Sri Lanka, a tropical island country located off southern coast of India is home to diverse ethnicities, languages and culture. With the population of 21.9 million, the country has the most literate population (Literacy rate- 92.5%) amongst developing countries. As a founding member of SAARC and member of the UN, the G77 and the Commonwealth of Nations, it has a long history of International Engagement.

But what’s going on with its economy?

With a sharp growth in foreign debt, High Inflation rate (at 12.1%), Devaluation of currency, and the continuity of Covid-19 pandemic inducing Global recession has resulted in acceleration of economic crisis in Sri Lanka. In September, 2021 the Sri Lankan Government declared an economic emergency. The shortage of dollars witnessed essential imports building up at Colombo port. The revenue from tourism (country’s highest revenue earner) dropped by 90% due to the pandemic. The food prices in the country increased by 21.1% in December, 2021 on y-o-y basis (Food Inflation rate 22.1%), causing protests in the country over rising living cost.

The country faced long hour power cuts as the electricity supplying utility was unable to purchase fuel for its power stations. An official from Ceylon Electricity Board (CEB) said, the company had run out of US Dollars to purchase fuel from Ceylon Petroleum Corporation (CPC), a wholly owned government company. The Central Bank had also put a ban for traders entering into Forward Contracts. Prohibiting them from exchanging more than Sri Lankan Rupees 200 for an US Dollar.

Its Foreign Exchange Reserves was dropped to US$ 1600 million by the end of the November, 2021 of which only few weeks of imports could have been paid. However, it managed to raise its FX reserves to US$ 3100 million through Currency Swap Arrangements with People’s Bank of China. Sri Lanka’s High Commission located in Nigeria and the Consulates in Cyprus and Germany will be closed to conserve foreign reserves and minimize expenditures which can be utilized to finance essential imports. However, certain import restrictions on vehicles were imposed to reduce foreign currency outflows by US$ 3.9 billion during the pandemic.

Its external debt is currently estimated to be more than US$ 50000 million putting a huge burden for debt servicing of the country. Credit agencies such as Fitch, Moody’s and S&P has downgraded country’s credit rating to CC, Caa2, CCC+ which makes it difficult obtaining further funds through International Sovereign Bonds. This year, Sri Lanka has to repay debt of US$ 4.5 billion and US$ 500 million International Sovereign Bond maturity due on 18^th January, 2022.

According to the Press release by the United Nations Conference on Trade & Development dated 18^th November, 2021, the disruptions in supply chain, port constraints due to high freight charges are likely to be continued in the coming months which may impact the recovery of Global Economy. A spike in freight charges was triggered due to high demand for goods in 2020 and 2021 during lockdowns and restrictions imposed worldwide. This spike has a greater impact on Small Island Developing Countries such as Sri Lanka which could see increase in consumer price by 7.5% and import price by 24%.

Gotabaya Rajapaksa, The President of Sri Lanka requested China to restructure its debt repayments as a solution to bring in control the effects of economic crisis in the country. China being the 4^th largest lender has over the decade lent more than US$ 5 billion for infra projects. The partly reason for the depletion in foreign reserves were caused due to these Chinese loans for projects not producing any income for the Government. Concession on imports from China and allowance of Chinese tourists to Sri Lanka (to boost revenues from tourism) by adhering covid regulations were some of the other requests and allowances by the President.

India-Sri Lanka Relations:

The relationship between India and Sri Lanka is more than 2500 years old. Both the countries share religious, cultural and intellectual relation. Trade and Investments have grown immensely and the cooperation in the fields of Education, Infrastructural Developments and Defence has broader understandings between the two.

India is Sri Lanka’s largest trade partner and also the largest contribution to FDI comes from India. Top leading companies from India have investments and have established their presence. The main investments in Sri Lanka includes in Tourism, Petroleum, Banking & Finance, Real Estate, Telecommunication and Manufacturing areas. The enhancement of connectivity between two countries has also entered into an Open Sky Agreement enabling Sri Lankan Airlines operation of unlimited flights to 6 airports in India. Prior to pandemic, the largest carrier in India was Sri Lankan Airlines operating over 100 flights to 14 destinations in India per week.            

India-Sri Lanka Trade Data:

Impact of crisis on India-Sri Lanka Trade

Sri Lanka being the largest 3^rd export destination for India, has heavy investments in Social and Infrastructure projects and therefore Banks in India are cautious on its exposures to Sri Lanka. A senior executive of State Bank of India said, “the bank has a long-term commitment with the country and noticing its financial situation, SBI will be cautious on its USD exposures to the entities in Sri Lanka”. India on 13^th January, 2022 extended US$ 900 million financial assistance to Sri Lanka in form of US$ 400 million currency swap while deferring US$ 500 million due for settlement to Asian Clearing Union (ACU). This move aims to assist Sri Lanka which is witnessing intense economic problems.

Meanwhile, many Financial Institutions in India have reduced discounting Export Letter of Credit (LC) issued by Sri Lankan banks. “There is no complete embargo on export bill discounting. It is done on the availability of limits with LC issuing banks”, senior official of SBI.

Other large banks in India have also been vigilant such as IndusInd Bank and Axis Bank are been selective in trade transactions and closely observing developments in Sri Lanka. HDFC Bank has reduced handling export LCs. ICICI Bank has completely cut banking limits with Sri Lanka and other small countries for time being. This move by the banks is to minimize the risk of payment maturity dues (up to 6 months or 1 year or more for Capital Goods) which may occur due to starving US Dollars in the forex market in Sri Lanka.

Top International Banks like Standard Chartered Bank, Citi, and HSBC having their presence in Sri Lanka continue to provide trade finance services with precautions as they are comfortable dealing with their Sri Lankan office being the counterparty. Exim Bank has extended 11 credit lines aggregating to $2.12 billion to Sri Lanka.

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