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Will Sri Lanka reach out to IMF for Balance of payment crisis?

Will Sri Lanka reach out to IMF for Balance of payment crisis?

Relevance:

  • GS 2 || International Relations || India & Its Neighbor || Sri Lanka

Why in news?

Economic crisis in Sri Lanka.

Introduction:

Sri Lanka’s government recently proclaimed a state of emergency in the economy. Food costs are rising, the currency is weakening, and the country’s foreign reserves are rapidly diminishing. The army has been dispatched to help manage the issue by restricting the supply of various necessities.

Sri Lanka’s strategic importance in the Indian Ocean region is unsurpassed due to its location at the crossroads of global trade lines.

As a result, India’s economic stability is critical.

What led to economic crisis in Sri Lanka?

  • The tourism business in Sri Lanka has been severely impacted by the covid-19 outbreak. It accounts for more than 10% of the country’s GDP and generates a significant amount of foreign money.As a result, currency reserves have declined from approximately 7.5 billion in 2019 to 2.8 billion in July 2021.
  • As the supply of foreign exchange decreases, the amount of money that Sri Lankans must spend to obtain foreign exchange has increased. The value of the Sri Lankan rupee has dropped by 8% this year.
  • Because Sri Lanka relies on imports to cover its basic food needs, the cost of food has risen in tandem with the rupee’s depreciation.

Current economic situation in Sri Lanka:

  • Tourism industry in poor shape: The tourism business, which accounts for about 10% of the country’s GDP and generates foreign cash, has been heavily damaged by the Easter Sunday terror attacks of 2019 and the coronavirus pandemic.
  • Lack of foreign exchange reserves: As a result, foreign exchange reserves have fallen from over $7.5 billion in 2019 to roughly $2.8 billion in July of this year.
  • Currency depreciation: The Central Bank of Sri Lanka has increased liquidity in the economy by printing Rs. 800 billion over the last 18 months to ameliorate the economic crisis. However, this inflow of cash, along with an increase in demand that hasn’t been matched by an increase in supply, has resulted in a dramatic rise in inflation.As a result, the currency has depreciated, making imports more expensive, adding to the debt, and putting strain on the foreign reserves. So far this year, the value of the Sri Lankan rupee has declined by roughly 8%.
  • Food price increases: It should be highlighted that the country relies significantly on imports to cover even its most basic food needs. As a result, food prices have grown in lockstep with the rupee’s depreciation. The government’s restriction on artificial fertilisers in agriculture has exacerbated the issue by reducing agricultural output.
  • High debt: Its public debt-to-GDP ratio was 109.7% in 2020, and its gross financing requirements to stay high at 18% of GDP, which is greater than most of its emerging-market counterparts. In the next two years, more than $2.7 billion in foreign currency debt will be due.

How economic crisis may push Sri Lanka to align its policies with China?

  • Reliance on Chinese credit: In order to pay off its international debt, Sri Lanka has become increasingly reliant on Chinese finance.In 2017, Sri Lanka lost the unprofitable Hambantota port to China on a 99-year lease due to its inability to service its debt.
  • Growing bilateral trade: In 2020, China’s exports to Sri Lanka topped those of India, totaling $3.8 billion (India’s exports totaled $3.2 billion).
  • Chinese strategic investment: Due to Sri Lanka’s strategic location at the crossroads of key transportation routes, China has made significant infrastructure investments (estimated at $12 billion between 2006 and 2019).
  • In May, Sri Lanka passed the Colombo Port City Economic Commission Act, which establishes a special economic zone and a new economic commission around the Port, to be funded by China.

Four-Pillar Initiative Comprises:

  • Lines of credit: India provides lines of credit for the purchase of food, medications, and gasoline. A line of credit is a credit facility provided by a bank or other financial institution to a government, business, or individual customer that allows the customer to borrow the maximum amount of money available.
  • Currency Swap: To address Sri Lanka’s balance of payment concerns, a currency swap agreement is in place. Swap is a term that signifies “exchange.” A currency swap is an agreement or contract between two countries to exchange currencies under predetermined terms and circumstances.
  • Modernisation Project: India has been working on a modernisation project for the Trinco oil plantations for several years. During World War II, the British built the TrincomaleeHarbour, which is one of the world’s deepest natural harbours. Projects to improve oil infrastructure in Trincomalee, in particular, have been on hold since 2017.
  • Indian Investments: Sri Lanka has pledged to make it easier for Indian companies to invest in the country’s numerous sectors.

Implications for India:

  • Relation declined:Since the beginning of the year, relations between India and Sri Lanka appear to have deteriorated.
  • Tripartite cooperation:In February, Sri Lanka withdrew from a tripartite cooperation with India and Japan for the Colombo Port’s East Container Terminal Project, citing domestic concerns.
  • Close alliance with China:Sri Lanka’s economic problems may force it to align its policies even more closely with Beijing’s.
  • Other South Asian countries such as Bangladesh, Nepal, and the Maldives have turned to China to finance large-scale infrastructure projects, putting India on a diplomatic tightrope with Afghanistan and Myanmar.

Issues in India-Sri Lanka relations:

  • Fishermen issue:Fishermen-related violence has always been a source of contention between the two South Asian neighbours. Sri Lanka has often complained about Indian fishermen fishing illegally in its territorial waters across the Palk Strait. Sri Lankan fishermen are also detained in India for unlawful fishing. 185 Indian boats were captured between January 2015 and January 2018, 188 Indian fisherman were slain, and 82 Indian fishermen went missing.
  • Katchatheevu Island:It is an uninhabited island that India handed over to Sri Lanka in 1974 under the terms of the “Katchatheevu island treaty.” According to the 1974 agreement, the central government respects Sri Lanka’s sovereignty over the island. However, Tamil Nadu claims that Katchatheevu is part of Indian Territory, and Tamil fisherman have long believed that it belonged to them, thus they want to keep their fishing rights.

Way forward:

  • Taking Care of Your Neighbourhood India’s first policy toward Sri Lanka will be crucial.
  • Investigate regional platforms: The BIMSTEC and the Indian Ocean Rim Association might be used to develop cooperation in areas of mutual interest such as technology-driven agriculture and the maritime industry, information technology, renewable energy, and transportation and connectivity.
  • Private-sector investment cooperation: Both countries may work together to boost private-sector investment to boost economic resilience.

Conclusion:

With its economy in disaster, Sri Lanka may be pushed even closer to China, and India must uphold its Neighbourhood First strategy to defend itself from the consequences.

Mains oriented question:

Consider the issue, “How could Sri Lanka’s economic troubles affect India?” “Suggest a plan of action.” (250 words)