Right now, the economic situation in Sri Lanka is grave. It has piled up external debt over the years, has run out of its foreign reserves, and is facing a food crisis. Two superpowers are plotting a strategic game amidst the crisis— India and China. In this piece, we discuss the economic crisis, what led to it, and how it could possibly impact India. 

The Situation

Simply put, Sri Lanka has taken a lot of loans from other countries. It accumulated a massive amount of debt over time. Between 2011 and 2021, Sri Lanka’s total external debt has more than doubled. The total debt owed by Sri Lanka in fiscal 2020 was USD 49.2 billion. This was close to ~57% of Sri Lanka’s total GDP. Sri Lanka did pay back a tiny part of the debt over time. In the process, it depleted its foreign exchange (forex) reserves. For a developing country like Sri Lanka, a forex reserve would help in three ways: 

  • To maintain confidence in its monetary policy and exchange rate in the foreign market for its own currency, the Sri Lankan Rupee (LKR).
  • To pay back the debt that it took from other countries.
  • For having a greater buying power that would enable Sri Lanka to import goods. 

India was in a similar situation in 1991. It had nearly depleted all of its forex reserves that would roughly last three weeks. That is when the government decided to liberalize and privatize the Indian economy to attract foreign investment. 

Coming back to Sri Lanka. The country is now facing a severe food shortage. Imports of essential goods were banned. These included motor vehicles, clothes, cosmetics, and even Sri Lanka’s staple item, turmeric. Sri Lanka imports 7,000 tonnes of turmeric every year, out of which 5,000 tonnes come from India. This has sent the price of turmeric skyrocketing, causing a row in Sri Lanka. Even its primary source of foreign currency was shut during the COVID-19 pandemic, the Tourism Industry. 

Sri Lanka has banned the import of fertilizers as well. The government is encouraging farmers to undertake ‘Organic Farming’. This fertilizer ban has caused a decline in crop production while impacting farmers’ financial conditions. Shortage of food has sent its prices skyrocketing. 

Sri Lanka has the daunting task of boosting economic growth, increasing forex reserves, and cutting down on its external debt. All of this is combined with the uncertainty of COVID-19. However, amidst Sri Lanka’s grim economic situation, two countries seem to play a tug of war amidst Sri Lanka’s grim situation, India and China.

China At Play

China is playing what is known as debt-trap diplomacy. In a debt trap move, China would target countries with poor economic conditions yet are rich in resources and raw materials. Chinese companies, banks, or financial institutions would then lend money to these countries for unsustainable projects, at commercial interest rates. Countries desperate enough for financial assistance would accept this deal, hoping to replenish forex reserves and boost economic activity. Unable to pay back the loan on time, these countries would then be ‘compelled’ to lease their essential assets to China. One such example is Sri Lanka’s port, Hambantota. 

Sri Lanka intended to develop the Hambantota seaport in Southern Sri Lanka. The only country that showed a willingness to fund the project was China, through its EXIM Bank. The bank extended loans to Sri Lanka between 2007-2016. For the first phase of the project, the bank lent USD 307 million to Sri Lanka at an interest rate of 6.3%, a considerably high interest rate. 

Sri Lanka did manage to complete the project, but there was no ship traffic to the port because of a rock in the sea bed that was blocking the way for ships. In 2016, low on forex reserves and unable to pay the loans, Sri Lanka was left with no choice but to lease it to China for a period of 99 years. There are reports that China is planning to turn around the project into a multipurpose port by 2022. Recently, a Chinese ship with radioactive material was intercepted by Sri Lankan authorities at Hambantota port. Is it possible that China is planning to convert it into a strategic military base?

When China took control of the Hambantota seaport, India initiated talks with Sri Lanka to run a joint venture and operate Hambantota Airport. This was an indicator of a power tiff between rivals India and China. 

What’s At Stake For India?

China has benefited immensely from Sri Lanka’s economic crisis. Close to 10% of Sri Lanka’s external debt is owed to China. In fiscal 2020, China beat India in being Sri Lanka’s top import partner. Although Sri Lanka forms a tiny portion of India’s export basket, its location is strategically crucial.  

India and China haven’t had the best trade relationships lately. China has now strategically surrounded India from all sides by acquiring important seaports and routes in all directions. This will not only give its Navy an advantage but will also help China in advancing its shipping route positions. Sri Lanka has till now been a small yet significant ally to India, in terms of diplomacy, military support, and trade. Nevertheless, China seems to be courting Sri Lanka.

India has had a bumpy relationship with Sri Lanka lately. In Feb 2021, India refused to extend a currency swap facility to Sri Lanka. Sri Lanka was allegedly responsible for the death of three Tamil Nadu fishermen that had apparently strayed into Sri Lanka waters.

To get out of a similar forex crisis in 1991, India took the help of the International Monetary Fund (IMF) but faced severe economic restrictions. Eventually, India got out of the crisis, and the rest is history. Sri Lanka has refused any help from the IMF and continues to take loans, grants, and currency swaps with China. Moving ahead, Korea, India, China, and even the Asian Development Bank have extended their support to Sri Lanka through grants and currency swaps. Banning imports cannot be the solution in the long term to maintain stability within the country. Sri Lanka will have to undertake some austerity measures to ensure sustainable growth. 

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