Smruti S. Pattanaik

While the agreement remains controversial, China is likely to consolidate its presence and Sri Lanka likely to get deeper into the Chinese debt trap even though it has gained temporary relief through the equity for debt swap.

• Published: August 14, 2017
• IDSA Comments

Research Fellow, IDSA, Dr Smruti Pattanaik’s article on political turbulence in Maldives, titled ‘Maldives: Political trouble in the nascent democracy’ was published in The Daily star on July 30, 2017.

Read article

• Published: 30 July, 2017

Sheikh Hasina’s visit should not be seen through the narrow prism of an agreement on defence cooperation or Teesta but through the broader perspective of the unexplored potential in India-Bangladesh relations.

• Published: April 07, 2017
• IDSA Comments

The reactions of Afghanistan, Bangladesh, Bhutan and India indicate a new regional consensus that state sponsored terrorism cannot be dealt with only at the bilateral level.

• Published: September 29, 2016
• IDSA Comments

Few issues have drawn as much attention and have been debated as intensely as the rise of India. There has been a plethora of literature that almost dissects various factors that have contributed to India’s rise and what the future holds for the country. Will India emerge as a major player in the international system? Will it be able to compete with a rising China as an Asian power? These are some of the questions that have confronted scholars of international relations and security.

• Published: July 2016
• Strategic Analysis

India’s engagement with its neighbours received a policy reinvigoration after the National Democratic Alliance (NDA) government assumed power and announced its ‘neighbourhood first’ policy. The first sign of this policy was visible when Prime Minister Narendra Modi invited all the heads of state of the neighbouring countries for his oath-taking ceremony, on May 26, 2014. India’s interest and engagement with the South Asian Association for Regional Cooperation (SAARC) has also intensified in the past few years – from being a reluctant player to driving the regional economic agenda.

• Published: May 2016
• Strategic Analysis

Last year, soon after taking power as president of Sri Lanka, Maithripala Sirisena requested a US$4 billion loan from the IMF to restructure its debt repayments. The bailout package was rejected by the IMF. It warned the government instead to rationalise the tax system and arrest growing inflation.

Yet, despite the bleak economic situation, the government decided to increase salaries and pensions for public servants, cut taxes for farmers and increase subsidies. It is therefore unsurprising that the government faced an imminent balance of payments crisis. The IMF finally decided to provide a bailout package of US$1.5 billion — considerably less than the US$4 billion initially requested by Sri Lanka — to boost Sri Lanka’s falling foreign exchange reserves in March 2016.

Following the end of the Sri Lankan civil war in 2009, the country experienced persistent high growth of 8 per cent and a comfortable foreign exchange reserve. But these all changed in late 2014. So what went wrong?

Sri Lanka’s positive postwar economic growth was based on two factors. First, in the postwar period Sri Lanka received massive investment in infrastructure and other reconstruction activities. The second factor is the sudden spurt in workers’ remittances, which contributed to foreign exchange reserves. Peace also boosted investor confidence.

Unfortunately, the government’s populist posture prevented it from implementing any structural reforms to expand the tax base or end its generous subsidy regime, resulting in a massive debt burden. Debt servicing for projects that are not earning returns have further added to Sri Lanka’s financial woes.

The country’s outstanding debt rose 12 per cent to 8.27 trillion rupees (about US$57 billion) in the first nine months of 2015 and foreign debt increased by around 5 per cent to 3.27 trillion rupees (US$22 billion). As the trade balance suffered, Sri Lanka’s macroeconomic indicators faltered. The fluctuating rupee undermined investor confidence contributing to capital flight, while foreign exchange reserves fell to US$6.3 billion in January this year. The GDP growth rate reduced to 4.5 per cent in 2014 from a high of 9.1 per cent in 2012. Massive money printing, which was intended to alleviate the budget deficit, only exacerbated Sri Lanka’s economic woes and the budget deficit climbed to 7.2 per cent in 2015.

