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India– Sri Lanka’s 2nd largest trading partner– worried as economic crisis hits the island nation

Sri Lanka President Gotabaya Rajapaksa

Concerns have risen for Indian exporters, who have engagements with Sri Lanka, as the island country declared an economic emergency after a sharp fall in its currency and surge in food prices, triggered by a near erosion of foreign exchange reserves.

India is Sri Lanka’s second largest trading partner after China.

“Exporters are concerned with the recent development in Sri Lanka particularly the sharp depreciation of the currency as well as the tightening of forex requirements,” Ajay Sahai, Director General, Federation of Indian Export Organisation told India Narrative.

Also read: IMF, Bangladesh rush financial assistance to Sri Lanka amid economic emergency

Sahai said that Sri Lanka’s current economic turmoil would impact all its trading partners and not India alone.

“We are hopeful that the situation will improve fast so that our trade remains unaffected, else we may have to explore other options including Line of Credit or trade in local currency etc so that the momentum on the export front continues,” he added.

Sahai, however, said that there has been no payment problem on the existing orders until now.

The Covid 19 pandemic has dealt a huge blow to the economy of the island nation, which has been facing challenges for sometime now. By July end, the country’s foreign exchange reserves had dropped to a mere $2.8 billion. According to an AFP report, importers are struggling to source dollars even to pay for the food and medicines they are allowed to buy.

Amid this, the Central Bank of Sri Lanka has increased interest rates in a bid to discourage people from withdrawing money from banks.

In 2020 the country's economy contracted by a record 3.6 per cent. To save foreign exchange, the government put a ban on imports of vehicles and other items, including edible oils and turmeric.

Sri Lanka’s liabilities relating to foreign debt payments this year is estimated at $3.7 billion, It has paid $1.3 billion so far.

According to the Indian Embassy in Sri Lanka, in 2020, bilateral merchandise trade between the two countries stood at about $3.6 billion. Sri Lankan exports to India have increased substantially since 2000 when the Indo-Sri Lanka Free Trade Agreement (ISLFTA) came into force and more than 60 per cent of Sri Lanka’s total exports to India over the past few years have used the benefits of the agreement. According to the Embassy, only about 5 per cent of India’s total exports to Sri Lanka in the past few years have used the ISFTA provisions, thereby indicating their overall competitiveness in the Sri Lankan market.

Also read: SL health system on alert over new Covid variant

Coffee, tea, spices, automobile, mineral fuels, cotton, pharmaceutical products, iron and steel, chemicals are among the main items that are exported from India to the island nation.

Challenges for the Gotabaya Rajapaksa government have been increasing since 2019 since the President took over.

“Managing the economy amid a pandemic induced economic shock has been a major challenge. Sri Lanka has experienced its worst economic downturn in the last four decades,” the Interpreter by the Lowy Institute said.

It also said that Sri Lanka’s high debt levels have risen exponentially during the pandemic, reflecting the “persistent fiscal and current account deficits, notable currency depreciation.”

Interestingly it must be noted that the bulk of Sri Lanka’s external debt stock is owed to international capital markets, followed by multilateral development banks and Japan, the Interpreter said.