrepreneurs to study. The China-ASEAN Free Trade Agreement, which impacted small countries such as Cambodia, and Laos, as well as larger economies such as Indonesia, Malaysia, Thailand, and Vietnam came into effect in 2009. At the time, unprepared businesses struggled in their own domestic markets with more affordable, and often superior  Chinese products – but were able to adapt by either re-investing in their own businesses, joining together with Chinese partners, and by looking more closely at the China market. Their China results have been significant (figures in US$ billions):

Country               2008 China Exports               2020 China Exports 

Cambodia                     0.841                                         1.46

Indonesia                     11.63                                          32.6

Laos                              0.47                                           1.68

Malaysia                       19.01                                          38.7

Thailand                        15.9                                            30.2

Vietnam                           4.8                                            49.4

Sri Lanka’s total exports in 2008 were worth US$10.11 billion, and in 2020, total exports were US$11.30 billion, illustrating that over the past decade plus, Sri Lanka’s export manufacturing sector has undergone significant decline. ASEAN’s meanwhile has grown significantly in comparison. This decline will continue if changes are not made to monopolistic practices by vested interests within Sri Lanka’s trade abilities, who purely rely on a diminishing domestic market.

It remains to be seen what will happen. A more enlightened Sri Lankan government with the ability to bring in foreign (and especially China) trade advisors can set the country onto a new path, albeit with some adjustments and business pain for a handful of industry monopolists. That pain is recoverable if managed correctly. If not, the Chinese are unlikely to provide funding for Sri Lanka into an economy it well knows cannot be productive without economic reforms. If Colombo refuses the opportunity, the Government will find themselves managing a smaller and smaller economic base with an increasing disparity between those who exploit the local market for themselves and the workers who provide for it. The country really is at a huge crossroads.

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