A decrease in the growth of remittances from 9.5 per cent in 2014 to just 0.8 per cent in November 2015 only made matters worse. This was due to the crash in oil prices and political turmoil in the Middle East, where most overseas Sri Lankan workers are employed. The Sri Lankan rupee also depreciated 8.8 per cent to the US dollar making imports costly. By October 2015 the trade deficit had increased by 2.5 per cent to US$6.9 billion, mostly due to an increase in non-oil imports.

The government tried several measures to overcome the impending crisis. For example, Sri Lanka issued 10-year sovereign bonds worth US$2.15 billion — US$1.7 billion from development bonds and US$1.5 billion from currency swaps with India. Sri Lanka’s central bank also increased the statutory reserve ratio — that is, the proportion of customer deposits that commercial banks must hold in reserve — to help combat inflation. And it issued short-term bonds to overcome the revenue deficit. This policy came under severe criticism by the opposition. For its part, the government accused the previous Rajapaksa regime of being responsible for the country’s 9.5 trillion rupee (US$65 billion) debt.

The government’s problems have been compounded as it faces a resurgent Mahinda Rajapaksa, who is preparing for a comeback and still enjoys considerable popularity. To survive, it has to keep both the people and the party leaders happy. To this end, the government increased the perks for the 225 members of parliament, creating an additional financial burden to the tune of 39.4 million rupees per month (US$270,000) and 472.8 million rupees (US$3.2 million) a year.

In July last year the Central Bank of Sri Lanka entered into an agreement with the Reserve Bank of India (RBI) for a currency swap agreement. As a result, Sri Lanka’s central bank was allowed to withdraw up to US$1.1 billion for a maximum period of six months. The deal is in addition to the existing RBI currency swap provision that is available for all the South Asian Association for Regional Cooperation (SAARC) countries under the 2012 ‘Framework on Currency Swap Arrangement for SAARC Member Countries’. Currency swaps under the SAARC agreement have a maximum ceiling of US$2 billion. To help Sri Lanka meet the imminent balance of payment crisis, the Indian government also approved an interim currency swap amounting to US$700 million.

India’s participation was partly motivated by a desire to strengthen ties with Sri Lanka to counter possible Chinese influence. When advocating the currency swaps to the Sri Lankan government, the RBI argued that the deal would help to mitigate ‘possible currency volatility in the spirit of strengthening India’s bilateral relations and economic ties with Sri Lanka.’

But Sri Lanka needs to go beyond just currency swaps to revitalise its flagging economy. In the recent past, Sri Lanka has taken steps to increase taxes to raise revenue. The value-added tax, for example, was increased by 15 per cent and the government removed tax concessions on telecommunication services, private education and health services. But it is yet to expand the tax base and reduce subsidies.

It appears that Sri Lanka is in for some tough negotiations with the IMF. It has to address the structural issues, bring in financial reform to expand the tax base, reduce unnecessary expenditure and address the budget deficit. And it must do all these in a difficult political climate. It will be difficult for the government to avoid giving in to its populist impulses, especially when the opposition is waiting in the wings.

The article was originally published in the East Asia Forum.

• Published: 14 April, 2016

International oversight in the form of a panel of judges and the UNHRC mechanism in general are likely to help address the apprehensions of the Tamils about a domestic investigation mechanism.

• Published: October 06, 2015
• IDSA Comments

The issue of ‘consensus’ that has been at the core of writing a constitution has been eroded through majoritarianism to secure the entrenchment in power of the hill political elites.

• Published: September 28, 2015
• IDSA Comments

Prime Minister Ranil Wickremesinghe undertook his maiden visit to India on September 15, days ahead of an important report pertaining to Sri Lanka's human rights status was to be released by the UN Human Rights Commissioner's Office in Geneva.

However, choosing India as the first foreign destination over other countries is not something that is new for Sri Lankan leaders. In the past, India has been the first chosen destination for the Sri Lankan Presidents and Prime Ministers.

Much should not be read into India being the first destination apart from the fact that India remains Sri Lanka's close neighbour, the largest trading partner and has today emerged as a country that is the largest partner in defence training programs and many of the officers of the Sri Lankan armed forces are trained in India. India remains a major pilgrimage destination for Sri Lankans. These facts attest to the close relationship that the two countries share.

