Sri Lanka's recent agreement to restructure its debt with the OCC (Official Creditor Committee) and China marks a significant milestone in the nation's efforts to stabilize its economy. This deal, crucial for addressing the crippling debt crisis, carries far-reaching implications not only for Sri Lanka’s economic landscape but also for its diplomatic ties, particularly with neighbouring India. The negotiation process itself highlights Sri Lanka's delicate balancing act between its major creditors and influential neighbours. Successfully brokering this agreement required Colombo to navigate the complexities of international finance while maintaining favourable relations with both China, its largest bilateral lender, and India, a key regional partner. This balancing act reflects Sri Lanka's strategic diplomacy in leveraging its geographic and political significance in the Indian Ocean Region to secure necessary financial relief while managing the geopolitical interests of major powers. 

The debt deal

Sri Lanka has faced a severe economic crisis over the past few years, characterized by mounting debt, dwindling foreign reserves, and a balance of payments crisis. The COVID-19 pandemic exacerbated these challenges, leading to a sharp decline in tourism revenues and remittances, two critical sources of foreign exchange. As a result, Sri Lanka struggled to service its external debt, prompting urgent calls for debt restructuring. The debt restructuring agreement involves the official creditor committee, which includes major economies and multilateral institutions, and bilateral creditors like China. The deal aims to extend the repayment period, reduce interest rates, and possibly include a debt haircut (partial debt forgiveness). For China, a major bilateral lender to Sri Lanka, the agreement reflects a pragmatic approach to ensuring the sustainability of its loans while maintaining strategic influence in the region.

Impact on economy

The debt restructuring provides immediate relief to Sri Lanka’s fiscal situation. By extending repayment periods and reducing interest rates, the deal alleviates short-term financial pressures. This fiscal space allows the government to allocate resources towards essential services, infrastructure development, and social welfare programs, fostering economic stability. The successful negotiation of the debt deal is likely to boost investor confidence. It signals to international markets that Sri Lanka is committed to addressing its financial woes responsibly. This can lead to an increase in foreign direct investment (FDI) and portfolio investment, essential for economic growth and job creation.

With the debt restructuring in place, Sri Lanka is better positioned to secure financial assistance from international institutions like the International Monetary Fund (IMF) and the World Bank. These institutions often require debt sustainability as a precondition for support, and the agreement with creditors meets this criterion. The deal is expected to come with conditions that promote structural reforms. These reforms may include measures to improve tax collection, enhance public sector efficiency, and liberalize trade policies. Such changes are crucial for creating a more resilient and diversified economy.

Implications on India-Sri Lanka relations

(i)  Strategic rivalry and cooperation

India and China have long been strategic rivals in South Asia. China's significant economic footprint in Sri Lanka, through investments in infrastructure projects like the Hambantota Port and the Colombo Port City, has raised concerns in New Delhi about Beijing’s growing influence. The debt deal, involving China, adds another layer to this complex relationship. India, however, has also extended financial assistance to Sri Lanka, reflecting a nuanced approach that balances rivalry with the need for regional stability.

(ii)  Economic interdependence

India is one of Sri Lanka’s largest trading partners and a key source of investments and tourists. The debt deal, by stabilizing Sri Lanka's economy, indirectly benefits India by ensuring a stable and prosperous neighbour. Enhanced economic stability in Sri Lanka can lead to increased trade and investment opportunities for Indian businesses, strengthening economic interdependence.

(iii) Regional security dynamics

Sri Lanka's strategic location in the Indian Ocean makes it a focal point in the broader regional security dynamics. A stable and economically resilient Sri Lanka is crucial for regional security. India's involvement in Sri Lanka's economic recovery, alongside China, highlights the importance of collaborative approaches to regional stability. The debt deal, therefore, could pave the way for more robust trilateral cooperation in areas like maritime security, counter-terrorism, and disaster management.

(iv) Soft power and public diplomacy

India and China’s engagement in Sri Lanka extends beyond economic assistance. Both nations aim to strengthen their soft power through cultural exchanges, educational initiatives, and developmental projects. India’s historical and cultural ties with Sri Lanka, particularly through Buddhism, provide a strong foundation for soft power diplomacy. The debt deal’s success may spur India to enhance its cultural and people-to-people engagements to counterbalance China’s economic influence.

