By Uditha Jayasinghe

COLOMBO (Reuters) -Sri Lanka has reached an agreement with the Export-Import Bank of China to cover about $4.2 billion of the island nation's outstanding debt, its finance ministry said in a statement on Thursday.

Sri Lanka is struggling with its worst financial crisis in more than seven decades after its foreign exchange dwindled to record lows, forcing the country to default on its foreign debt last May.

China is Sri Lanka's largest bilateral creditor, owing about $7 billion.

Sri Lanka started negotiating with its bondholders and key bilateral creditors including China, Japan and India last September, parallel to moving forward on a $2.9 billion bailout from the International Monetary Fund (IMF).

The agreement with China EXIM Bank will assist Sri Lanka in getting past the first review of the IMF programme in the coming weeks and in securing the release of the second IMF tranche of about $334 million, the statement said.

"This agreement constitutes a key milestone in Sri Lanka’s ongoing efforts to foster its economic recovery,” the statement added. "In the next few weeks, the Sri Lankan authorities and China EXIM bank will actively work on formalizing and implementing the agreed parameters of the debt treatment."

A debt rework deal between Sri Lanka and countries including Japan, India and France was expected this week. But those countries and the IMF were surprised on Tuesday when Sri Lanka made a deal with China.

Japan, France and India, which are co-chairs of a creditor committee for Sri Lanka, may need to see details of the agreement Sri Lanka has made with China EXIM Bank to proceed with debt restructuring negotiations.