In the post Mahinda Rajapaksa regime, these visits - earlier by President Sirisena and now by Prime Minister Wickremesinghe also signify that Sri Lanka in the process of making a major foreign policy shift. These shifts arise from three different factors.

First, the election of President Sirisena and Prime Minister Wickremesinghe as the heads of the United National Front for Good Governance (UNFGG), symbolises a departure from Rajapaksa politics which is a welcome development from India's point of view.

The current government realises that it would need India's political support to resolve the long-standing Tamil issue; second, Sri Lanka needs investments.

Economic development

Sri Lanka has taken a massive loan from China and some of the projects completed by China are yet to bring in the promised economic dividend. It fears the huge debt that the last government incurred will cripple the economy. The only country in the region that can help Sri Lanka in economic development and building of infrastructure would be India.

Third, on the eve of the UNHRC report that was unveiled on September 16; Sri Lanka would need India's support in the UNHRC to have a domestic investigation approved. This would need a huge diplomatic effort. Fourth, Sri Lanka also wanted to convey that it is sensitive to India's security interest in the Indian Ocean region.

Moreover, during Rajapaksa's regime, bilateral relations was at its lowest point as Mahinda Rajapaksa attempted to undermine India's security interests to pressurise New Delhi to give up its insistence on implementing the 13th Amendment and going beyond it. Prime Minister Modi, who visited Sri Lanka in March this year emphasised on building a close economic partnership between the two countries and harnessing the close socio-cultural relations that the two countries share to take their bilateral relations to a new phase.

He reiterated that Indian businessmen are interested in investing in infrastructure, energy and the transport sectors and emphasised need for bilateral arrangements on trade and investment.

Though India did not speak of the Comprehensive Economic Partnership Agreement (CEPA) which Prime Minister Modi had mentioned during his visit to Sri Lanka in March; but signing CEPA would remain a major priority.

There is some domestic opposition due to apprehensions expressed by business community in Sri Lanka pertaining to this agreement.

The two countries need to take steps to convince the public regarding the benefits of signing a comprehensive economic partnership agreement which includes trade in services and value addition by Sri Lankan companies - a natural progression from the Free Trade Agreement that the two countries signed in the late 1990s.

Major concerns

SAARC countries have already signed an agreement on trade in service in 2010 which came into force in 2012. Both countries hope to sign a framework document to encourage private sector investment.

The security dimension would be a significant factor in forging close ties. The growing influence of China in the Indian Ocean region is one of the major concerns taking into account the Chinese interest in building ports across the Indian Ocean region. China has a controlling stake in the Hambanthota port and received operational control of four berths which was leased out to a Chinese company last year.

China built and also controls the Colombo South Container Terminal (CSCT) where a Chinese submarine docked twice in 2014 much to the concern of New Delhi. With the change of government in Sri Lanka India expects Colombo to take into account New Delhi's security concerns. Taking a cue from close cooperation that exists between the armed forces which is signified by the number of officers who come to India for training, Prime Minister Modi said that the two countries have "closely aligned security interests and they need to remain sensitive to each other's concerns". Combatting terrorism and cooperation in protecting the common maritime neighbourhood was emphasised by both governments.

Prime Minister Wickremesinghe said that peace and stability in the Indian Ocean is linked to prosperity of India and Sri Lanka. It needs to be mentioned here that there already exists an annual trilateral naval exercise among India, Sri Lanka and the Maldives.

The fishermen's issue remain a major irritant. While the two countries reactivated the stalled dialogue between the fishermen of the two countries in March this year; bottom trawling remains a major concern for Sri Lanka since it damages marine resources. Indian fishermen demand to be allowed 83 fishing days in the Palk Strait for the next three years.

Taking into account the game changing election in Sri Lanka; India-Sri Lanka relations certainly would receive a boost as Sri Lanka moves away from the notion of 'national security' State to establish genuine peace and reconciliation and accelerate economic growth and generate employment opportunities for its people.

India will remain a major partner in Sri Lanka's economic trajectory and would be a stakeholder in Sri Lanka's effort at greater democratisation and its attempt to shape an inclusive political system.

This article was originally published in Sunday Observer

• Published: 21 September, 2015