In its September 2026 Discussion Paper #349, “Neighbourhood First Policy: India’s Role in Sri Lanka’s Debt Recovery”, Dr Ganeshan Wignaraja, Adjunct Senior Fellow at RIS and Visiting Senior Fellow at ODI Global, examines India’s key role in Sri Lanka’s economic recovery. Published by the Research and Information System for Developing Countries (RIS), the paper argues that India’s crisis response must now give way to a relationship centred on trade, investment, and connectivity. As Wignaraja puts it, “the time is therefore ripe” for India’s Neighbourhood First Policy (NFP) engagement with Sri Lanka to move “beyond aid towards trade and connectivity”.
Sri Lanka announced a pre-emptive default on its foreign debt in April 2022, when public debt stood at about US$80 billion and gross foreign reserves had fallen to just US$25 million. The economy contracted by 7.3% that year, inflation surged, and poverty doubled. Wignaraja attributes the crisis to persistent fiscal and current account deficits, extensive external borrowing for low-return infrastructure, external shocks including the COVID-19 pandemic, the Ukraine war and the Easter Sunday bombings, and domestic policy missteps such as tax cuts, a chemical fertiliser ban, a fixed exchange rate, and import controls. India provided around US$4 billion in support in 2022–23 through credit facilities for essential imports and fuel, a currency swap, deferred payments under the Asian Clearing Union, and humanitarian supplies. Alongside the International Monetary Fund (IMF) programme and domestic policy measures, this assistance helped support the recovery. The economy grew by 5% in 2025, while inflation fell from 46.4% in 2022 to −0.5%. Gross foreign reserves exceeded US$6.4 billion in July 2026. However, public debt remained at 101.1% of gross domestic product (GDP) in 2025, and about a quarter of the population continued to live in poverty.
Subsequent shocks have exposed the recovery’s fragility. Cyclone Ditwah affected nearly 10% of Sri Lanka’s population, damaged or destroyed more than 91,000 homes, and caused an estimated US$4.1 billion in damage, equivalent to about 4% of GDP. India announced a US$450 million reconstruction package, comprising US$100 million in grants and US$350 million in concessional loans, alongside relief supplies, helicopters, and disaster-response personnel. The Iran war has created further risks through higher oil prices and disruptions to shipping and aviation. These could affect Sri Lanka’s annual remittances of around US$8 billion, roughly half of which come from the Middle East, as well as its tea exports, about half of which go to the region. India also supplied 38,000 metric tonnes of petroleum products and helped evacuate Sri Lankan nationals from Iran.
Wignaraja argues that repeated crises underline the limits of an aid-centred relationship. Sri Lanka needs to reduce its vulnerability to future shocks, particularly as the current IMF programme ends in March 2027 and substantial external debt repayments resume from 2028. The author estimates that the country will require at least US$20–25 billion between 2028 and 2030 for debt servicing, essential imports, and investment. Since another IMF programme alone would not meet these needs, he recommends early engagement on an 18th programme and an Indian-led aid consortium involving Japan, the United States, the European Union, the IMF, and multilateral development banks. He also calls for a dedicated disaster management ministry, with India helping Sri Lanka strengthen its institutional capacity and preparedness.
The paper identifies deeper economic integration as the basis for a more sustainable partnership. Wignaraja calls for modernising the India–Sri Lanka Free Trade Agreement, signed in 1998, by updating rules of origin, liberalising trade in services, simplifying customs procedures, and strengthening investment protection. Bilateral merchandise trade reached about US$5.4 billion in 2025, and the author considers US$10–12 billion by 2030 achievable. Better air and ferry links, port investment, digital connectivity, an undersea electricity transmission line, and an oil pipeline could support this expansion. The proposed electricity link between Anuradhapura and Chennai is estimated to cost US$1.2 billion.
Realising these ambitions will also require domestic reforms in Sri Lanka. The paper highlights regulatory barriers, weak export capacity, skills gaps, and constraints on private investment. It calls for stronger macroeconomic management, more effective state institutions, and policies that improve competitiveness and regional supply-chain integration. India could contribute through its experience of economic liberalisation, digital public infrastructure, and investment facilitation.
Overall, Wignaraja argues that while India’s emergency assistance helped Sri Lanka navigate its economic crisis and subsequent shocks, sustaining recovery will require a shift towards trade, investment, and connectivity, backed by domestic reform. For India, this would deepen regional economic integration, strengthen its position in Sri Lanka, and reduce the risks that renewed instability in its neighbourhood could pose to its own security.
