21 June 2022, NIICE Commentary 8101
Harleen Kaur
The island nation is facing one of its worst economic crises since its independence in 1948. The huge pile of public debt that constitutes 119 percent of its GDP, devaluation of its currency and the highest inflation rate of 17 percent has left the country in a state where it is unable to pay for essential commodities. As Sri Lanka’s foreign reserves rapidly dwindle, it is faced with USD 7 billion foreign debt repayment this year, most of it to investors who bought international sovereign bonds.
The cancellation of examinations due to shortage of dollars to import papers and long power cuts for 20 hours a day, has sparked outrage all around the country. A shortage of essential medicines has further increased the vulnerability of the public health system in the country, causing people to fear for their lives.
A twin deficit has led to a major economic crisis in the island nation, with the entire cabinet resigning except for the Rajapaksa brothers. The mismanagement of finances and the ill decisions by the authorities is termed as one of the greatest contributors to this crisis. The situation is getting worsened by the majority of the Lankan people being pushed to below poverty line, making living more difficult in the country.
Reasons behind the Crisis
The nation has been witnessing an economic crisis before the pandemic but the lockdown has further added to its woes. Tourism, which is one of the major economic sectors that contributes to 10 percent of its GDP and a main source of forex, saw a great decline. Easter bombing of 2019 shook the tourist industry which was accompanied by COVID-19 situation. Moreover, the tax deduction move by the Rajapaksa government to win elections met an unfortunate end as well. Although tax deduction was aimed at increasing the spending of the people in order to refuel the economy, it was slashed by the lockdowns. In addition, the government’s sudden move to switch to Organic Farming went catastrophically wrong. As Lanka was already dependent on imports for meagre products like cereals, sugar, pharmaceuticals, this move further added to the list those items in which the country was independent (rice, tea crops, etc). It is ballooning imports of Colombo as it lacks the funds to repay debt.
Geopolitics of Sri Lanka
Since Sri Lanka is in a desperate need of financial assistance, it is playing its card to secure its own basket. It is securing funds from almost every nation in the region and the institutional banks to recover from the economic crisis. In addition to India and China, it has sought financial assistance from Bangladesh of USD 100 million under a swap agreement, on the top of USD 50 million in August. The island nation is also making its move to secure some support from the world bank in addition to the IMF’s rescue plan. However, Sri Lanka is now trying to get an edge by crying out to both China and India because of the known rivalry. It is trying to get the best of both worlds.
India and Sri Lanka have recently signed three defence pacts – two of them were kept secret and one was signed publicly. Further, India responded by giving USD 1 billion line of credit for food, medicines and essential items. Then another USD 500 million line of credit was issued for petroleum production. USD400 million currency swap was also initiated between the two nations. The ties between both nations went to another level with financial assistance worth USD 2.5 billion, Joint deal on Trincomalle oil tank farm, three power projects in North of which one was initially promised to China, were made within just three months of 2022.
Despite this Sri Lanka is making moves to make its way out through requesting Chinese authorities to restructure its loan, making it more flexible. Further it sought additional loans from China worth USD 2.5 billion. It consists of USD 1 billion loan and a USD 1.5 billion line of credit. There are also plans to push a Free Trade Agreement (FTA) by the Chinese authorities to bind Sri Lankan and Chinese markets. This is mainly because Rajapaksa is a strong Sinhalese and pro Chinese leader.
Clearly Sri Lanka is performing a balance act between India and China, and it is doing well. The nature of adversarial rivalry between both the countries is evident in the entire neighbourhood. The small nations like Sri Lanka in the Indian Ocean will use it to benefit themselves as much as they can. Although China’s strategic interests have added pressure on countries in the Indian ocean, it is also an opportunity to play between two great powers against each other in order to secure one’s own interests.
China’s Role
According to researchers, the main reason for Sri Lanka’s suffocating economy is the burden of Chinese debt. Sri Lanka has turned to China for loan since the civil war started in 2009. Now, it owes over USD 5 billion to China, which is approximately 10 percent of its national debt. The reckless borrowing from China to finance unprofitable infrastructure projects has contributed to the unenviable position of Lanka. These loans are given at a higher rate of interest as compared to western governments, making it difficult for countries like Sri Lanka to repay it. Borrowing nations, when unable to repay loans, are compelled to cede strategic assets to China. As was seen in Indian ocean’s most strategically located port, Hambantota, was given on lease to Chinese authorities for 99 years. It is an example of how big ticket Chinese investments can go awfully wrong for a country. Moreover, there is a fear among people that Chinese investment in Hambantota can end up becoming a ‘Chinese colony’. That has triggered the crisis and protests against the government.
Options for India
Since India is geo-strategically located near Sri Lanka, it mustn’t remain passive rather should act diplomatically mainly for two reasons – the economic crisis has led to an increased migration of people to India, which can prove detrimental to India’s national security and secondly, to prevent Chinese presence in the Colombo in particular and Indian Ocean in general. As Colombo is strategic to China’s Belt and Road Initiative, it will try to retain its dominance over Sri Lanka through credit facilities and investments. It will allow China to use them as a part of its ‘String of Pearls’ to encircle India.
Therefore, the economic crisis mandates India to rebuild its ties with the Colombo. It should embrace the spirit of neighbourhood first policy to restore its image of a reliable traditional partner. It should further fasten its decision-making process in order to provide timely relief by addressing the problems in the region. India should try to prepare a Marshall plan for Colombo instead of additional debt policy. It must also focus on building capacity within the island nation especially in areas like pharmaceuticals which constitutes a large part of its imports.
Moreover, India should take the opportunity to highlight the fallouts of Chinese credit facilities. The intention of China to achieve its geopolitical objectives through geo-economic means can best be unleashed by India through its leadership role in Sri Lanka. However, India cannot act like China given its own principles and economic constraints. Nevertheless, it can secure its presence through the shared values and soft power. As was seen in S. Jaishankar’s tweet to ask the high commissioner in Sri Lanka to do what is possible to restart the surgeries in Sri Lanka, which were stopped due to financial shortages. The surgeries were restored and the Peridamba hospital was back to its operations. These gestures of deploying soft power goes a long way building relations between India and Sri Lankan people, if not the Sri Lankan government. India should use the opportunity to seize the stability in the region to restore its traditional links as instability will have repercussions on India alone.
Harleen Kaur is a Research Intern at NIICE.
