Introduction

India and Sri Lanka share a deep-rooted economic relationship shaped by historical, geographical, and cultural ties. Their economic integration holds significant potential, not just for mutual growth but also for fostering regional stability. India, projected to become the world’s third-largest economy by 2030, has the resources and influence to support Sri Lanka’s economic revival. Meanwhile, Sri Lanka, facing a financial crisis and a pressing need for economic reforms, stands to benefit from deeper trade and investment ties with India.

The Free Trade Agreement (FTA) signed between the two nations in 2000 has laid the foundation for increased economic collaboration. However, despite India being Sri Lanka’s largest trading partner and investor, challenges such as trade imbalances, protectionist policies, and political sensitivities continue to hinder full-scale integration. Addressing these challenges through enhanced trade agreements, infrastructure projects, and investment in key sectors can bring long-term economic benefits for both nations.

The State of India-Sri Lanka Economic Relations

• India and Sri Lanka enjoy a longstanding relationship, strengthened by political, economic, and cultural ties. India is Sri Lanka’s largest trading partner, top investor, and primary source of tourists. This economic interdependence has played a critical role in Sri Lanka’s development.
• In 2022, when Sri Lanka faced its worst economic crisis in decades, India was the only country to provide immediate financial and logistical assistance.
• With Sri Lanka’s debt-to-GDP ratio at 115%—nearly half of which is in foreign currency—the country remains vulnerable to external financial pressures.
• To achieve stability, Sri Lanka must enhance exports, attract foreign direct investment (FDI), and implement economic reforms. India, given its economic trajectory, is well-positioned to play a crucial role in Sri Lanka’s recovery.
• Despite shared economic interests, some Sri Lankan industries fear that deeper integration with India may increase economic dependence. Protectionist policies and concerns over India’s economic dominance have resulted in delays in expanding trade agreements.
• However, Sri Lanka’s ongoing economic crisis highlights the need for pragmatic economic collaboration. Greater engagement with India can reduce vulnerabilities to external financial institutions and geopolitical pressures from other global powers.

 Sri Lanka’s Potential Gains from Economic Integration

1. Expansion of Export Markets

• Economic integration with India offers Sri Lanka increased access to a rapidly expanding market.
• India’s middle class is projected to reach 700 million by 2030, creating immense demand for various goods and services.
• The FTA signed in 2000 has already facilitated significant trade benefits, with over 60% of Sri Lankan exports to India benefiting from preferential tariffs.
• However, only 5% of Indian exports to Sri Lanka have utilized these provisions, indicating untapped potential for Sri Lankan industries.
• Greater trade liberalization would allow Sri Lankan businesses to scale up production and compete in India’s growing market. Sectors such as tea, apparel, and agriculture can gain from expanded trade agreements.
• However, Indian-imposed quotas on key Sri Lankan exports, such as apparel and pepper, remain a challenge. Addressing these trade barriers through negotiations and sectoral cooperation can help maximize Sri Lanka’s export potential.

2. Boosting Foreign Direct Investment (FDI)

• Sri Lanka urgently needs large-scale FDI to overcome its economic crisis. The country’s reliance on non-tradable sectors has hindered long-term growth.
• Encouraging investment in manufacturing, technology, and services can diversify the economy and enhance its resilience.
• India, already a key investor, has the potential to further contribute to Sri Lanka’s economic revival.
• Large Indian firms, including HCL, have expressed interest in Sri Lanka’s technology sector. Increased investments from Indian businesses can bring capital, create jobs, and facilitate knowledge transfer.
• Additionally, Sri Lanka’s recent Free Trade Agreement (FTA) with Thailand and its interest in joining the Regional Comprehensive Economic Partnership (RCEP) signal a shift toward a more open economic framework.
• Strengthening ties with India complements these efforts and positions Sri Lanka as a gateway to South Asian markets.

