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Sri Lanka’s graceless cancellation of Japan-funded rail project may affect foreign investment

SAM SPECIAL-ENG-01-10-2020 (1)

The cancellation of the Japanese-funded Light Railway Transport (LRT) project in Colombo by the Sri Lankan government may have been based on rational grounds, weighing its “limited use” against the “huge cost”. But the abrupt and graceless way in which it was done could sour relations with Japan which has been a friendly country since Lanka’s independence in 1948 and its main loan giver till 2016 when China took over. 

The decision to cancel the project was announced without taking the Japanese into confidence first or even officially informing them about it. 

Commenting on it, a diplomat said that it could adversely affect foreign investors’ sentiment, especially that of foreign private investors. Private investors’ decisions are not amenable to political expediency and are purely commercial.   

This is not the first time that Sri Lanka has attempted to walk out of an international agreement or MoU. The previous United National Party (UNP) government (2015- 2019) had stopped the US$ 1.4 billion Chinese-funded Colombo Port City project for more than a year alleging corruption. Finally it ended up giving more land to the Chinese as a compensation. The present Rajapaksa government is dragging its feet over the implementation of a Memorandum of Cooperation signed with Japan and India to run the Eastern Terminal in Colombo Port.  Pressure from nationalistic port workers and government’s policy on keeping national assets to itself, are cited as reasons for stalling. 

In 2017, Sri Lanka had signed with India about 15 MoUs on a variety of joint venture projects. But there has been no movement on these, despite New Delhi’s prodding. The present Gotabaya Rajapaksa government has said that it will review these projects and implement only what is needed by Sri Lanka and what it considers implementable.  

Early indications 

The Light Rail Transport (LRT) project involved laying a single 16 km elevated track from Malabe in the outskirts to the Fort in the middle of the city. The distance was to be covered in 32 minutes by a train going at 80 km per hour carrying 800 passengers per trip. Work was to be completed in 2025. It was to be funded by a US$ 2.2 billion Japanese soft loan (one component at 0.1% and another at 0.01% annual interest) to be repaid over 40 years.

To be fair to the Gotabaya government it had been indicating for some months, that it would not like to go ahead with the LRT project. Though a joint Sri Lanka-Japan feasibility study had concluded that it was a worthwhile project considering the traffic congestion in Colombo, the Gotabaya government, which came into existence in November 2019, was skeptical about it. Further, President Gotabaya, who has hands-on experience as an urban development official, having been Secretary to the Ministry of Urban Development earlier, had his own ideas on the subject. 

Financial constraints

An important consideration was the country’s financial situation which did not permit extravagance. In the first quarter of 2020, Sri Lanka’s economy had contracted by 1.6%. Sri Lanka is saddled with a US$ 55 billion debt burden.Of that debt, China accounts for 14%, the Asian Development bank 14%, Japan 12%, the World Bank 11%, and India 2%.

This month, the rating agency Moody’s, downgraded Sri Lanka saying that it expects government liquidity and external risks to intensify, as its external debt service payments amount to approximately U$4 billion (annually) between 2020 and 2025. Wide budget deficits in the next few years are likely to require at least partial external financing, which is increasingly difficult to access, the international ratings agency said. Moody’s further said it expected Sri Lanka to repay its US$1.0 billion debt maturing next month by drawing down its foreign reserves, but it warned that this would “further deplete already thin external buffers.”

Request for debt repayment moratorium 

Both President Gotabaya Rajapaksa and Prime Minister Mahinda Rajapaksa had sought a loan repayment moratorium from India, China and the European Union. The Central Bank of Sri Lanka had sought a US$ 400 million currency swap with the Reserve Bank of India under the SAARC facility. In May, President Gotabaya sought a “special” U$ 1.1 billion currency swap with India. These requests are still under consideration in New Delhi. 

Meanwhile, China gave US$ 500 million to help Sri Lanka fight COVID-19. But as regards Colombo’s request to re-schedule debt repayment moratorium, the acting Chinese Ambassador said that it would not be good for Sri Lanka to ask for it.

Consequences of cancelling project  

Be that as it may, a key issue in regard to the LRT project is its politico-psychological dimension. Knowledgeable circles regret that the Japanese were not officially informed about the impending cancellation nor was there any discussion with them on the issue and the possible alternatives to the project.

It is pointed out in diplomatic circles that the 2017 agreement on the LRT project was an international one between two governments which cannot be terminated unilaterally. It is not certain if Tokyo will take punitive action against Sri Lanka, for that will be a difficult political decision taken at the highest level based on geo-political considerations given the looming China factor. But it cannot be denied that any cancellation of this type and in the manner in which it is done, will adversely affect international investment confidence in the Sri Lankan government.  

There is also a feeling in Sri Lanka that the government should not upset Japan, which has been a long-standing friend of the country. Sri Lankans see Japan as a benevolent friend which had aided Sri Lanka and invested in it heavily before China overtook it in 2016. 

In turn, the Japanese are grateful to Sri Lanka as it had called for the humane treatment of Japan after the latter’s humiliating defeat in World War II. When the victorious Allies wanted to divide Japan among themselves as they did in post-war Germany, Sri Lanka protested and its delegate at the post-war conference, J.R. Jayewardene, quoted the Buddha to say that love and not hatred would pave the way for genuine peace. Sri Lanka had also decided not to accept any war reparations from Japan.  

It is learnt that Japan is still willing to re-negotiate the urban railway project if the Lankan government is interested in doing so. On its part, the Gotabaya government is interested in a transport plan for Colombo. According to the letter of cancellation sent by the Secretary to the President Dr.P.B. Jayasundara to the Transport Ministry Secretary, the government will be working on a plan under the aegis of the Urban Development Authority, the railways, and other relevant state institutions. As said earler, President Gotabaya is keenly interested in urban development as seen when he functioned as Urban Development Ministry Secretary from 2010 to 2014. He had changed the face of Colombo at that time.

However, it is not clear as to how the government’s urban transport plan will be funded. Government could use the US Millennium Challenge Corporation’s funds earmarked for transport modernization which is substantial. But the draft US$ 480 million MCC compact had become very controversial. A Presidential committee had recommended renegotiation to safeguard Sri Lanka’s sovereignty and national laws.