In 2022, as Sri Lanka’s economy entered into its biggest crisis since independence, the emergency financing extended or facilitated by India amounted to about $4 billion. Sri Lanka used about $3.3 billion during the course of the year, especially in the tumultuous first seven months. India became Sri Lanka’s lender of last resort even as the island entered sovereign default.
A lender of last resort is the place a person, firm, financial institution, or country to which a country turns when in urgent need of funds. As the term suggests, a lender of last resort is the only chance once all other options have been exhausted. While the International Monetary Fund (IMF) is the global institution that is meant to be the lender of last resort for sovereign states, the delays in governments’ approaching the IMF and the length of the IMF’s processes can often mean that other countries or institutions need to step into provide emergency financing before IMF funding kicks in. For instance, the United States acted as a lender of last resort during Mexico’s 1994 crisis.
Sri Lankans headed into 2022 hoping for some support from both India and China in the face of mounting economic and financial woes. However, the magnitude of Indian financing – and the lack of anything in comparison from China – came as a significant surprise. In fact, Indian External Affairs Minister S. Jaishankar’s recent comments highlight that India perceives the significant emergency financial assistance it rendered to Sri Lanka in 2022 as a pivotal point in the expansion of its role within South Asia and the wider Indian Ocean region:
The linkage and perception today of India in the neighborhood has changed, and nothing illustrated that more dramatically than what happened to Sri Lanka last year when it went through a very deep economic crisis… And we have actually stepped forward in a way in which we ourselves never have before. What we have done for Sri Lanka is bigger than what the IMF has done for Sri Lanka.
How Did India Became a Lender of Last Resort?
Heading into 2022, the Central Bank of Sri Lanka had only about $1.6 billion in forex reserves, sufficient for less than one month of imports at the time. While Sri Lanka also had a 10 billion yuan currency swap from China’s central bank, the People’s Bank of China, it was not usable since total reserves were below the required level (enough to cover three months of imports).
Meanwhile, Sri Lanka faced about $6.9 billion in foreign currency debt repayments scheduled to be made over the course of 2022, in addition to financing the country’s usual current account deficit. Of the $6.9 billion, about $1.2 billion was due in January 2022, including a $500 million International Sovereign Bond (ISB) maturing on January 18. With no access to international capital markets to raise new commercial foreign debt and multilaterals also unwilling to extend new financing amid concerns about Sri Lanka’s debt sustainability, the central bank was facing a significant drain on remaining usable forex reserves.
It was at this point in early January 2022 that India stepped in, providing a $400 million currency swap via the Reserve Bank of India (RBI)’s SAARC swap facility and deferring repayment of trade liabilities accumulated via the Asian Clearing Union (ACU) that were otherwise due to be repaid in January.
While these steps helped maintain a positive usable reserves balance, Sri Lanka was still struggling to obtain essential imports, including fuel, as the banking system was struggling to facilitate letters of credit (LCs). Foreign firms and banks were increasingly unwilling to trust the ability of Sri Lanka to repay import credits extended via LCs. Therefore, India in February confirmed the provision of a $500 million fuel import credit facility via the EXIM Bank of India and in April provided a $1 billion import credit facility via the State Bank of India (SBI). A further $55 million fertilizer import credit line was provided in July by the EXIM Bank to help Sri Lanka’s agricultural sector.
India also facilitated the expansion in Sri Lanka’s access to ACU trade liabilities to be settled in arrears among nine regional economies. The ACU “is a payment arrangement whereby the participants settle payments for intra-regional transactions among the participating central banks on a net multilateral basis.” It consists of the seven South Asian countries, excluding Afghanistan, plus Myanmar and Iran. While the transactions occur through the banking system, outstanding net amounts are liabilities of the central banks and cleared on a net basis every two months. In effect, the ACU allows the participating central banks to reduce the amount of dollar liquidity needed to settle trade between the member countries.
As the largest economy in the region, India is the largest provider of ACU credit, including in the case of Sri Lanka. In normal times, the ACU allows Sri Lanka to have access to about $200-500 million trade credit every two months. Amidst the crisis, the ACU allowed Sri Lanka to run up to $2 billion in trade credit, mostly for imports from India.
Combined, through these three instruments – a currency swap, bilateral import credits, and ACU arrears – India facilitated $4 billion in new financing amid Sri Lanka’s economic crisis. There was no other country or institution willing to provide such a large amount of financing to a country heading toward sovereign default. India provided this financing even as the Rajapaksa-led government in power in early 2022 still dragged its feet about approaching the IMF.
The lender of last resort role that India played in early 2022 has been recognized in Sri Lanka’s IMF program and external debt restructuring process. The emergency financing India provided was excluded from the debt restructuring process, and since March of this year, Sri Lanka has begun to utilize multilateral fund disbursements, including IMF funds, to start repaying the short-term Indian import credit.
