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Sri Lanka’s Economic Crisis: An Opportunity for India to Reclaim Influence

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Sri Lanka’s Economic Crisis: An Opportunity for India to Reclaim Influence

Continued instability on the island will have repercussions in India. That will be a burden for India, not for China.

Sri Lanka’s Economic Crisis: An Opportunity for India to Reclaim Influence

India’s Minister for External Affairs S Jaishankar (second from left) visits a Lanka Indian Oil Corporation filling station in Colombo on Monday, March 28, 2022, where he was briefed on the fuel supply situation by Lanka IOC.

Credit: Twitter /DrSJaishankar

Sri Lanka is in crisis. In the capital, Colombo, last week, authorities fired tear gas and water cannons at protesters who had gathered outside the home of President Gotabaya Rajapaksa demanding his resignation. The country of 22 million people is in the throes of a major economic crisis, one not seen since its independence in 1948.  The crisis has stretched the ability of policymakers to pay for essential public services as the treasuries have been drained. Coupled with a severe shortage of foreign currency, vital to the payment of tremendous amounts of Chinese-funded debt, the government had little choice but to ban critical imports, leaving many with a shortage of everyday essential items.

The past few years have been particularly difficult for Sri Lanka. The country has been devastated by the tourism-related impacts of the COVID-19 pandemic, as well as the fallout from the Easter Sunday bombing in 2019 that shook the confidence of foreign investors as well as tourists. Many depend on the $4.4 billion tourism industry, which slumped 70 percent in May 2019 due to the terrorist attack. Because of COVID-19, the Sri Lankan economy lost more than $3 billion over the first eight months of 2021.

In this period of economic uncertainty, however, there is an opportunity for India and Sri Lanka to repair more than a decade of chaotic bilateral relations. As Colombo struggles, an opportunity arises for New Delhi to repair and restore the traditional relationship it had with its island neighbor.

India-Sri Lanka ties turned frosty during Mahinda Rajapaksa’s presidency (2005-15). The Sri Lankan president used the availability of Chinese credit to buy himself domestic legitimacy and tighten his grip over power. Especially after 2012 when India faulted Sri Lanka for human rights violations during its three-decade-long civil war, Sri Lanka moved into the Chinese orbit. It firmed up a series of agreements that it had signed with China beginning in 2005, including a $1.35-billion deal to construct the coal-fired Lakvijaya Power Plant in Puttalam, and the controversial Hambantota Port.

Sri Lanka eventually lost the Hambantota Port when it began to struggle with repayment of loans. It resulted in the Port and more than 15,000 acres of land being handed to Beijing in a 99-year lease. India was right to worry when the leases gave China an advantage for using it as a possible strategic military port for its Indian Ocean fleet.

These and other arrangements are significant because they possibly represent opportunities that were not available to other foreign companies, or they were blocked by Chinese interests. For example, the East Container Terminal (ECT) of the Colombo Port was supposed to be offered to India and Japan, but Sri Lanka backed out after local resistance. When Indian External Affairs Minister S. Jaishankar visited Sri Lanka in January 2021, he expressed concern that China was behind delays in Colombo’s decision-making on Indian investments in Sri Lanka,  including the one in partnership with Japan in the ECT project.

Sri Lanka’s ambitions for a lucrative future, conveniently financed by Chinese loans, have been upended by the downturn in the Sri Lankan economy. The rupee’s decline saw above-average food prices, with a 22 percent increase at the end of last year. The government issued a controversial $1 billion relief package, which gave local salaries a boost, while removing taxes on food and medicine and providing cash assistance to vulnerable populations. President Gotabaya Rajapaksa, now on the back foot, asked Chinese Foreign Minister Wang Yi in January 2022 to restructure Colombo’s debt repayments as a part of efforts to relieve pressure on its economy.

After realizing the limits of economic and strategic cooperation with China and the predicament in which Sri Lanka was placed, President Gotabaya Rajapaksa undertook his maiden overseas trip to India in November 2019. A flurry of visits by other Sri Lankan leaders to Delhi have followed.

To assuage India’s concerns, Sri Lanka has not only tried to balance its relations with India, but also it declared an India first policy in October 2020. Furthermore, the Sri Lankan leadership has realized that India has always stepped in when Sri Lanka needed it, and the relationship with China could not be at the expense of India.

Now, India and China appear to be in a diplomatic struggle for the good graces of Sri Lanka. If India wants to loosen China’s grip and restore its traditional influence over Sri Lanka, it must act swiftly.

China has been quick to lend assistance, offering a $1.5 billion line of credit and a $1 billion loan. It has also pushed for acceleration of the China-Sri Lanka free trade agreement, which China believes will benefit local Sri Lankan goods. China also sent 2,000 tons of rice to address food shortages.

To its credit, New Delhi provided Colombo with a $1 billion line of credit for food, medicine and other essential items. India’s Foreign Secretary Harsh Vardhan Shringla recently reiterated that Sri Lanka is a core part of Prime Minister Narendra Modi’s Neighborhood First policy, designed to dilute anti-India sentiment and establish better relationships with states in the region.

As Sri Lanka struggles, India should embrace the spirit of Neighborhood First and restore the image of a traditional partner with Sri Lanka. It should not look for economic concessions or strap Colombo with additional future debt. It should instead develop a Marshall Plan for the economically-devastated island.

India needs to recognize the fragility of the situation. As a state with ethnic ties to Sri Lanka, a worsening of the situation in the island could lead to large-scale movement of Sri Lankan nationals to India. Some have already started arriving at the Indian coast. Refugees from the civil war still live in Tamil Nadu state or have integrated into Indian society.

With inflation at 14.2 percent eating away the ability of Sri Lankans to afford daily essentials, India, which has the resources, should extend them support through supplies of food, medicine, and other essential goods. India has already responded by sending $500 million worth of fuel, almost all of which had run out last week.

But India can do better. It can work to boost the production of essential medicines, for which Sri Lanka lacks the capacity and later develop Indian pharmaceutical production facilities in the short-term, while working to build the capacity of Sri Lanka’s own industry. As of now, 85 percent of all pharmaceutical products in Sri Lanka are imported, which makes them vulnerable to price spikes.

While India in January facilitated a $400 million currency swap with Sri Lanka and deferred $500 million that was due for settlement to the Asian Clearing Union (ACU), it could also increase foreign direct investment and ODA to Sri Lanka. After China, India is a major FDI contributor in Sri Lanka, investing $1.7 billion from 2005 to 2019 in the areas of oil and gas, tourism, real estate, and financial services.

According to the High Commission of India, the government has committed $2.6 billion to Sri Lanka, of which $436 million came in the form of grant assistance and $2.17 billion as lines of credit. Indian assistance has been focused on capacity-building, human resources development, and infrastructure development. Additional ODA could be viewed in the context of near-term humanitarian assistance, agricultural development, and financial management.

India should look at the Sri Lankan economic crisis as a cautionary tale, inviting the Rajapaksas to treat their partnership with China as a story of excess and to learn from the mistakes of easy access to cheap credit and short-sighted policymaking. While acknowledging the continued presence of China and Sri Lanka’s strategic value in its quest to acquire a “string of pearls,” India must seize the opportunity to restore its traditional influence in Sri Lanka. After all, continued instability on the island will have repercussions in India. That will be a burden for India, not for China.