It's in India's interest to help Sri Lanka tide over crisis

The economic emergency in India's southern neighbor Sri Lanka is rapidly turning into a political crisis as well. The government led by President Gotabaya Rajapaksa has already lost its majority in the legislature and there are now calls for his resignation. The crisis which hit the headlines only recently has been building up for the past two years ever since the pandemic reached the shores of the island nation. Unfortunately, the government's ill-advised policies added to the woes due to the pandemic which have been felt by most emerging economies. It was only when the situation worsened to the extent that the people came out in the streets to demonstrate against soaring inflation and shortages of essential commodities that the government decided to seek help from the International Monetary Fund.

The outlook for the economy began to deteriorate as long ago as 2019 when the country faced a string of terrorists attacks in April on Easter Sunday. Tourist inflows into the country dried up but it was expected the situation would revive in the following year. This was critical since tourism has always been one of the main revenue earners for the economy. But the spread of the pandemic to the island nation in early 2020, prevented the anticipated resurgence in this sector.

While this was a factor beyond the government's control, the situation was aggravated by the Rajapaksa regime's policy initiatives. The first to backfire was the decision to carry out deep cuts in tax rates. This led to a further shortfall in revenue collections and widened the budgetary deficit. It also created an expansion of the country's debt burden. Foreign debt, which constituted 42 per cent of GDP in 2019 rose to 119 per cent in 2021. Foreign exchange reserves also fell to 2.3 billion dollars while debt repayments due at the end of 2022 are currently estimated at four billion dollars.

Inward remittances from the Sri Lankan diaspora, on which the country used to rely heavily, simultaneously slumped to a ten year low of 5.49 billion dollars in 2021. One of the reasons given by a Colombo based think-tank, Verite Research, was that workers were using informal "hawala" channels to transmit funds as this gave higher returns on the dollars than the formal banking channels.

Another radical move that brought about more problems was the decision in April last year to ban use of chemical fertilizers along with pesticides and weedicides. The net result was a dramatic drop in yields of agricultural crops especially rice along with cash crops like tea and rubber. This affected the annual tea export revenue estimated at about 3 billion dollars. The ban was partially rolled back in November last year but rice output had already fallen by over 50 per cent, forcing the country to resort to imports.

The economic emergency is also being blamed partly on unprofitable construction projects begun with Chinese assistance. There are conflicting assessments on this issue. The European Foundation for South Asian Studies, for instance, gives this as a major reason for the depleting foreign exchange reserves. Other studies, however, show that external debt owed to China comprised only ten per cent of the country's total debt stock.

It has thus been a combination of factors that led to derailing of the Sri Lankan economy. The draining of foreign exchange reserves meant that funds were not available to import essential commodities needed for daily life. The situation has become so bad that examinations are not being held due to lack of paper and hospitals are having to suspend treatment owing to shortage of medicines.

India has been providing short term relief to its neighbor. It has already provided a one billion dollar line of credit to help pay for essential imports, and is expected to extend another 1.5 billion dollars. It also extended a 400 million dollar currency swap and 500 million dollar credit line for fuel purchases to crisis. In addition, shipments of badly needed diesel and rice have been sent to that country.

The fact is, it is in India's interests to ensure that the situation does not worsen in the island. The fall-out of an economic emergency would be felt here in many ways. First, there could be a flood of refugees seeking to escape from hardships in their own country. Small numbers have already begun arriving and action must be taken before these enlarge rapidly.

Second, there are close trade and industry linkages with the island nation. Colombo port is strategically and economically important for this country. It serves as a trans-shipment hub for about 60 per cent of India's global trade. Congestion problems there, which are already occurring, will mean higher costs for movement of goods. Besides, it may account for a relatively small share of the country's total exports but remain at a significant level of 4.8 billion dollars. Indian industry has also made substantial investments in Sri Lanka in areas including tourism, real estate, manufacturing, communications and petroleum. In fact, foreign direct investment flows from India are among the largest in that country. FDI from India is estimated at about 1.7 billion dollars over the period from 2005 to 2019.

It is thus imperative for India to support all measures to bring the economy on an even keel. There are also strategic considerations as China has been trying to increase its influence here. But the ramifications of an economic collapse of such a close neighbor are far more significant for this country. Fortunately there is light on the horizon as the Rajapaksa government has finally agreed to seek loan assistance from the International Monetary Fund (IMF). The loan conditionalities may be stringent, but there is no doubt that reforms are inevitable in any case for the Sri Lankan economy to emerge successfully out of this crisis.