Magazine : 
Sri Lanka Crisis: Lesson for India
From the era of Great Emperor Ashoka, India and Sri Lanka have cultural, social, intellectual, religious, and economic ties. Whenever the Teardrop of the Indian Ocean was under distress, India acted as a Big Brother. Whether it was the Sri Lankan Civil War in the 1970s or the current economic crisis, India came out as an all-weather friend of Sri Lanka.
At present, Sri Lanka is going through the worst economic crisis, and India is the only country to provide aid to the country by supplying essential commodities and giving a line of credit to purchase fuel and fertilizers. Also, the crisis has raised certain economic concerns in India too.
Recently, External Affair Minister S Jaishankar in All-Party meeting said, “The lessons from Sri Lanka are very, very strong. They are of fiscal prudence, responsible governance and that there should not be a culture of freebies,”
What led to the economic crisis in Sri Lanka?
Sri Lanka is an island nation driven by the tourism industry which contributed 13% to its overall GDP growth as of 2019 data. When the world was under lockdown due to the COVID-19 pandemic it subsequently impacted the flow of foreign currency into the nation. Due to travel restrictions, the footfall of international tourists drastically fell, which led to the depletion of foreign exchange (forex) reserves. The country is also heavily dependent on the export of tea, and this industry was also impacted by the pandemic and ongoing Russia-Ukraine conflict, as both these nations are the largest importers of Sri Lankan tea, and also account for a large number of tourists.
Another reason for the fall in forex reserve was taking loans for importing food items. In 2021, the Sri Lankan government shifted to organic farming without ensuring food security. This lowered the agriculture production to 30%, as a result, agriculture became inefficient to meet the demand of the country, thereby pushing the government to import food items. The Hambantota port was another white elephant project by the Sri Lankan government intended to shorten its economic woes. Instead, it only increased the debt problem that Sri Lanka faced as it leased the port to China for 99 years for $1 billion to repay previous sanctioned loans. Furthermore, the depreciation of the Sri Lankan rupee against the Dollar, and borrowing from IMF trickled down the economy of Sri Lanka.
The last nail in the coffin was the populist economic policy of the Sri Lanka government. To win the votes of the public, the political parties announced welfare policies without paying attention to the current fiscal deficit of the country. The elected government lowered the goods and service tax from 15% to 8% and removed the tax slab for the people of income, from 500,000 to 3,000,000 Sri Lankan rupees. Drastically, the percentage of people paying taxes came down to 33%. The country took expensive short-term loans and issued International Sovereign Bonds but instead of investing the money in developmental projects, they channeled the money towards welfare and populist schemes. Thus the country failed to generate a new source of income and increased the debt-to-GDP by 60%.
What’s in for India?
Top bureaucrats and experts have pointed out the populist schemes and freebies of states like Punjab, UP, West Bengal, Andhra Pradesh, and Telangana governments. The state government of these states announced populist schemes and freebies to win the election. The experts have shown concern over the greater autonomy to spend revenue given to state government under 14th Finance Commission. Instead of focusing on developmental projects, the revenue is shifted towards populist schemes. As a result, their revenue growth remained slow over the years, and the debt-to-GSDP ratio increased significantly. In 2017, the Central government proposed the Fiscal Responsibility and Budget Management Act that stated the Debt-to-GDP ratio should remain below 60%, and the ideal percentage is 40. For states recommendation is below 40% and ideal 20%.
Many states like Punjab whose revenue generation is declining over the years announced free electricity and a 1000 rupee pension for women, thereby, leading to an increase in the debt-to-GDP ratio to 53%, which is the highest among all Indian states. Also, the Uttar Pradesh government announced schemes like free LPG cylinders and free cycles for school girls that increased the interest debt at the rate of 6%.
According to RBI, the debt-to-GSDP ratio of 18 states has crossed 53%, while the market borrowing of states has reached 63% of the GSDP.
Even though the state receives some revenue from the Central government’s GST compensation, the independent source of income is very less for states. They are dependent on revenue from excise duty on alcohol and petrol, property tax, and motor vehicle registration. Over the years, investment in Health, and Social Welfare, increased due to the COVID-19 pandemic, and the states had to borrow money for welfare.
Way forward
Experts have pointed out that, there is a need for the fiscal council to enforce the FRBM mechanism and also assess the expenditure by the states. There is a need for federal cooperation between Central and State governments to develop sustainable welfare schemes. The efficiency in public spending should be the focal point of the policies. Further, outcome documentation should be done to check on policy reach. State-specific policies can be derived to reduce the debt-to-GSDP ratio for the states because every state is unique and has different demands. The states should keep the fiscal condition into account before announcing a welfare scheme as this scheme has a direct impact on lower investment in developmental projects, thus creating lesser jobs.
Eventually, Sri Lanka discovered that excessive consumption cannot be sustained without a corresponding rise in income and independent production of necessities. Therefore, it's crucial to be cautious about converting to organic farming, undertaking large projects that might not be profitable, and increasing the debt-to-GDP ratio. The country should focus on developing industries to be self-sufficient.
India is moving in the right direction by launching initiatives like Atmanirbhar Bharat, which promotes localized production and implementing production-linked incentive programs (PLIs) for several economic sectors. Even the export basket of India is much more diversified, unlike Sri Lanka. Lessons from Sri Lanka may even enable India to showcase sustainable consumerism and a self-sufficient manufacturing economic model that is unhindered by the influence of multinational firms and banks.
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