Sri Lanka’s current crisis is an opportunity for India to draw the island nation away from China
As the Taliban’s takeover indicates structural changes in India’s neighbourhood, a new challenge is now emerging from the South. A food-scarce Sri Lanka is now standing atop of an economic disaster that will have severe security repercussions for India if left unattended.
This economic crisis is a product of decades of Sri Lanka's economic growth model. Despite transforming into a middle-income country, Sri Lanka could not generate large Foreign Direct Investments (FDIs) due to the prolonged civil war and political instability. It continued to sustain its economic growth by borrowing through sovereign bonds and international bilateral commercial loans, generally at high-interest rates and short payback periods (refer to Table 1); this compelled the government to spend its income and foreign reserves on repaying the loans and sustaining itself through continued borrowing. By 2020, this external debt summed up to US $35.3 billion.
Table 1. Sri Lanka’s outstanding external debt.
| Donor | Market Borrowings | Asian Development Bank | Japan | China | World Bank | India |
| Percent (%) | 47% | 13% | 10% | 10% | 9% | 2% |
Source: News Wire
The country’s revenue and foreign reserves depleted further as Sri Lanka’s tourism industry worth US$ 3-5 billion (or 10 percent of the country’s GDP) came to a halt with the Easter blasts and subsequent COVID waves. This crisis exacerbated further with the depletion of the state’s food production and exports due to the government’s arbitrary policy to move to organic farming. The subsequent practices of running the governments on a deficit and reduction of taxes further worsened the situation, leaving Sri Lanka with a meagre foreign reserve of US $2.8 billion by July 2021.
Despite transforming into a middle-income country, Sri Lanka could not generate large Foreign Direct Investments (FDIs) due to the prolonged civil war and political instability.
These factors together contributed to inflation, a ban on several imported goods, and a food emergency. Moreover, this crisis is expected to be prolonged as the Sri Lankan government continues to misgovern the situation and as its debt maturities continue to increase till 2030.
In the past, Sri Lanka had approached China, India, and the IMF for economic assistance. However, the current government is keen on avoiding the IMF and has been seeking assistance from India and China for currency swaps and from China for syndicated loans/Foreign Currency Terms Facilities.
However, as the crisis continues, Sri Lanka will move further closer to China for multiple reasons. Primarily, China has provided and will continue providing huge loans and dollar swap facilities to Sri Lanka. These syndicated loans will also be prioritised by the former, as they are disbursed with no conditions and will also boost the much-needed foreign reserves. On the other hand, India has not only fallen short of lending to Sri Lanka when compared to China (refer to Table 1) but has also refused to extend the currency swap agreement with the former.
Similarly, as Indian investments promote social development, China’s key projects and investments, such as the Colombo Port City and the Hambantota Port, increase the much-needed FDIs and profits. Thus, making China a point of attraction.
Finally, for Sri Lanka, winning international support and cooperation from China works on only one factor (at least for now), i.e., economic cooperation. In contrast, if Sri Lanka has to seek India’s international support and cooperation, it will have to act on issues that will hurt its politics dearly, this includes minority rights, implementing the 13th Amendment, and distancing itself from China.
China has provided and will continue providing huge loans and dollar swap facilities to Sri Lanka. These syndicated loans will also be prioritised by the former, as they are disbursed with no conditions and will also boost the much-needed foreign reserves.
A similar concern haunts the EU-Sri Lanka ties. Being one of the largest importers of Sri Lankan goods (refer to Table 2), the Union has displayed annoyance and signs of repercussions with the Sri Lanka’s decision to impose long-term import bans. This can exaggerate the EU-Sri Lankan divide on the human rights issues in Sri Lanka and will only disrupt further trade and investments. Thus, pushing Sri Lanka further closer to China
However, these incentives for Sri Lanka aren’t free of the Chinese debt trap either. Thus, India has no other option but to deter Sri Lanka from completely tilting towards China. The crisis provides India with an opportunity to compel Sri Lanka to respect and act on Indian national interests/sensitivities.
In addition to its traditional means of providing loans and financial assistance, India can use goodwill policies/relief measures to pressurise Sri Lanka. Primarily, with its import bans, the Sri Lankan government is focusing on improving its export revenues and forex reserves. Being one of the top importers of Sri Lankan goods (refer to Table 2), with 70 percent of it directed through an FTA, India possesses a great potential to boost the former's revenue and forex reserves. India can thus use this opportunity to propose time-framed concessions for Sri Lankan imports and compel the former to align and act along Indian national interests.
Being one of the top importers of Sri Lankan goods (refer to Table 2), with 70 percent of it directed through an FTA, India possesses a great potential to boost the former's revenue and forex reserves.
Table 2. Sri Lanka’s top export destinations and their values
| Sri Lanka top export destinations in 2020 | Export values (in US $) |
| USA | 2.66 billion |
| UK | 956 million |
| India | 654 million |
| Germany | 611 million |
| Italy | 477 million |
| Belgium | 313 million |
| Netherlands | 307 million |
| China | 252 million |
Source: Trading economics
Secondly, the import ban on non-essential goods has reduced the exports from both India and China. However, it is India's export of edibles and essential goods that provides it with an advantage over China's exports (refer to Table 3). This provides an opportunity for India to export humanitarian food supplies and essential commodities on concessions to Sri Lanka for a specific period. It can further use this goodwill gesture to persuade Sri Lanka to have more sensitivities for Indian interests and concerns.
Table 3. Top exported articles to Sri Lanka
| Top exported articles from India | Top exported articles from China | |
| 1 | Pharmaceutical products | Iron and Steel |
| 2 | Sugar and Sugar confectionery | Knitted or crocheted fabrics |
| 3 | Mineral fuels, oils, and waxes | Telephone sets |
| 4 | Iron and Steel | Man-made staple fibres |
| 5 | Salt, Sulphur, earths and stone, plastering materials, lime and cement | Cotton |
| 6 | Coffee, tea, mate and spices | Nuclear reactors, boilers, machinery, and mechanical appliances |
| 7 | Knitted or crocheted fabrics | Plastics and its articles |
| 8 | Vehicles and their parts and accessories | Special woven fabrics, tufted textile fabrics, tapestries, trimmings, embroidery and lace |
| 9 | Edible vegetables, and roots and tubers | Man-made filaments |
Source: High Commission of India, Embassy of Sri Lanka
This economic crisis, therefore, provides an opportunity for India to display its goodwill in Sri Lanka and also nudge the state to respect Indian interests and sensitivities. While Sri Lanka’s interests and aspirations might lie with a closer relationship with China, it is India’s responsibility to begin engaging and negotiating with Sri Lanka over the crisis. And the more India delays to tap on this crisis, the more it opens the door for Sri Lanka to make concessions and negotiations with others, especially China.
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Aditya Gowdara Shivamurthy is an Associate Fellow with ORFs Strategic Studies Programme. He focuses on broader strategic and security related-developments throughout the South Asian region ...
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