The Great Chinese White Elephant of Sri Lanka

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Sri Lankan President Gotabaya Rajapaksa has a fetish for the fiasco. The Indian Ocean island is a basket case for several reasons. Covid-19 decimated dollar revenue from tourism; the resulting increase in social spending has inflated public debt. Then came the war in Ukraine, worsening shortages of food, fuel and foreign currency. But the lion’s share of the blame must fall on the fanciful policies of the strongman.

Rajapaksa presided over the fall of the economy: it began with a costly tax cut soon after he took office in 2019; this was followed by an ill-conceived enthusiasm for organic farming, which destroyed the production of rice, the local staple, and tea, a crucial export; and then there’s the bizarre embrace of a Chinese-built tax haven as a ticket to growth. Sri Lanka now has the fastest inflation rate in Asia at almost 19%; widespread power outages; and nearly $5 billion in dollar-denominated borrowings due this year and next with just over $2 billion remaining in the currency pool. The administration threw in the towel on Tuesday by announcing its intention to default on foreign debt.

Emblematic of this mess, the white elephant that Rajapaksa recovered from China: the Colombo Port City project, envisioned as a playground for the rich who would earn dollars and keep everything. Companies located there could, at the discretion of the city management commission, also be exempted from paying taxes and duties. The reclaimed 269-hectare plot of land is meant to position the commercial capital of Colombo as South Asia’s most livable city, a tropical paradise version of Dubai’s international financial center only twice as large. Never mind the sinking feeling that is taking hold in other coastal metropolises from Singapore to Jakarta to Manila due to rising sea levels.

The port city is an expensive fantasy, even if it continues to generate a sixth of Sri Lanka’s current economic output by 2041, as an independent study predicts. Although Chinese money builds it, a hub of residential, commercial, commercial and financial activity that produces little revenue for the debt-ridden nation may not be the best use of its coastline or its real estate. As a saviour, the IMF must insist that companies in the special economic zone pay their share of taxes.

So far, the Fund has been cautious about calling the port city for what it is: sheer madness. But he questioned his overriding purpose. “The creation of a low-tax jurisdiction is likely to attract the attention of the international community given the renewed attention on these issues,” the institution noted recently after consultation with the government of the country. ‘Isle. Sri Lanka is swimming against the tide: tax-free UAE introduces 9% tax on business profits from next year; and Singapore is considering an “additional tax” on multinationals to align its policies with the Organization for Economic Co-operation and Development’s global rules on base erosion and profit shifting.

Largesse could perhaps be justified if it were an effective means of attracting investment and improving living standards. But until the area is functional, its links to the wider economy will remain largely limited to pump priming construction. Even after 2041, it’s unclear just how much Port City will attract. “Tax incentives”, as the IMF notes, “are often not a key determinant in attracting investment and the revenue foregone could be better spent on human capital and infrastructure, while improving the business environment”.

The project was launched in 2014 when Gotabaya’s brother Mahinda, the current prime minister, was president. The family (until recently there were several other members of the Rajapaksa clan in government) probably believed that Sri Lanka could exploit its strategic naval position to profit from rising China and India, the two big regional powers against each other. China Harbor Engineering Co., which oversaw the reclamation, secured a 99-year lease on 116 hectares. The share of marketable land owned by the government is only 62 hectares.

India has been extremely critical of a new Chinese enclave in its backyard. His suspicions of Sri Lanka’s pro-Beijing tilt were heightened when Rajapaksa kicked India and Japan out of a deal to jointly rebuild a partially functional Eastern Terminal at the port of Colombo, next to the South Terminal backed by the China, including China Merchants Port Holdings Co. . owns 85%. The government decided to keep ownership of the eastern terminal in local hands, but still gave CHEC a role in construction. To sweeten New Delhi, Rajapaksa awarded a 51% stake in a new western terminal to the Indian group Adani, without a public tender.

Including the port of Hambantota, leased to China Merchants Ports by a previous administration to ease its debt burden, and a Colombo elevated highway project handed over to CHEC, the tiny nation (population: 22 million) appears to have staked the most – if not all – of its strategic assets. Yet all it has to show for its participation in the Sino-Indian strategic rivalry is economic misery, shattered public finances and a plummeting currency even after the central bank raised interest rates. by 7 percentage points in one day to stabilize the fall. local rupee.

If it was a bad idea for tiny Sri Lanka to get caught up in regional geopolitics, taking sides in the US-China Cold War might be worse. Given the project’s Belt-Road connection, Washington would be wary if Port City was as lax on financial regulation as it was generous in letting the wealthy keep their money. A new tax haven in the Indian Ocean will raise eyebrows, but a potential hub for circumventing US sanctions? It just won’t be enough.

More from Bloomberg Opinion:

• A tropical paradise cooks up a storm in a teacup: Andy Mukherjee

• The street has spoken. Will strong men listen? : Ruth Pollard

• How Four Powerful Brothers Shattered an Island Nation: Ruth Pollard

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services. He was previously a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

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