Financing Infrastructure: The (non) Concessionality of Concessional Loans

Sri Lanka is highly dependent on international loans from multilateral and bilateral sources to finance infrastructure development. 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, this report finds that the practice of ‘tying’ loans to procurement from contractors in the lending country and resulting cost escalations can significantly erode the concessional or grant element of these loans.

This paper thus explores the extent to which seemingly concessional loans might have other hidden costs attached to it by developing and deploying a methodology for analysing the trade-off between the grant element and tied element of a selection of foreign loans taken by Sri Lanka from multiple lenders (e.g. China, Japan and India). The findings of this research suggest that Sri Lanka may be overestimating the benefits of bilateral loans that are concessional.