The Sri Lankan government has been misled by some international lending agencies and donor countries in granting concessional loans for development projects and services.

A recent study published by Verité Research sheds light on this financial discrepancy in a comprehensive manner. Multilateral and bilateral borrowing is often favoured by governments such as Sri Lanka because such financing tends to have ‘concessional’ elements, relative to the international financial markets.

However, the study done by Verité Research reveals that the extent of concessionality is being overestimated, and that in some cases, loans that are deemed concessional can be less favourable than borrowing on international financial markets.

The findings of the study were presented by Dr. Nishan de Mel (Executive Director) and Ms. Subhashini Abeysinghe (Research Director) at a webinar hosted by Verité Research on 10 September 2020.

The study showed that the erosion of concessionality arises from the widely accepted practice of ‘tying’ loans to sources of procurement preferred by the lender.

A loan is tied when a certain portion of the loan is restricted to the procurement of goods and services from contractors connected to the lender.

This limits the recipient country’s ability to secure the best value for money through a process of competitive bidding. Therefore, projects funded by tied loans can have significant escalations in costs.

The cost escalation on the tied component has the consequence reversing the concessionality or grant element of the loan.

The study by Verité Research provides a measurement of the initial concessionality of major infrastructure loans taken by Sri Lanka between 2005-2018, by source of the loan.

28 out of 35 evaluated bilateral loans to Sri Lanka between 2005 – 2018 were tied loans worth USD 9.2 billion.

All evaluated loans from China (18) and India (3) were tied, and 6 of the 13 evaluated loans from Japan were also tied.

The study also measured and evaluated the extent to which each loan is vulnerable to being non concessional due to the tied component of the loan. The study concluded that  18 of the tied loans would be non-concessional with a cost escalation of 50% on the tied element. 4 of these loans were vulnerable to becoming non-concessional with a cost-escalation of 15% on the tied element.

The vulnerability of loans to being non-concessional can vary significantly and can depend on the country from which the loan is secured.

The study suggested that for Sri Lanka, the risk of cost escalation is likely to be higher for projects funded by tied loans that originated as unsolicited proposals. In Sri Lanka’s case, 13 of the 28 projects funded by tied loans originated as unsolicited proposals.