With every passing day, the headlines around South Asia’s economic contagion have grown more dire. It began with Sri Lanka after Russia’s invasion of Ukraine, then seemingly shot up the Arabian Sea to Pakistan before careening across to Bangladesh. In each case, we saw skyrocketing energy and food import bills, currency devaluations, evaporating foreign exchange reserves and urgent pleas for foreign bailouts amidst angry protests on the streets.
Some of the most pressing question marks have been over who is going to step up to help these countries, and who would set the terms – especially given the level of outside influence such aid would bring.
A popular narrative, particularly in India and the West, is that the current set of crises represents an opportunity to end what is perceived to be China’s expanding debt-fuelled takeover of small and mid-sized South Asian states. With western governments largely quiet, and with India’s economy still growing, economic assistance to the region has often been cast as a contest between New Delhi and Beijing.
However, as is so often the case, these media narratives suffer from highly flawed assumptions. The most egregious has been the failure to recognise the starkly different kinds of economic risks faced by Pakistan, Bangladesh and Sri Lanka after all three governments approached the International Monetary Fund (IMF) for financing.
Bangladesh, for example, is not yet actually in a crisis. Its economic growth and strong export sector mean that, although foreign exchange reserves have taken a hit, they are nowhere close to exhaustion. Rather, Dhaka has sought assistance in order to prevent a difficult situation from getting worse, as well as to fund long-term investments in climate resilience.
Pakistan’s situation is far more serious, with its foreign reserves diminishing down to a dangerous level. However, crude oil prices have stabilised and global financial markets anticipated that Prime Minister Shehbaz Sharif's government would secure an IMF bailout in time to avoid the catastrophe of a default on debt repayment.
Sri Lanka, in contrast, represented something of a worst-case scenario, with its economy in free-fall after default. Its level of indebtedness even before the pandemic and the Ukraine war was far more serious than either Pakistan or Bangladesh. Besides, the formerly presiding Rajapaksa dynasty in Colombo was not only far less responsive to the concerns of international markets and lenders, but also had less geopolitical leverage than the leadership of the other two South Asian states.
It is worth remembering that institutions such as the IMF (headquartered in Washington) have been intended right from the start to balance the management of a market-friendly global economy with the management of global security. At a certain point, the case for lending can be made on the basis of a country’s contributions to the international security order as much as how market forces feel about an economy’s numbers.
The extent to which these matters are entangled with economic ones was revealed by the fact that Pakistan’s Army Chief, Gen Qamar Javed Bajwa, who reached out to the US State Department’s leadership in July to secure the early disbursal of a pre-approved $1.17 billion loan from the IMF to avoid a liquidity crunch. Only days after Gen Bajwa’s call, Al Qaeda leader Ayman Al Zawahiri was killed in Kabul by an American strike. This was the Biden administration’s "over-the-horizon" counterterrorism strategy in action, established as part of its withdrawal of US-led forces from Afghanistan last year.
This sequence so closely resembled past patterns of covert co-operation that the Pakistani government was forced to officially deny allowing the use of its airspace for this attack, but Pakistani analysts have either questioned or dismissed the denials.
Although the rash of speculative suggestions in the media about some kind of deal linking Zawahiri to the IMF loan are impossible to verify at this point, the bigger picture is clear. Pakistan’s relationship with the US over the past decade has been routinely described by knowledgeable observers as “transactional” and “security-focused”, so the channel of this financial request, and its success implies that the Biden administration is satisfied with Islamabad’s counterterrorism co-operation.
There is no equivalent in terms of American favours owed to Sri Lanka. But India, as the US’s strategic partner in the Quad, can pull real weight. New Delhi is now calling for the IMF to temporarily reclassify Sri Lanka as a low-income country, in order to qualify it for easier terms from G20 lenders during debt-restructuring negotiations. This is much more irregular than the terms Pakistan requested, and therefore less likely to be successful, but it still is a good example of the changing nature of aid.
In an environment where economic assistance is increasingly multilateral – in other words, closely co-ordinated between donors – India’s biggest source of assistance to the Global South is not so much what it can give directly, but its ability and willingness to influence lenders in the Global North.
This is particularly relevant to the question of what happens to China as the world’s largest bilateral lender and as Sri Lanka’s principal creditor. It is important to understand that most of the loans issued by Chinese banks to foreign governments for infrastructure projects are treated by these banks as commercial in nature, rather than development aid. It requires intervention by the Chinese government at the highest levels in order to persuade these banks to overlook their financial interests and their own regulations.
Once again, Islamabad was able to persuade Beijing to reschedule some of its debt, in part, because of the strength of its security ties with China. Until now, China only extended such special treatment to the handful of countries with whom it shared a strategic relationship, but there are signs that this is changing.
China’s leadership has set itself a number of ambitious goals for the next few years, from reforming the international system, to achieving “peaceful reunification” with Taiwan. All of these require the support of the Global South, especially as Beijing’s relationship with the West deteriorates.
In view of the challenges to China’s soft power in the Global South over so-called "debt-trap" lending, Beijing is showing some willingness to change its approach and co-ordinate with the international community. It has, in Zambia’s case, recently agreed to co-chair creditor committees. Most recently, Sri Lanka represents another important test case for China’s changing approach. It is likely that India’s role as an advocate in the international community will add to the pressure on China to do the same.
And yet, regardless of how feelings towards China may change, Beijing’s significant economic presence in Sri Lanka, and the region at large, is unlikely to shrink; the consensus is that such an unwinding would be a lose-lose scenario. The Sri Lankan government as well as analysts in the global market agree that China remains an irreplaceable source of trade, investment and tourism. In other words, this is not a mutually exclusive tussle between India and China, or even China and the West.
Instead, it has transformed into a set of contests over the way that money-matters are handled between governments – multilateral versus unilateral, and financial profit versus stability. The changes that are being signalled represent a win for the whole world, China included.
