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The role China played in pushing Sri Lanka into a debt trap & what India can do to help

Indian diplomacy needs to be more proactive when it comes to Sri Lanka. China could leverage its position in the current economic crisis.

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Sri Lanka’s economic crisis is an emergent phenomenon and has been stewing for a long time. What is strange about it is the lack of basic planning and foresight by the Rajapaksa government to have gauged its enormity in time and initiate necessary corrective measures. The Rajapaksas themselves were also, in some way, involved in the making of this crisis.

The island nation’s financial downward spiral started almost a decade ago when its GDP began to fall after 2012. Not only this, the current account deficit concomitantly started increasing as exports first marginally rose and then experienced a sharp fall in 2019. While every nation is supposed to diversify its exports and scale them up, Sri Lanka held itself hostage to colonial-era exports of garments, rubber and tea, failing to invest in any major industries, education or training. Since a country’s export potential is hostage to fluctuations in international demand and supply, reduced demand and thereby global commodity prices had a negative impact.

Until 2018, tourism was as the only vibrant and consistent contributor to Sri Lanka’s economy until 2018. But in 2019, that sector too suffered a major setback due to the horrendous Easter bomb blasts in Colombo that killed more than 250 people. The effect on Sri Lanka’s economy was immediate and shock-inducing. There was a reduction in income through tourists by around 20 per cent, adversely affecting foreign exchange reserves. The country followed the International Monetary Fund’s ‘suggestions’ from 2016 to 2019 and gained some forex back but the GDP growth kept slipping.

In 2019, the Rajapaksa government offered huge cuts in value-added tax, corporate tax and all categories of direct and indirect taxes. While it earned Sri Lanka the tag of being a country with one of the lowest tax regimes in the world, the rate cuts destroyed the government’s ability to capitalise and invest in welfare, employment, sectoral development and other schemes. To give an example, tax collections plunged more than 50 per cent in just one year alone (2019-20). While on the one hand, the revenue deficit was more pronounced due to low tax collections, on the other, the government also increased its expenditure substantially. This resulted in the budget deficit increasing by more than 100 basis points. As if this was not enough, two additional factors contributed to Sri Lanka’s current state.

Also Read: Sri Lanka slipped by pursuing Chinese prosperity dream. It’s in India’s interest to help it

Covid-19, Vandana Shiva and China

The Covid-19 pandemic affected Sri Lanka badly. Countries closed borders and the movement of people came to a standstill. Demand for exports, especially of the products Sri Lanka sold, also fell. Even remittances from Sri Lankans working abroad reduced substantially due to the economic stress and job losses in those countries.

Enter Vandana Shiva, propagating a pseudo-scientific and untested theory of organic farming for large-scale commercial plots, advising bạn on urea imports to save forex. While organic farming, per se, may not be a bad idea at an opportune time, its abrupt adoption nationally affected grain production adversely, especially at a time when the Sri Lankan economy was already under serious stress. The current situation would not have become so alarming had Sri Lanka had enough grain to feed its population. In fact, the availability of surplus grain stock in the country offered the best response mechanism to the Narendra Modi government to feed its population during the same time.

While all of this was happening, China was playing a shrewd game — not only to gain a strategic advantage in the island nation but also to keep its economy hostage. While China is currently involved in more than 50 projects in Sri Lanka, their nature and execution are alarming, to say the least. These are Hambantota and Colombo Port City, both of which have been given for 99 years of lease to China. Chinese economic support for Sri Lanka was never meant only for trade and economic considerations. It was always a means to gain political and security leverage against India and safeguard its interest in the Indian Ocean Rim, through which the bulk of China’s energy movement takes place.

China is now the second-largest lender to Sri Lanka. By 2019, it was holding more than 10 per cent of Sri Lanka’s outstanding foreign debt. China became the largest investor in Sri Lanka between 2010 and 2020, displacing India from the position of the largest importer of Sri Lankan goods despite an adversarial geographic location. What’s worse, India let it happen despite serious stakes related to security.

In fact, the Sri Lanka-China nexus was so strong that Chinese imports were reduced by only 8 per cent compared to India’s nearly 20 per cent. This happened despite our geographic proximity, indicating the deep roots China has developed in Sri Lanka. China had only one per cent share in Sri Lanka’s official development assistance (ODA) in 2005. Today, it has surpassed India and Japan and reached 23 per cent.

Sri Lankan efforts to restrict foreign debt obligations drew a blank from China, which does nothing without an agenda. Beijing’s current assistance offer is primarily to make Sri Lanka clear its previous dues to China. While China provided initial financial assistance for infrastructure development, its later assistance was consumed in budgetary support and mitigating the balance-of-payments crisis. This transition in the nature of financial support was allowed to thrust Sri Lanka deeper into the Chinese ‘debt trap’. China has always had an eye on projects in the northern islets of Sri Lanka to come closer to India and offset New Delhi’s advantages in the Indian Ocean region. Thankfully, some sense has prevailed in the Sri Lankan polity to cancel some of these projects and give them to India in the recently concluded negotiations.

Also Read: Instead of trying to beat China in Sri Lanka, New Delhi needs to change the game

Indian overtures

While Indian diplomacy keeps getting sharper with every passing day, there is a need to be more proactive when it comes to Sri Lanka. The 99-year lease of Hambantota, located on the southern coast of Sri Lanka, assists China in addressing its Malacca dilemma to a reasonable degree, giving it a vantage position. The Colombo Port City project, with the same conditions, also brings China closer to India. Not only this, Indian projects (East Container Terminal) led by India’s Adani Group and Japan were also cancelled by the Sri Lankan government. There has been some solace with West Container Terminal being given in a 35-year lease to the joint venture.

New Delhi had intervened in Sri Lanka in 1987 through the Indian Peace Keeping Force (IPKF) based on a mutual accord (of course, the main stakeholder Liberation Tigers of Tamil Eelam, or LTTE, was not included in this accord) but the experiment did not go well. India played a key role in the 13th Amendment of the Sri Lankan constitution for devolution of powers for Tamils but the same is yet to be fully implemented. India continues to be perceived as a well-wisher of the Tamil population of Sri Lanka where the majority populace is Sinhalese. India’s narrative and plan of action, therefore, need to undergo a major change, treating the current crisis as an opportunity for a people-centred approach to resolution.

The Indian government has not made much strategic investment in the island country. Indian Oil is the only strategic venture that controls approximately 35 per cent of oil shipping to Sri Lanka. Some investments have been done through the private sector but it’s not enough. While a Free Trade Agreement (FTA) was signed in 1998, the mechanism has been sparsely used. It needs fresh impetus.

While the meeting of the Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC) in Sri Lanka and dialogues are positive developments as India has not only offered liberal financial aid and goods to mitigate the crisis, it has also got projects on these islets in the northern part of Sri Lanka which was also promised to China at some point of time. A closer involvement with the Sri Lankan people is needed to synergise our mutual interest in multiple fields. The creation of a dedicated team for Sri Lankan affairs is probably the need of the hour.

Maj Gen Ashok Kumar, VSM (Retd) is a Kargil war veteran and defence analyst. He is visiting fellow of CLAWS and specialises in neighbouring countries with a focus on China. He can be contacted at and tweets from @chanakyaoracle. Views are personal.

(Edited by Srinjoy Dey)

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