India tries to free Sri Lanka from China’s ’embrace’

The Minister of Foreign Affairs of the India, Subrahmanyam Jaishankar, was in Sri Lanka this week to offer aid to Sri Lanka’s struggling economy in an attempt to wean it out of the decades-long Chinese embrace.

Sri Lanka’s two-year economic crisis comes after two decades of heavy Chinese investment, under what one geopolitical pundit called “strategic trap diplomacy.”

Having a giant and increasingly assertive neighbor so closely intertwined with Sri Lanka has unsettled India, which is locked in a standoff with China on its disputed border with the Himalayas.

Sri Lanka’s economic crisis provides India with an opportunity to remove the country from the influence of Beijing.

Located just off the busy East-West shipping lanes, Sri Lanka has attracted billions in investment under China’s Belt and Road Initiative.

The program was launched in 2013 to build ports, roads, railways, oil pipelines and other infrastructure in Asia.

But China has taken over at least one strategic port when Sri Lanka defaulted on its debt.

Sri Lanka is of great interest to both powers.

New Delhi scored a small but significant victory on Tuesday when it seized a power project previously awarded to China.

India is also trying to outdo China in its speed to provide financial aid to Sri Lanka, which is running dangerously low on foreign exchange reserves to service its debt.

According to central bank data obtained by Reuters, Sri Lanka currently has about $2bn in foreign exchange reserves against $7bn in total debt due this year, including $1bn in notes due in July.

During Jaishankar’s trip, Sri Lanka sought a $1.5 billion line of credit to buy basic goods, Reuters reported.

That’s on top of the $2.4 billion that India has transferred since January through a currency swap, loan deferral and lines of credit.

China, which has deeper pockets, has yet to agree to a Sri Lankan request for a $2.5 billion credit line or a full debt restructuring.

About 22% of Sri Lanka’s debt is owed to bilateral creditors: China and Japan (10% each), as well as India (2%).

Milk, medicine, gasoline running out worry India

Food, milk, medicines and other basic products are in short supply as the inflation rate exceeds 17%, a situation monitored by India.

Power outages are common and some people have died of heatstroke while waiting in long lines to buy fuel.

India is trying to stabilize the region, said Gulbin Sultana, an associate fellow at the Manohar Parrikar Institute for Defense Studies and Analysis in New Delhi.

“China’s presence worries India, it’s true. But India and Sri Lanka are also maritime neighbors. Any instability in Sri Lanka will have a knock-on effect in India,” he told CNBC.

More than a dozen refugees have arrived in India by boat and Indian media reported, citing intelligence sources, that some 2,000 more would follow in the coming days.

Sri Lanka’s nationalist Rajapaksa government, which had hoped to overcome the crisis without help from the IMF, changed course this month.

Finance Minister Basil Rajapaksa, who is also the president’s brother, will soon travel to Washington to submit policy proposals to the lender.

Sri Lanka has sought IMF bailouts 16 times in the last 56 years, second only to the debt of Pakistan.

The current crisis was precipitated by tax cuts that hit government revenues that were already under pressure after the coronavirus pandemic COVID-19 bring down the $5 billion tourism industry.

In 2020, real GDP contracted by 3.6% and Sri Lanka lost access to international debt markets after its ratings were downgraded.

So far, China has not agreed to Sri Lanka’s debt restructuring request.

Ganeshan Wignaraja, a non-resident senior fellow at the Institute for South Asian Studies at the National University of Singapore, attributed China’s reluctance to two factors.

“First, it will set a bad precedent for other nations that have borrowed from China,” he told CNBC from Colombo. “And two, it will associate China with failure because Sri Lanka’s economic model was based on China’s.”

In response to CNBC’s request for comment, the Chinese Foreign Ministry said that China and Sri Lanka have always supported each other.

Beijing has supported the Sri Lankan economy within its capacity to do so and will continue to do so in the future, the statement said.

Sri Lanka adopted China’s infrastructure-led growth model in the early 2000s on the premise that it would create jobs and usher in prosperity.

No reliable figures are available, but the cumulative value of Chinese infrastructure investment in Sri Lanka is estimated at more than $12 billion between 2006 and 2019.

Beyond Sri Lanka’s financial crisis, Colombo is also caught in a “strategic trap,” said Asanga Abeyagoonasekera, a Sri Lankan geopolitical analyst and senior fellow at the Washington-based Millennium Project.

He described the strategic trap as an extension of a “debt trap” with political, security and human rights aspects.

China shields Sri Lanka from criticism of its human rights record at the United Nations and favors a heavily militarized and authoritarian model of government over democracy, it added.

“The quantitative economic projection of the debt trap falls short of capturing the strategic depth of Chinese projects.

The Chinese projects have a long-term strategic design that could comfortably bring a ‘hybrid model’ of civil-military activity to the country, a security concern for Sri Lanka and the entire region,” said Abeyagoonasekera.

“Large-scale Chinese infrastructure loans are one of the direct concerns; none of them could generate the expected income to repay the loans,” he said, calling Chinese loans “opaque”.

Both experts believe that IMF assistance will be key to solving Sri Lanka’s economic problems.

Sri Lanka, Wignaraja suggested, would best benefit from India adding its “powerful voice” to get Colombo to implement an IMF program that will require deep economic reforms.

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