Case Examples

(i) Hambantota Port

The Hambantota Port, leased to China for 99 years, symbolizes the strategic depth of China’s investments in Sri Lanka. While the port has faced criticism as a debt trap, its operational success is vital for Sri Lanka’s economic recovery. The debt deal ensures that Sri Lanka can manage its repayments without compromising national assets, potentially leading to more balanced and mutually beneficial economic agreements.

(ii) Indian Line of Credit

   India has extended multiple lines of credit to Sri Lanka, including $1 billion in 2022 to help alleviate the country's economic crisis. These credits have been crucial for importing essential commodities and stabilizing the economy. The debt deal enhances the prospects for such financial assistance, reinforcing India’s role as a reliable partner in Sri Lanka’s economic recovery. 

Need to balance ties

The debt restructuring deal between Sri Lanka, the official creditor committee, and China represents a critical juncture in the country’s economic recovery. It offers a lifeline to a beleaguered economy, providing the fiscal space needed for stability and growth. The implications for India-Sri Lanka relations are multifaceted, encompassing strategic, economic, and cultural dimensions. By navigating this complex landscape, Sri Lanka has the opportunity to foster balanced and mutually beneficial relationships with both India and China, contributing to regional stability and prosperity.

References

1. Meera Srinivasan, Sri Lanka seals debt deal with Official Creditor Committee after financial crisis. 26 Jun 2024. The Hindu. https://www.thehindu.com/news/international/sri-lanka-finalises-debt-restructuring-agreement-after-financial-crisis/article68335968.ece

2. Beyer, Robert Carl Michael; Abeygunawardana, Kishan Weditha Namanayaka; Kim, Yeon Soo; Sarma, Nayantara. Economic and Poverty Impact of COVID-19: Sri Lanka Development Update 2021 (English). Washington, D.C. World Bank Group. https://documents.worldbank.org/en/publication/documents-reports/documentdetail/284901624350168752/Sri-Lanka-Development-Update-2021

3. Amal Jayasinghe Sri Lank Seals Debt Deal with China, Others after Crash. 26 Jun 2024. Barron’s https://www.barrons.com/news/sri-lanka-seals-partial-debt-deal-after-financial-crash55ed26f9#:~:text=Sri%20Lanka%20said%20on%20Wednesday,after%20a%202022%20financial%20crash

4.  High Commission of India, Colombo, Sri Lanka. India- Sri Lanka Bilateral Relations. 1 July 2021. https://hcicolombo.gov.in/pages?id=eyJpdiI6Iit0TjFpQ3VQYjBjZm1DN0FaSGpaekE9PSIsInZhbHVlIjoibU9kQ3lPdGd6aTE0VWtWM2hTWXhiUT09IiwibWFjIjoiM2Y0ZWFhYjUyYTI0ZDgzMjMzMzg5ZmY3NTM0MjczNGQ5YTQ3NjdlMjI1ZGJkOGYwZjM5YjFiMTJjZmM4OTUyMSJ9&subid=eyJpdiI6IlVPdEVUamd1YmpiOEUzaGE2SDdGalE9PSIsInZhbHVlIjoiSGQzZVdnSVVaM08rMHo3Tm1LVUZwZz09IiwibWFjIjoiNWFmNzIxZDA4YjQxYjRlODJmMzdmZGUwZGRkNmY0ZDU5OGQzNmUzNjRiNTA3ZDBkMzMxYTFjZDFkYTY2OTRmOSJ9#:~:text=India%20has%20traditionally%20been%20among,US%24%205.45%20billion%20in%202021.

5. Maria Adele Carrai, Questioning the Debt-Trap Diplomacy Rhetoric surrounding Hambantota Port. 5 June 2021. https://gjia.georgetown.edu/2021/06/05/questioning-the-debt-trap-diplomacy-rhetoric-surrounding-hambantota-port/ 

(The author is a Master’s student of politics and international relations at Pondicherry University, India. Views are personal. His X handle is  https://twitter.com/LPKMR1?t=6OVQZ4kBfVZdNkDoRp8klA&s=09 and LinkedIn profile https://www.linkedin.com/in/lipun-kumar-sanbad-191397281? )