Explained: How bad is the Sri Lanka crisis and how does it impact India

by 5paisa Research Team Last Updated: Dec 13, 2022 - 11:08 am 32.6k Views
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India’s tiny island neighbour Sri Lanka is in the throes of what is perhaps the worst ever financial crisis in its independent history. On Tuesday, Sri Lanka defaulted on its entire $51 billion external debt. 

According to World Bank estimates, five lakh people in Sri Lanka have fallen into poverty since the crisis began. It is a "huge setback similar to five years' worth of growth," according to the bank.

The situation is so bad that refugees from the island nation are beginning to trickle into India’s southern state of Tamil Nadu. Moreover, inflation in Sri Lanka has soared to 17%. The country is running out of essential medical supplies and food, and the government has even had to cancel school exams because there is simply not enough paper and ink left in the country and it has run out of foreign exchange to import these goods. 

India has extended a $1 billion line of credit to Sri Lanka, and has promised all possible help as it deals with the situation. 

How significant is the impact on India?

Sri Lanka is small, so the size of trade with India is not very significant as compared to several other countries in the region. But India has been one of Sri Lanka’s biggest trade partners. Moreover, India relies heavily on Colombo, which is a transhipment port. Colombo handles about 60% of India’s transhipment cargo. The port itself is heavily dependent on Indian cargo, which accounts for 70% of its total volume. 

The Business Standard newspaper said in a recent report that thousands of containers sent from India to Sri Lanka, including for its own consumption as well as trans-shipment cargo, have been lying uncleared at Colombo port as authorities can’t afford to transfer containers between terminals. This, in turn, has led to some build-up of cargo intended for Sri Lanka at Indian ports.

Do any big Indian companies have a presence in Sri Lanka?

Yes, several well-known Indian companies operate in the country. These include Indian Oil, Airtel, Taj Hotels, Dabur, Ashok Leyland, Tata Communications, Asian Paints, SBI and ICICI Bank.

Does India invest significantly in Sri Lanka?

India is one of the biggest contributors of foreign direct investment into Sri Lanka. FDI from India amounted to about $1.7 billion from 2005 to 2019. After China and the UK, India was the biggest source of FDI for Sri Lanka in 2019 at $139 million. The main investments from India are in the areas of petroleum retail, tourism and hotel, manufacturing, real estate, telecommunication, banking and financial services.

Does India have any significant exports to Sri Lanka?

At $4.8 billion, India’s annual exports to Sri Lanka accounted for just 1.3% of India's total exports. Sri Lanka’s share in India’s total imports was just 0.16%.

What about tourism?

Tourism is a major revenue source and foreign exchange earner for Sri Lanka. Before the coronavirus pandemic, India was the top source for tourism for the island nation. 

What caused the crisis in the first place?

The crisis has been mainly caused by a shortage of foreign exchange reserves. They have plummeted 70% in two years to just $2 billion at the end of February, which can barely cover two months of imports. Meanwhile, the country has foreign debt obligations of about $7 billion this year. The forex crisis is the result of several factors.

Tourism, which is the country’s third-largest foreign exchange earner, came to a virtual halt after the 2019 Easter Sunday suicide bombings which killed more than 250 people. Tourist arrivals dropped by as much as 70%.

Then, the Covid-19 pandemic struck, dealing a severe blow to the tourism industry. And remittances from foreign workers, which is the nation’s biggest source of dollars, slumped 22.7% to $5.5 billion in 2021.

The country’s heavy dependence on imports for essential goods like sugar, pharmaceuticals, fuel, pulses and cereals worsened the crisis. The government’s ban on chemical fertilizers last April as it looked to become the first country to fully adopt organic farming backfired as 90% of Sri Lanka’s farmers use chemical fertilisers for cultivation.

The move led to a drastic drop in domestic food production, pushing up food prices. The decision was rolled back after months of mass protests by farmers but the damage was done. Food inflation soared to 25.7% in February. The crisis is now starting to impact Indian exporters.

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