Source: The New York Times

Akhil Bery

Sri Lanka is in the midst of the worst economic crisis since independence. Power shortages in some areas are lasting up to 13 hours per day, reports of food shortages are common, and there are long queues for gas, as supplies have dwindled. And, for the first time, Sri Lanka has defaulted on its debt. Amidst all of this, President Gotabaya “Gota” Rajapaksa has been confronted by protestors chanting “Go Home Gota.” The economic crisis has brought about political turmoil as well, with the entire cabinet resigning in early April, and most recently, Prime Minister Mahinda Rajapaksa stepping down to make way for a unity government. The most pressing crisis confronting the government though is to secure financing from the International Monetary Fund (IMF) and other multilateral institutions in order to pay for basic goods, such as food, gas, and medicines.

Throughout the economic crisis, India has been Sri Lanka’s most important partner, stepping up to regain some of its lost influence, and crucially, India has been Sri Lanka’s biggest advocate at multilateral institutions such as the IMF. Since January 2022, India has taken a number of steps to support the Sri Lankan economy, including extending a currency swap to Sri Lanka, supplying 40,000 tons of rice, and issuing lines of credit to Sri Lanka to purchase fuel and medicine. India has also supplied around 200,000 MT of diesel. Overall, India has provided at least $2.4 billion in assistance to Sri Lanka, and more is likely to come.

India’s speed in helping Sri Lanka has been a part of an effort to regain some of its lost influence in the island, as well as to achieve some of India’s own strategic objectives. For example, India has signed a deal with Sri Lanka to jointly develop the Trincomalee Oil Tank Farm, a deal which serves India’s security interests, especially with attention shifting towards the Bay of Bengal. Similarly, India was able to apply pressure on Sri Lanka to cancel a $12 million renewable energy project that was to be developed by Chinese firm Sinosar-Etechwin on three islands off the coast of Jaffna (and close to the Indian state of Tamil Nadu). Following the cancellation, India and Sri Lanka then signed an agreement on implementing the hybrid power projects.

The decision to cancel the Chinese contract was the first time since Gota came into power that a decision went against Chinese interests. The Rajapaksas have always been known to be close to China, a relationship that dates back to when Mahinda was President. During the Sri Lankan civil war, China provided aid and weapons to the government, which helped beat the Liberation Tigers of Tamil Eelam, ending the 25-year-long civil war. Since then, the Rajapaksas’ bond with China grew stronger, with China financing a number of ambitious infrastructure projects that were seen to be unviable, most notably, Hambantota Port, which was a pet project of Mahinda. India was offered the opportunity to develop the port first, but declined, due to the commercial unviability of the project, allowing China to step in.

Under Gota, the tilt towards China accelerated, as his government made a number of policy decisions that seemingly favored Chinese interests. For example, the government cancelled a Japanese-funded light rail project, which caught Japanese officials by surprise. Next, the government withdrew from a joint venture with the Adani Group from India, the Japan International Cooperation Agency, and the Sri Lanka Ports Authority to jointly develop the Eastern Container Terminal at the Colombo Port; that project was later awarded to the China Harbor Engineering Company. Finally, the government passed the Colombo Port City Economic Commission Bill, which created a special commission to govern the Special Economic Zone of the Colombo Port City (which is being developed by China), leading to accusations that the government was giving away Sri Lanka’s sovereignty.

Further, Gota’s government was willing to be a tool for China’s strategic objectives wherever possible. For example, when China was trying to rebuild its international image following the onset of the COVID-19 pandemic, Sri Lanka was more than happy to aid in that narrative, taking a $500 million loan and redefining it as a COVID-19 loan (the loan had been under discussion for several months prior to the COVID-19 pandemic). The willingness to change policies to suit Chinese interests while also being a part of Chinese image-building exercises did not ultimately help Sri Lanka with its objective of trying to obtain some debt relief from China. Instead, Gota’s actions angered key partners such as India and Japan.

Though China has extended some help to Sri Lanka during the current crisis, it is not on the same scale as India, and is in stark contrast to efforts during the initial stages of the pandemic. For example, during the pandemic, China extended more loans to Sri Lanka, a currency swap to help Sri Lanka purchase goods from China, as well as vaccine donations. Yet, what Sri Lanka needs now is some form of debt relief. Though there is a misperception that Sri Lanka is stuck in a Chinese debt trap, according to the IMF, China accounts for about 10% of Sri Lankan debt; it is not even the largest bilateral creditor. Sri Lanka has asked China on numerous occasions for debt relief, including a request in January to delay the repayment of $11 billion in loans. Instead, China has offered it more loans. Even in terms of humanitarian relief, China’s silence has been quite telling. Belatedly, at the end of April, China announced $31 million in humanitarian aid, which consisted of 5,000 tons of rice, pharmaceuticals, and other essential materials; separately, China’s Yunnan province announced a donation of $227,000 worth of food packages to Sri Lanka.

Sri Lanka’s mistake was believing that China would be willing to restructure the loans in light of the various decisions made that seemingly benefited Chinese interests. However, this was a fundamental misreading of the global environment; during the pandemic, China did not grant debt relief to any country, likely due to the precedent it would set for other countries seeking the same relief. The other big mistake that the Rajapaksa government made was that this misguided belief that debt relief was coming led the government not to approach other creditors for a restructuring, which would have unlocked financial assistance from the IMF and other multilateral institutions. The latest triggers for China’s ambivalence seem to be the willingness of Sri Lanka to accept Indian assistance, the cancellation of the renewable energy projects off the coast of Jaffna, and Sri Lanka’s request to the IMF for assistance. The IMF request seems to have been made because China is delaying a decision on an additional $2.5 billion in assistance for Sri Lanka (of this, $1 billion would be used to repay Beijing for existing loans, and $1.5 billion would be a credit line to purchase Chinese goods). Also, India has been pushing Sri Lanka to approach the IMF for a full program, and has been insistent that all creditors take a “haircut,” including China.

Sri Lanka has constantly been involved in the tug-of-war between India and China for influence in South Asia, and has, in the past, effectively leveraged this for assistance and investment. Under the Rajapaksas, the pendulum of influence had swung towards China. However, the current economic crisis has caused the pendulum to swing back towards India. The swiftness and willingness of India to extend humanitarian aid to Sri Lanka rather than bailing them out, has meant a greater appreciation amongst citizens for India. Indeed, during the recent World Bank/IMF meetings, India advocated for more assistance for Sri Lanka, with some commentators saying that India’s Finance Minister was doing more for Sri Lanka then their own. The IMF negotiations are the next litmus test for which way Sri Lanka swings. India has been pushing for a full IMF program, and unless China comes to Sri Lanka’s rescue with a massive foreign exchange influx, it seems that for now, India has all but staged a comeback in the  great power competition with China in South Asia.

Akhil Bery is the Director of South Asia Initiatives at the Asia Society Policy Institute (ASPI).