India and Sri Lanka Beyond the IMF

Sri Lanka is putting behind it, the dark economic days of 2022. At the time, it faced an acute balance of payments crisis, and announced a pre-emptive default on its foreign debt of over $50 billion in April 2022, which triggered the worst economic contraction in Sri Lanka’s post-independence history. The country’s GDP fell by -7.8% in 2022[1], year-on-year inflation reached 69.8% in September 2022 (measured by the Colombo Consumer Price Index)[2], business confidence plummeted to an all-time low and poverty increased.

A year later, the Sri Lankan economy is showing signs of stabilizing. A return to growth in Sri Lanka is expected next year. The latest IMF forecast released in April 2023 suggests a less severe economic contraction of -3.1% in 2023 and growth of 1.5% in 2024.[3] Year-on-year inflation fell to 35.3% in April 2023 according to the Colombo Consumer Price Index.[4] The LMD-NielsenIQ Business Confidence Index (BCI) reported that business confidence in March 2023 is picking up slightly due to an uptick in tourism and migrant worker remittances to Sri Lanka.[5]

Decisive policies by the new Sri Lankan government led by President Ranil Wickremasinghe[6] and timely Indian aid helped to bring Sri Lanka back from the brink of an economic abyss. From late July 2022 onwards, the Wickremasinghe government began implementing measures to stabilize the economy, intensified talks on an IMF Programme and sought assurances from Sri Lanka’s creditors on debt restructuring. Concrete economic stabilization measures included significantly tightening monetary policy to control spiraling inflation, raising taxes, removing fuel and electricity subsidies, and developing a privatization programme for loss-making state-owned enterprises including Sri Lankan Airlines.

India provided the largest bilateral aid package in its history to any country. Indian aid of about $4 billion during the first half of 2022 flowed to Sri Lanka through credit lines, loans and grants.[7] India also actively pursued quiet behind the scenes diplomacy to make the case for an IMF Programme for Sri Lanka. The assistance began in July 2020, when, to tackle the economic fallout from the Covid-19 pandemic, the Reserve Bank of India entered into a currency swap arrangement with the Central Bank of Sri Lanka to provide short-term financing of $400 million. India’s aid efforts were motivated by the unfolding humanitarian crisis affecting the Sri Lankan people and political pressure from South India. Perhaps, India also felt that an unstable Sri Lankan economy could pose security risks to India and lead to a flood of refugees across the Palk Strait.

Several months after reaching a Staff-level Agreement, in March 2023 the IMF Board approved an IMF Programme of $2.9 billion over 48 months to support Sri Lanka’s economic stabilization efforts. The 17^th and toughest IMF Program in Sri Lanka’s history is a milestone towards resolving the crippling economic crisis. Focusing on revenue-based fiscal consolidation, it seeks to achieve the following six goals:

1. increase tax proceeds and increase utility prices;

2. control inflation by raising interest rates,

3. eliminating monetary financing and creating an independent Central Bank

4. rebuild reserves through a flexible exchange rate;

5. safeguard financial stability by ensuring adequately capitalized banks through the enactment of a new banking legislation; and

6. reduce corruption risks by better fiscal transparency and public financial management.[8]

External financing from the Asian Development Bank and the World Bank will follow the immediate disbursement of $333 million from the IMF Programme.

With the Sri Lankan economy showing signs of stabilizing and an IMF Programme in place, India-Sri Lanka ties are ready to shift from an aid relationship to one which deepens bilateral trade and investment flows. A robust Sri Lankan economy could be a major win for Prime Minister Modi’s Neighbourhood-First policy and enable India to steal a march on China as an emerging donor.

Private Indian investment is starting to make a mark. Recent eye-catching investments of more than $1 billion by the conglomerate Adani Group’s in Sri Lanka are grabbing the headlines. These include: (a) $442 million in two renewable energy wind power plants in the Mannar basin and (b) a $700 million partnership between Adani, John Keels Holdings and the Sri Lanka Ports Authority to develop the West Container Terminal in Colombo Port for transshipment trade with India.

The hope, bilaterally, is that such Indian infrastructure projects will be transformative for Sri Lanka, bringing not only capital but technology and skills transfer, as also deepen local linkages with the Sri Lankan economy. The confidence built though such investments will encourage an additional $5-8 billion in Indian private investment in Sri Lanka in the next few years in sectors like agro-processing, textiles and light manufacturing, and information technology services sectors.

Simultaneously, globalizing Sri Lankan firms like apparel maker Brandix, tea giant Dilmah and conglomerate John Keels Holdings should invest in South Indian states in sectors like textiles, food processing and tourism. With confidence presiding well on both sides, this is the time for India and Sri Lanka to promote bilateral FDI flows by better marketing to investors, opening up FDI entry regulations and significantly streamlining the red tape hampering investment through digitization. Early resumption of talks on a deep India-Sri Lankan trade deal to promote regional rules-based trade and investment would crown the bilateral relationship.

With political will and open-door, investor friendly policies, Sri Lanka now stands a sporting chance of achieving some economic normalcy in the next three years. India’s continuing support and enhanced investments will support Sri Lanka – still fragile but moving ahead – by turning aid into business engagement.

Dr. Ganeshan Wignaraja is Professorial Fellow for Economics & Trade at Gateway House.

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References

[1] “Home,” Department of Census and Statistics, Government of Sri Lanka, http://www.statistics.gov.lk.

[2] “Consumer Price Inflation,” Central Bank of Sri Lanka, https://www.cbsl.gov.lk/en/measures-of-consumer-price-inflation

[3] “Countries: Sri Lanka,” International Monetary Fund, https://www.imf.org/en/Countries/LKA

[4] “CCPI based headline inflation eased further in March 2023,” Communications Department, Central Bank of Sri Lanka, 31 Mar 2023, https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/press/pr/press_20230331_inflation_in_march_2023_ccpi_e_0.pdf.

[5] “Business confidence picks up slightly,” DailyFT¸ 4 Apr 2023, https://www.ft.lk/front-page/Business-confidence-picks-up-slightly/44-747025.

[6] Ganeshan Wignaraja, “The reforms Sri Lanka needs,” Gateway House, 21 Jul 2022, https://www.gatewayhouse.in/the-reforms-sri-lanka-needs/.

[7] Ganeshan Wignaraja, “India as an emerging aid donor to debt crisis hit Sri Lanka,” Overseas Development Institute, 27 July 2022, https://odi.org/en/insights/india-as-an-emerging-aid-donor-to-debt-crisis-hit-sri-lanka/.

[8] “Opening Remarks for the Press Briefing on the IMF Executive Board Approval of the Extended Fund Facility (EFF) Arrangement for Sri Lanka,” International Monetary Fund, 21 Mar 2023, https://www.imf.org/en/News/Articles/2023/03/21/sp032123-sri-lanka-board-approval-of-eff-arrangement.