3. Infrastructure and Connectivity Improvements

• Investment in Sri Lanka’s port infrastructure aligns with its goal of becoming a regional logistics hub.
• India has already invested in Colombo Port and is exploring opportunities in Trincomalee, home to the world’s fifth-largest natural harbour.
• Strengthening maritime connectivity with India will enhance Sri Lanka’s role as an intermediary trade hub, generating revenue and attracting further investments.
• The Colombo West International Terminal project, set for completion in 2026, is expected to boost regional trade.
• Additionally, integrating Sri Lanka’s transport and logistics network with India’s would reduce costs and improve supply chain efficiency, benefiting both nations.

4. Strengthening the Services Sector

• Sri Lanka’s services sector, particularly IT and finance, stands to benefit from deeper integration with India.
• The Sri Lankan government aims to expand its IT workforce to 200,000 in the next five years, creating a skilled labour force that can serve Indian firms.
• Many multinational companies already outsource work to Sri Lanka, and further economic cooperation could establish Sri Lanka as a key services hub.
• An Economic and Technical Cooperation Agreement between the two nations can enhance the mobility of skilled professionals, facilitate technology sharing, and boost Sri Lanka’s competitiveness in global markets.

5. Energy Collaboration and Renewable Energy Exports

• Energy security is critical for Sri Lanka’s economic stability. Integrating Sri Lanka’s electricity grid with India’s can provide access to cost-effective energy, reducing dependence on volatile global energy markets.
• India has some of the lowest energy production costs in the world, and interlinking the grids could ensure a stable supply for Sri Lanka.
• Sri Lanka also has significant renewable energy potential, particularly offshore wind energy.
• According to the World Bank, Sri Lanka’s offshore wind capacity exceeds its domestic demand, offering an opportunity to export surplus energy to India.
• Learning from Nepal and Bangladesh, which have already integrated their electricity grids with India, Sri Lanka could develop a long-term renewable energy export strategy, securing additional foreign exchange revenue.

India’s Strategic and Economic Interests

1. Regional Security and Stability

• A stable Sri Lanka aligns with India’s “Neighbourhood First” policy. Economic integration fosters political stability, reducing the risk of external influences from global rivals.
• Historically, Sri Lanka has leaned toward China, especially during periods of economic distress.
• China remains Sri Lanka’s largest bilateral lender and has significant investments in infrastructure, such as the Hambantota Port, which was leased to a Chinese firm for 99 years due to debt obligations.
• Strengthening economic ties with Sri Lanka can counterbalance China’s influence in the Indian Ocean region.
• India’s investments in Sri Lanka’s energy, port, and transport sectors not only benefit bilateral trade but also serve broader geopolitical interests.

2. Enhancing Maritime and Trade Influence

• Sri Lanka sits along one of the world’s busiest maritime routes, critical for global trade.
• Strengthening trade relations ensures that Sri Lanka remains aligned with India’s economic and security interests.
• Given that 80% of India’s oil imports and 90% of its trade volumes pass through the Indian Ocean, ensuring stability in Sri Lanka is crucial.
• Strategic investments in Trincomalee and Colombo will help India secure vital trade routes and expand its maritime capabilities.
• The construction of an oil pipeline from Tamil Nadu to Sri Lanka is another step toward deeper energy collaboration, ensuring long-term economic and energy security.

3. Leveraging Trade for Soft Power

• Trade can serve as a powerful tool to enhance India’s soft power in Sri Lanka.
• As seen in ASEAN’s growing economic ties with China, increased trade can create a vested interest among Sri Lankan businesses and policymakers in maintaining strong ties with India.
• Indian investments in manufacturing, banking, and hospitality further solidify India’s economic influence, fostering long-term goodwill.

Conclusion

Economic integration between India and Sri Lanka presents a unique opportunity for mutual growth, regional stability, and strengthened bilateral ties. While challenges remain, the potential benefits outweigh the risks. For Sri Lanka, deeper trade and investment cooperation with India can provide much-needed economic relief, create jobs, and improve energy security. In return, India secures a stable southern neighbour, enhances its regional influence, and strengthens its position in the Indian Ocean.

India and Sri Lanka can unlock economic integration by expanding trade agreements, addressing regulatory challenges, and fostering key investments. An Economic Cooperation Council can aid policy alignment. Strengthening infrastructure, services, and energy ties will enhance bilateral relations, driving mutual growth and regional stability.