India’s Motivations
India’s government has not been shy about acknowledging that this lender of last resort action was motivated by the need to avoid a greater humanitarian and social disaster on its doorstep – and to offset China’s influence in Sri Lanka. India also seems keen to maintain the perception of itself as the lead bilateral partner to Sri Lanka, having become the first country to extend financing assurances in line with the IMF program needs in January 2023. It also clear that there are significant Indian economic interests in Sri Lanka.
Even though Sri Lanka accounted for only 1.2 percent of Indian goods exports from 2019-2021, those goods accounted for 20.4 percent of Sri Lanka’s imports in the same period. China accounted for a slightly higher share of Sri Lanka’s imports, 21.8 percent on average. But in 2022, Sri Lanka’s overall imports contracted 11.4 percent from 2021 as the economy shrank. Sri Lankan imports from China dropped about $1.5 billion in 2022, with a total value of $3.3 billion. On the other hand, imports from India remained stable in dollar terms at $4.7 billion, compared to $4.6 billion in 2021, allowing India’s share of Sri Lanka’s imports to rise to 25.9 percent. This was due to the financing facilitated by India.
As detailed out above, most of the Indian financing took the form of trade or import credit via the Asian Clearing Union, EXIM Bank of India, and State Bank of India, usable for importing goods from India. Overall, Sri Lanka used about $1.5 billion of the new ACU trade credit and $845 million in import credit lines, accounting for about 50 percent of goods imported from India in 2022. Therefore, it is clear that minus these mechanisms, Sri Lankan imports from India (and to an extent from other ACU member countries) would have contracted much more, depriving Sri Lanka of essential imports such as fuel, medicines, food, and fertilizer. While there were shortages of these items in 2022, especially fuel, the situation would have been worse without the Indian financed imports.
Beyond the humanitarian crisis in a neighbor, India also has direct economic interests in Sri Lanka. Most importantly, the Port of Colombo remains the largest port in the region, handling 30-40 percent of global transshipments into Indian ports in past years. A grave situation that prevents the Port of Colombo from operating properly is a negative for the Indian economy. There is also a significant presence of Indian firms operating in Sri Lanka, including the Indian Oil Corporation and technology services giant HCL. Adani has also begun significant investments in the Port of Colombo’s new West Container Terminal and in the Mannar wind farms. These give India a vested interest in a stable, functional Sri Lankan economy.
India also saw the 2022 crisis as a great opportunity to offset China’s role in Sri Lanka. Over the previous two decades, China grew to become Sri Lanka’s largest bilateral creditor and a major source of FDI, as Umesh Moramudali and I have highlighted. During the COVID-19 pandemic, China provided Sri Lanka with $1.3 billion in term loans to replenish forex reserves and help refinance debt repayments. But in 2022, China was struggling with its own domestic issues and unsure about how to help multiple Belt and Road Initiative countries struggling with debt distress at the same time. India stepped in to show that when things were at their worst, its “Neighborhood First” policy was robust.
In effect, China was shown to be the lender of penultimate resort that provided financing when Sri Lanka retained some repayment capacity, but India was willing to be much more of a lender of last resort in the South Asian region. It was India that helped Sri Lanka through the process of sovereign default and recovery.
Future of India as a Major Regional Financier
While the magnitude of financing to Sri Lanka was large and highly visible in 2022, India has been playing an increasing role in helping small South Asian countries in the recent past when their external balances were in trouble. In late 2022, Maldives, which is also facing external debt and balance of payment issues, received a $100 million infusion in November 2022 via the State Bank of India and a $200 million RBI currency swap – very large figures relative to the size of the Maldivian economy. Nepal is another country that has received significant financing support from India, especially following the 2015 earthquake.
The past two years of India’s expanding Neighborhood First policy also coincided with attempts to expand the use of the Indian rupee in international transactions. The RBI has been expanding the number of countries and international banks that are able to transact directly in rupees with the Indian banking system, including Indian Ocean Region countries like Sri Lanka and Mauritius. Such an expansion of rupee-denominated transactions potentially opens up the possibility for India to extend rupee lending to neighboring countries in times of crisis, helping sustain vital supply chains from India for essential items like food and medicines. The ACU, which was vital to Sri Lanka in 2022, has also expressed an intention to expand its regional transactions system, including by adding new members in the region.
However, while India became the key bilateral partner during Sri Lanka’s worst-ever economic crisis, there are constraints on India’s ability to continue to be a major financier for Sri Lanka’s recovery. The financing tools India used in Sri Lanka were short-term facilities. The EXIM Bank of India fuel credit line is being repaid within 12 months, the SBI import credit is to be repaid within three years, and the ACU credit and RBI swap are likely to be repaid over the next 18 months.
While India has extended long-term loans, such as for the Northern Railway line, and grants to Sri Lanka for development, the amounts have been small in size. Overall, India is one of the smaller bilateral lenders, accounting for about 5 percent of Sri Lanka’s public external debt, compared to close to 20 percent for China as of the end of 2022. Expanding the size of such lending, alongside FDI by Indian firms, will be vital if India is to expand its role beyond a lender of last resort and offset China’s role as a longer-term development financier in South Asia and the wider Indian Ocean Region.