Sri Lanka's Strategic Shift Toward China: Implications for Regional Infrastructure and Debt Sustainability

In the intricate dance of global geopolitics and emerging market debt, Sri Lanka stands as a case study of both opportunity and peril. The island nation’s strategic location in the Indian Ocean has long made it a focal point for great-power competition, but its recent economic crisis and deepening ties to China’s Belt and Road Initiative (BRI) have amplified the stakes. For investors, the interplay between infrastructure development, debt sustainability, and geopolitical positioning demands a nuanced understanding of the risks and rewards embedded in this volatile landscape.

The BRI’s Dual-Edged Sword

China’s investments in Sri Lanka under the BRI have transformed the country’s infrastructure landscape. The Hambantota International Port, once a flagship project, epitomizes the initiative’s promise and pitfalls. By 2022, Sri Lanka had borrowed $13.2 billion from Chinese state-run banks to fund such projects, only to face a debt crisis that forced it to lease the port to a Chinese firm for 99 years—a move that sparked fears of strategic overreach and military entanglement [1]. This pattern—of large-scale, resource-backed projects with opaque terms—has become emblematic of the BRI’s broader risks.

Data from the Lowy Institute reveals that 75 of the world’s most vulnerable countries, including Sri Lanka, face a record $22 billion in debt repayments to China in 2025 [5]. While the BRI has driven unprecedented infrastructure spending—$66.2 billion in construction contracts and $57.1 billion in investments in 2025 H1—the focus on megaprojects and extractive industries raises questions about long-term sustainability [2]. For Sri Lanka, the 2022 restructuring of $4.2 billion in Chinese debt underscored the fragility of its fiscal position, even as it sought to balance competing geopolitical interests [4].

Debt Sustainability: A Fragile Equilibrium

Sri Lanka’s debt crisis, which culminated in a default in 2022, has forced a reevaluation of its economic strategy. The IMF’s Extended Fund Facility (EFF) program, now in its fourth review, has provided critical support, with $350 million in SDR access to stabilize the economy [3]. However, the World Bank warns that South Asia’s high debt levels and limited fiscal space remain significant risks, particularly as global trade policy uncertainties persist [6].

The geopolitical dimensions of this crisis are equally complex. While China accounts for only 10% of Sri Lanka’s external debt, its influence is magnified by strategic investments and the absence of robust institutional frameworks to manage borrowing [3]. This has prompted India to step in as a counterbalance, offering $4 billion in emergency financing during the 2022 crisis and advocating for “green debt swaps” to redirect resources toward renewable energy and climate resilience [1]. Such initiatives reflect India’s broader ambition to counter Chinese economic leverage in the region while promoting sustainable development.

Geopolitical Investment Positioning

The Quad’s infrastructure diplomacy—pledging $50 billion for Indo-Pacific projects by 2027—highlights the growing competition between China’s BRI and Western-led alternatives [5]. Yet, progress remains uneven. While the Quad emphasizes transparency and sustainability, its scale pales in comparison to China’s rapid deployment of capital. For investors, this dichotomy presents a paradox: Chinese projects offer speed and scale but carry debt and governance risks, whereas Western alternatives prioritize sustainability but struggle to match the pace of investment.

Sri Lanka’s experience illustrates this tension. The country’s 2025 Development Update notes a modest economic rebound, driven by construction and tourism, but cautions that medium-term growth will remain constrained by global uncertainties [4]. The challenge for policymakers—and by extension, investors—is to align infrastructure spending with fiscal discipline, ensuring that projects generate returns rather than liabilities.

Risk Management in Emerging Markets

For investors navigating this terrain, the lessons from Sri Lanka are clear. First, debt sustainability must be assessed through a multidimensional lens, incorporating not just financial metrics but also geopolitical dynamics and institutional capacity. Second, diversification of funding sources is critical. Sri Lanka’s reliance on a single creditor—whether China or Western institutions—exposes it to volatile terms and leverage. Third, transparency and environmental safeguards must be non-negotiable. The BRI’s recent shift toward “small and beautiful” projects [2] suggests a recognition of these risks, but implementation remains inconsistent.

Conclusion

Sri Lanka’s journey from economic collapse to cautious recovery underscores the delicate balance between infrastructure ambition and fiscal prudence. As China consolidates its role as a global debt collector and India recalibrates its regional strategy, the island nation’s fate will hinge on its ability to navigate these competing pressures. For investors, the imperative is to embed geopolitical awareness into risk assessments, recognizing that infrastructure projects are not merely economic endeavors but also instruments of power. In an era of fragmented globalization, the path to sustainable growth lies not in choosing between China and the West, but in crafting frameworks that align capital with resilience.

Source:
[1] From debts to solutions: Green debt swaps in India-Sri Lanka relations, [https://www.orfonline.org/english/expert-speak/from-debts-to-solutions-green-debt-swaps-in-india-sri-lanka-relations]
[2] China Belt and Road Initiative (BRI) investment report 2025 H1, [https://blogs.griffith.edu.au/asiainsights/china-bri-investment-report-2025/]
[3] IMF Executive Board Completes the Fourth Review Under the 48-month Extended Fund Facility with Sri Lanka, [https://www.imf.org/en/News/Articles/2025/07/02/pr24235-sri-lanka-imf-executive-board-completes-the-fourth-review-under-the-eff]
[4] Sri Lanka Development Update 2025, [https://www.worldbank.org/en/country/srilanka/publication/sri-lanka-development-update-2025]
[5] The Quad's Infrastructure Diplomacy: Current Trends and Future Prospects, [https://www.orfonline.org/research/the-quad-s-infrastructure-diplomacy-current-trends-and-future-prospects]
[6] South Asia Overview: Development news, research, data, [https://www.worldbank.org/en/region/sar/overview]