Sri Lanka’s economic crisis: Challenges for India – Explained, pointwise

Introduction

Sri Lanka’s government recently declared an economic emergency. The country is witnessing rising food prices, a depreciating currency, and rapidly depleting forex reserves. The army has been called in to manage the crisis by rationing the supply of various essential goods.

Sri Lanka, located at the crossroads of global shipping lanes, enjoys an unrivaled strategic significance in the Indian Ocean region.

Hence, its economic stability assumes importance for India.

What is the current economic situation in Sri Lanka?

Poor state of tourism industry: The tourism industry, which represents over 10% of the country’s Gross Domestic Product and brings in foreign exchange, has been hit hard by the Easter Sunday terror attacks of 2019 and coronavirus pandemic.

Shortage of forex reserves: As a result, forex reserves have dropped from over $7.5 billion in 2019 to around $2.8 billion in July this year.

Depreciation of currency: The printing of Rs. 800 billion by the Central Bank of Sri Lanka over the last 18 months to ease the economic crisis has increased liquidity in the economy. But this infusion of money, and the consequent increase in demand without a corresponding increase in supply, has led to a sharp spike in inflation. This in turn has devalued the currency, made imports costlier, added to the debt, and put the forex reserves under more pressure. So, the value of the Sri Lankan rupee has depreciated by around 8% so far this year.

Rise in price of food items: It has to be noted that the country depends heavily on imports to meet even its basic food supplies. So the price of food items has risen in tandem with the depreciating rupee. The government’s ban on the use of chemical fertilizers in farming has further aggravated the crisis by dampening agricultural production.

High debt: Its public debt-to-GDP ratio was at 109.7% in 2020, and its gross financing needs to remain high at 18% of GDP, higher than most of its emerging economy peers. More than $2.7 billion of foreign currency debt will be due in the next two years.

Issues in India-Sri Lanka relations 

India and Sri Lanka have enjoyed a cordial and relatively stable relationship since their independence, but over the years the ties seem to have declined, due to multiple outstanding and recent issues:

Fishermen issue: Fishermen-related conflict has been a constant area of concern between the two South Asian neighbors for a long time. Sri Lanka has long expressed concerns about illegal fishing by Indian fishermen within its territorial waters across the Palk Strait. India also detains Sri Lankan fishermen for illegal fishing. Between January 2015 to January 2018 alone, 185 Indian boats got seized, 188 Indian fishermen have been killed, and 82 Indian fishermen are missing.

Katchatheevu Island: It is an uninhabited island that India ceded to Sri Lanka in 1974 based on a conditional agreement called “Katchatheevu island pact”. The central government recognizes Sri Lanka’s sovereignty over the island as per the 1974 accord. But Tamil Nadu claimed that Katchatheevu falls under the Indian territory and Tamil fishermen have traditionally believed that it belongs to them and therefore want to preserve the right to fish there.

Many recent issues have cropped up too, like

Colombo port issue: In February 2021, Sri Lanka backed out from a tripartite partnership with India and Japan for its East Container Terminal Project at the Colombo Port, citing domestic issues. The Colombo port is crucial for India as it handles 60% of India’s trans-shipment cargo.

Non extension of Currency swap agreement: The RBI had signed a currency swap agreement with the Central Bank of Sri Lanka (CBSL) under the SAARC Currency Swap Framework 2019-22, for withdrawals of up to $400 million. Even though the agreement was valid till 13 November 2022, India declined any further renewal of it in the absence of an International Monetary Fund program to address Sri Lanka’s current macroeconomic imbalances.

Sri Lanka’s drift towards China: Over the years, Sri Lanka has drifted towards China for economic support and views her as a more reliable partner in enabling domestic economic development. Moreover, the present govt led by the Rajapaksa family is historically known to be closer to China. India is, hence, concerned about China’s growing influence in the Indo-Pacific waters. China, for instance, is set to commence the construction of a US $13 billion city on Sri Lanka’s seafront close to Colombo.

Implications for India

Impact on India’s strategic interests: Colombo assumes importance for India since almost 70% of all container cargo for and from India is trans-shipped there, mostly at Chinese-operated terminals. Thus, a long-term economic crisis in Sri Lanka will threaten India’s strategic interests.

Opportunity for China: The growing economic crisis in Sri Lanka offers more opportunities for China to increase its dominance in the Indian Ocean region. Allowing this to continue will adversely affect India’s strategic interests. The economic crisis may further push Sri Lanka to align its policies with Beijing’s interests. This comes at a time when India is already in a difficult situation diplomatically with Afghanistan and Myanmar.

Problem for exporters: Decreasing forex reserves of Sri Lanka has Indian exporters worried about the possible payment of dues by Sri Lankan importers.

Thus, considering the strategic and economic implications for India, it should invariably help Sri Lanka to tide over the present economic crisis by whatever means necessary.

Suggestions/Measures

Nurturing the Neighborhood First policy with Sri Lanka is important for India, albeit with due caution, to preserve its strategic interests in the Indian Ocean region. India also must look for ways to boost people-to-people contacts. In the technology sector, India could create job opportunities by expanding the presence of its information technology companies in Sri Lanka.

Regional platforms like the Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC) and the Indian Ocean Rim Association could be leveraged to foster cooperation in common areas of interest.

Way forward

History, cultural closeness, and the constraints of geography poise India and Sri Lanka as natural and permanent partners. They need to explore cooperation in new avenues to further their respective economic and developmental aspirations jointly.

The present situation actually affords an opportunity to India. It can step up its aid to help rescue Sri Lanka from this economic crisis. Assistance given at this particular juncture will carry major diplomatic weight than the assistance given during normal times. This crisis can jumpstart a new chapter in India-Sri Lanka relations.