In the otherwise bleak landscape of India’s relations with its neighbours, Sri Lanka constitutes a bright exception. Defaulting last year for the first time on its external debt, Sri Lanka faced huge economic challenges and the threat of internal chaos when it was unable to buy essential commodities, including food and fuel. The then president, Gotabaya Rajapaksa, fled the country and Ranil Wickremesinghe, aged 73, became head of State despite being the only representative in Parliament of his faction from the United National Party. Despite five decades of experience in politics and a deep understanding of economic issues, he could hardly have expected to become president at the beginning of July last year.

Sri Lanka was reduced to dire straits due to decades-long populist politics and an entrenched entitlement culture. The noted economist, Joan Robinson, who visited Ceylon, declared, “You Ceylonese have eat­en the fruit before you planted the tree.” The island nation had been sustained by donor support and 17 IMF programmes despite deficits in both budget and current account of balance of payments, with high inflation, high nominal interest rate and over-valued currency, even while subsidising foreign producers at the expense of domestic ones. Inevitably, over time, concessional assistance was phased out and the country became increasingly ex­p­osed to discipline imposed by in­ter­national capital markets and ra­ting agencies. The immediate cau­ses of the 2022 crisis included wide-ranging tax cuts, the ban on chemical fertiliser, the pandemic and the effects of the Ukraine war. The poverty level, which was 6% before the pandemic, rose to 25% last year.

To their credit, the prime minister Narendra Modi, the finance minister Nirmala Sitharaman, and the foreign minister, S. Jaishankar, responded swiftly, extending emergency assistance of $4 billion, delivering food, fuel and medicine, and joining Japan and other creditor countries to negotiate the restructuring of Sri Lanka’s external debt. From the 1980s, due to the ill-advised deployment of the Indian Peace Keeping Force, Sri Lankans have viewed India negatively. But that sentiment has now changed.

Thanks to the timely help mainly from India, along with other donors and the International Monetary Fund, which approved a programme of $3 bil­lion, considerable progress was made in stabilising Sri Lanka before Wickremesinghe’s visit to New Delhi last month. Mac­roeconomic indicators improved and the mass protests subsided. Ag­g­ressive monetary tightening has been pursued by the Central Bank and inflation has declined from about 70% in September 2022 to 12% in June 2023. It should decline to 4%-6% by the end of this year. Fiscal outcomes have improved with a small primary surplus being achieved in the government budget in the first five months of this year. Tight monetary and fiscal policies, import and capital restrictions, and declining commodity prices have contributed to improvement in the balance of payments, the import bill has declined sharply, tourism is recovering and inward remittances are stable. With positive movements in government securities and share markets and $2 billion in reserves as of last June, the shortages in fuel, food, pharmaceuticals and fertiliser have eased significantly. The government has given the Central Bank greater autonomy while increasing its accountability, seven parastatal organisations are to be disinvested, and the dominance of the Ceylon Petroleum Corporation and the Ceylon Electricity Board diluted. However, addressing the scourge of corruption is essential, including during the presidential and parliamentary elections that are due to be held separately within the next two years.

During their discussions with Wi­ck­re­mesinghe, Indian leaders wisely kept legacy issues like the 13th Amendment of 1987 and Indian fisherfolk’s access to Sri Lankan waters in the background, even though these were discussed. To mark 200 years since the arrival of Indians to work in tea plantations in Sri Lanka, Modi announced a package of Rs 75 crore for development projects for Indian-origin Tamil citizens of Sri Lanka and reminded the visiting president about Sri Lanka’s stated commitment to the 13th Amendment, which provides for a provincial council system and the devolution of powers, including those on police and land, to the provinces. Wickremesinghe laid out his development and devolution proposals to implement the Amendment, although he also explained the constraints regarding the devolution of police and other sensitive powers without the approval of Parliament where he is supported by the ruling Sri Lanka Podujana Peramuna that opposes the concept of further decentralisation.

The negotiations centred on economic relations, with emphasis on connectivity, energy connectivity through green and renewable sources, and people-to-people connectivity through the resumption of ferry services between Tamil Nadu and northern Sri Lanka which were abandoned since 1982 due to the ethnic conflict in the island. Air connections beyond the existing 150 a week will boost tourism. Financial connectivity is envisaged through permission for transaction in Indian rupees through UPI in Sri Lanka; it was also decided to develop Trincomalee as a national and regional hub of industry, energy and economic activity where Indian businesses will get new opportunities. Feasibility studies for a multi-product pipeline, high-capacity power grid interconnection and a land bridge between the two neighbours were approved. Sri Lanka has an existing Free Trade Agreement with India, but it was decided to resume talks, suspended in 2018, on a broader Economic and Technological Co-operation Agreement.

Sri Lanka’s pathway to full recovery will be hazardous; its glass is yet only half-full. It is reported that Colombo seeks 30% reduction on external debt (by now nearly $40 billion) and a nine-year freeze on repayments which is still being negotiated. The IMF reform conditions with enhanced taxes and reduced subsidies will affect the common people and Sri Lanka will need to follow the macroeconomic framework that is supported by the IMF until 2031. There is thus a potential for the revival of the popular revolt if the burden of reform on the public becomes intolerable. To prevent this, the country needs factor market reforms, agricultural modernisation, an investment-friendly climate, investment promotion, trade policy and facilitation, a long-term power generation strategy and the alignment of education, training and skills development to contemporary requirements.

Sri Lanka will benefit through greater integration with the Indian economy, leveraging the growth expected in India with higher-value employment and enhancing energy security. With the Indian rupee being recognised as an authorised currency for bilateral trade and UPI as a digital payments system, this should boost trade, investment and tourism. India views with suspicion China’s presence in Sri Lanka, accounting for 23.6% of the foreign investment (as against 10.4% from India) and 18% of the island’s GDP. Given its strategic location, Colombo needs to handle its foreign relations with care and sophistication to balance the competing interests of major powers as well as complete transparency in its longstanding relations with China to access its considerable exportable capital.

There are obligations on India as well. While India’s Parliamentary Standing Committee has recommended that the government “should continue to be Sri Lanka’s biggest friend in times of crisis,” it behoves New Delhi to deliver the economic agenda and avoid any semblance of the ‘big brother’ attitude that alienated Sri Lanka earlier. Already, voices are being raised on the island accusing Wickremesinghe of selling his country to India and warning that he has no mandate to implement the 13th Amendment. Modi, while responding to Sri Lanka’s needs generously, told Colombo “it is essential that we work together keeping in mind each other’s safety and sensitivities.” This, in essence, is the Gujral Doctrine recycled by the Modi government.

Indrajit Coomaraswamy is a former governor of the Central Bank of Sri Lanka. Krishnan Srinivasan is a former foreign secretary