Two months ago, India extended $1.7 billion of debt repayments which was due from Sri Lanka in a proactive manner without the Sri Lankan government even having to reach out to New Delhi. This prevented Sri Lanka from defaulting once again. The Indian government saved the day for the new National People’s Power (NPP) government which was less than a month-old at the time. This amount is almost as much as what the the Modi government has spent on subsidising the Micron project. What is India’s position in Sri Lanka and why is it doing this?
Indian assistance to Sri Lanka
In 2022, when Sri Lanka defaulted on its external debt, it was in a desperate situation staring at the abyss. There were 12-hour long power cuts, no fuel for almost 3 weeks and many shortages. Sri Lanka, considered Asia’s oldest democracy, had a popular uprising of its people which led to the then Sri Lankan President Gotabaya Rajapakse fleeing the country.
India that came to Sri Lanka’s assistance as the time with $4 billion. Sri Lanka’s many other friends did not step in to help the island nation, as India did. India was the first nation to give debt assurance to the IMF regarding Sri Lanka and also it took the lead, along with France and Japan, in forming the official creditors committee to help Sri Lanka restructure its debt.
Current economic situation in Sri Lanka
Sri Lanka has largely stabilised its economy though it is not out of the woods yet. The macroeconomic indicators are stable but the problem will arise in 2028, when much of the debt repayments are due. So Sri Lanka has a fast closing window to make an economic buffer to take the economic shock that would hit the nation in 2028.
The island nation also has a long way to go as its debt is over 100% of its GDP, with half of it in foreign currency. Its government revenue is still one of the lowest in the world, though improving and Sri Lanka has one of the largest public sectors in proportion to its population. Sri Lanka needs to expand its tradable sector of the economy at a rapid pace by 2028, while increasing other foreign currency revenues through tourism and worker remittances. Sri Lanka will have to manage its fiscal policies well in order to regain access to international capital markets as its gross financing needs are too high to sustain itself without rolling over its debt.
India’s regional geopolitical outlook
India is geographically situated in a complex neighbourhood. To its west and north, it has large land borders with Pakistan and China ,with whom India does not get along. Nepal too has shown signs of moving towards China, with its new prime minister makiing Beijing his first official visit and Nepal signing the BRI framework with China. Bangladesh, once a friend of India under its former leader Sheikh Hasina, has now moved away from India with the new government in Bangladesh taking a more hostile approach towards India.
To the south of India is the Indian Ocean, through which a large portion of global trade flows. Nearly 80% of India’s oil imports and 90% of its trade volume also comes through here. It is in India’s strategic interest for it to be in a place of strength when it comes to the Indian Ocean. Maldives too has a president who came to power on an anti-India campaign. This leaves Sri Lanka, which would like to keep as either pro-India or at least neutral.
How is Sri Lanka’s economic situation related to Indian foreign policy?
Sri Lanka’s economic situation complicates India’s regional strategic manoeuvring. With a population of only 22 million people and an economy that is around $80 billion, Sri Lanka is not a threat to a large power like India. But Sri Lanka’s economic vulnerability leaves it open to interference from other world powers such as China.
China is Sri Lanka’s largest bilateral lender and Sri Lanka defaulting on its debts would put it in a very compromising position with Beijing. Sri Lanka had already done a debt to equity deal with China with the Hambantota Port in 2017. Another economic default by Sri Lanka would lead to possibilities of such deals happening in the near future. This could have been the case even in 2022 had India not stepped in with $4 billion in economic relief.
India’s endgame
Can India afford to keep bailing out Sri Lanka in the future? The other option is for India to be stricter with the Sri Lankan government, like the IMF, to ensure macroeconomic stability and implement tough reforms. But in a sensitive relationship between India and Sri Lanka, it is not possible for India to impose conditions on Sri Lanka, like Germany did with Greece during the Greek economic crisis in the 2010s.
The best path forward for India and Sri Lanka would be to have greater economic integration between the two nations which would benefit Sri Lanka’s economy greatly and at the same time, it would help India maintain a friendly neighbour to its south with which it has had deep ties for centuries. A developed Sri Lanka is in India’s interest.
Talal Rafi is a Sri Lankan economist.
