Relevance: GS-2: India and its neighbourhood relations.

Key Phrases: currency swap, International Monetary Fund, Devaluation, forex crisis, Foreign Direct Investment, Trincomalee Oil Tank Farm project, diplomatic blackmail.

Why in News ?

• Recently, Inflation in Sri-Lanka has soared past 17%. People are dying while waiting in queues for fuel, and authorities are scrapping school exams after running out of dollars to import paper and ink.
• Sri Lanka is going through its worst economic crisis since its Independence.
• The ripples of the economic crisis are now being felt in India too.
  1. Driven out by hunger and loss of jobs, people from the island nation are seeking refuge in India, which is doing its best to help the neighbouring country.
  2. Despite continuous helping hands from India, the situation is not improving in Sri Lanka.

Key Highlights:

• India has extended financial assistance to the tune of $2.4 billion in the last three months to Sri Lanka:
  1. A $400 million RBI currency swap
  2. Deferral of a $500 million loan
  3. A $1.5-billion credit line for importing fuel, food and medicines.
• Besides the International Monetary Fund Bailout, the southern neighbour also has sought credit support of $2.5 billion from China.
• The island has been facing severe power cuts and double-digit inflation, which hit double digits since the beginning of the year.
• The Sri Lankan central bank allowed the local currency to devalue by 30% in a month to enhance exports.
• The crisis has been mainly caused by a shortage of foreign exchange reserves. They have plummeted 70% in two years to just $2 billion at the end of February, which can barely cover two months of imports. Meanwhile, the country has foreign debt obligations of about $7 billion this year.

Reasons:

1. The forex crisis is the result of several factors:
   • Tourism, which is the country’s third-largest foreign exchange earner, came to a virtual halt after the 2019 Easter Sunday suicide bombings which killed more than 250 people. Tourist arrivals dropped by as much as 70%.
   • The Covid-19 pandemic brought a severe blow to the tourism industry. And remittances from foreign workers, which is the nation’s biggest source of dollars, slumped 22.7% to $5.5 billion in 2021.
   • The country’s heavy dependence on imports for essential goods like sugar, pharmaceuticals, fuel, pulses and cereals worsened the crisis.
2. Sudden shift to 'Organic Farming':
   • The government’s ban on chemical fertilizers last April as it looked to become the first country to fully adopt organic farming backfired.
   • A survey showed that 90% of Sri Lanka’s farmers used chemical fertilisers for cultivation.
   • The move led to a drastic drop in domestic food production, pushing up food prices.
   • The decision was rolled back after months of mass protests by farmers but the damage was done. Food inflation soared to 25.7% in February.
3. Low Industrial production: Garment factories and tea estates could not function, as Covid-19 raged in clusters.Thousands of Sri Lankan labourers in West Asian countries were left stranded and returned jobless.
4. Policy Failures of Government:
   • Food hoarding : The government declared emergency regulations for the distribution of essential food items. It put wide import restrictions to save dollars which in turn led to consequent market irregularities and reported hoarding.
   • Continuous borrowing : Fears of a sovereign default rose by the end of 2021, with the country’s foreign reserves plummeting to $1.6 billion, and deadlines for repaying external loans looming.

Impact of the Sri-Lankan crisis:

1. Transhipment nature of Sri-Lankan ports:
   • Thousands of containers sent from India to Sri Lanka, including for its own consumption as well as trans-shipment cargo, have been lying uncleared at Colombo port as authorities can’t economically afford to transfer containers between terminals.
   • India also relies considerably on Colombo port for global trade given it is a transhipment hub.
   • 60% of India’s trans-shipment cargo is handled by the port. India-linked cargo, in turn, accounts for 70% of the port’s total trans-shipment volume.
2. Relations deterioration with India impacting Lankan Tourism and Investment:
   • India has traditionally been among Sri Lanka’s largest trade partners. Prior to the pandemic, India was the top tourism source for Sri Lanka.
   • More than one-fifth of Sri Lanka’s total imports come from India.
   • India is also one of the largest contributors to Foreign Direct Investment in Sri Lanka. FDI from India amounted to about $1.7 billion from 2005 to 2019.
   • The main investments from India are in the areas of petroleum retail, tourism and hotel, manufacturing, real estate, telecommunication, banking and financial services.
   • A number of leading companies from India have invested and established their presence in Sri Lanka. These include Indian Oil, Airtel, Taj Hotels, Dabur, Ashok Leyland, Tata Communications, Asian Paints, SBI and ICICI Bank.
3. Sri-Lankan geopolitical location in Indian Ocean :
   • A predatory bond between Sri Lanka and China will threaten India's interest in the Indian Ocean.
   • Sri-Lanka economic crisis can change into refugee crisis, if it leads to polarisation between different communities.
   • The Food scarcity, unemployment crisis and communal politics are breeding grounds for fundamentalism and extremism.
4. India’s assistance being viewed in Sri Lanka very sceptically:
   • The leadership has thanked India for the timely assistance, but there is growing scepticism in Sri Lankan media and some sections, over Indian assistance “being tied” to New Delhi inking key infrastructure projects.
   • They mainly include the strategic Trincomalee Oil Tank Farm project, the National Thermal Power Corporation’s recent agreement with Ceylon Electricity Board to set up a solar power plant in Sampur, with investment from India’s Adani Group.
   • Lankan media accuses New Delhi of resorting to “diplomatic blackmail”. The political opposition has accused the Adani Group of entering Sri Lanka through the “back door”, avoiding competitive bids and due process.

Conclusion:

• Although Sri Lanka holds minor importance to India in terms of trade, it is a geopolitically important country and India needs to counter the growing Chinese influence on its economy.
• Any disruption in Colombo port operations makes India vulnerable to an increase in costs and congestion issues.
• While the work on building a transshipment hub in Kerala has begun, it is in India’s interest to help Sri Lanka come out of the economic crisis in the short-term.

Source: The Hindu BL

Mains Question:

Q. Sri-Lanka is not only important in neighbourhood first policy but also it remains a key component in India’s maritime policy. Discuss. ( 10 marks).