Sri Lanka, India to Sign Defence Pact; Ranil Warns of Risks in rejecting the Neighbor

Weekly Economic Review

India and Sri Lanka are working towards strengthening their economic and defense relations through key initiatives such as the stalled Economic and Technology Cooperation Agreement (ETCA), cross-border energy projects, and India’s continued support in Sri Lanka’s debt restructuring and economic recovery. Strengthening economic cooperation with India is critical for Sri Lanka’s access to investment, technology transfer, and market expansion. Indian Prime Minister Narendra Modi’s upcoming visit to Sri Lanka is expected to further cement these ties.

A major focus is on advancing business-to-business collaborations in high-growth sectors, developing energy infrastructure, supporting Indian private sector investment in Sri Lanka’s West Container Terminal of Colombo Port, implementing a digital ID scheme, and deepening free trade agreements.

Former Sri Lankan President Ranil Wickremesinghe has emphasized India’s crucial role in Sri Lanka’s economic stability, stating that rejecting Indian support would hinder the nation’s growth and deepen poverty by 2050.

The two nations are set to sign a landmark defense cooperation agreement during Prime Minister Modi’s visit, signaling a strategic shift amid China’s growing influence in Colombo. Additionally, discussions between Modi and Sri Lankan President Anura Kumara Dissanayake will cover bilateral agreements, including one on restructuring Sri Lanka’s debt.

One of the most anticipated developments is the revival of the long-delayed Sampur power project in Trincomalee, which Modi will inaugurate during his visit. Initially planned as a coal power plant in 2006, the project transitioned to LNG in 2016 and has now been revised into a solar power initiative at Sri Lanka’s request.

This project, in partnership with the Ceylon Electricity Board and India’s National Thermal Power Corporation (NTPC), is set to be a milestone in Indo-Sri Lankan energy cooperation.

India remains a key energy supplier to Sri Lanka, notably through the operations of Lanka IOC, the Sri Lankan subsidiary of Indian Oil Corporation. India and Sri Lanka are actively negotiating the ETCA to further enhance trade and investment ties.

India has been a dominant trade partner for Sri Lanka, with cumulative foreign direct investment (FDI) reaching USD 2.25 billion by 2023. Both nations are also exploring the potential use of the Indian Rupee for economic transactions to facilitate bilateral trade.

An ambitious cross-border energy connectivity project is underway, with plans to establish a high-voltage direct current (HVDC) transmission link between Madurai in Tamil Nadu and Anuradhapura in Sri Lanka.

This initiative is expected to reduce Sri Lanka’s dependence on costly thermal power while promoting sustainable energy solutions such as rooftop solar panels for religious institutions. Ongoing discussions aim to accelerate the Sampur project and other energy collaborations.

On the financial front, Central Bank Governor Nandalal Weerasinghe reaffirmed Sri Lanka’s commitment to the IMF-led economic recovery program and debt re-profiling efforts. Addressing a recent monetary policy review in Colombo, he ruled out any short-term reduction in interest rates or access to international markets for borrowing over the next two years. Despite Sri Lanka experiencing deflation since September 2024, the Central Bank has maintained the Overnight Policy Rate (OPR) at 8.00 percent since November, targeting a 5 percent inflation rate.

Weerasinghe pointed out that temporary factors, such as reduced electricity prices, contributed to deflation and predicted inflation stabilization in the latter half of 2025.

He reassured stakeholders of Sri Lanka’s favorable progress in the IMF review, emphasizing the need for fiscal discipline, governance reforms, and revenue-based consolidation to meet IMF objectives. Significant progress has been made in debt restructuring, particularly concerning euro bonds and bilateral agreements with major creditor nations.

Regarding Sri Lanka’s re-entry into global financial markets, Weerasinghe projected that it would take at least two years to regain a B-grade credit rating necessary for accessing international funds.

However, he cautioned that commercial borrowing would be contingent on government policies. Currently, Sri Lanka is relying on multilateral funding and prudent financial management to reduce the budget deficit and mitigate the need for short-term commercial loans. Additionally, the country is exploring alternative financing methods, such as debt-for-nature swaps.

Consumer prices in Sri Lanka rose by 1.2 percent from September 2022 to March 2025, with food prices declining by 3.1 percent. In the 12 months leading up to March 2025, the Colombo Consumer Price Index (CCPI) registered a 2.6 percent decrease, marking a deflationary trend that followed rising food prices in December 2024. The CCPI dropped for the second consecutive month, reaching 191.6 points in March from 192.2 points in February. The food price sub-index fell by 1.3 percent in March after experiencing steady increases in the previous quarter.

Under the Central Bank’s deflationary policy, which includes controlling sterilization inflows, the Sri Lankan Rupee has appreciated from 360 to approximately 300 per US dollar. With appropriate interest rate adjustments, the Central Bank retains control over the exchange rate, ensuring stability in the balance of payments.

As Sri Lanka navigates economic recovery, collaboration with India remains pivotal in securing investments, improving trade flows, and stabilizing the financial sector. Strengthened economic ties through initiatives such as ETCA, energy connectivity, and digital infrastructure development will play a crucial role in Sri Lanka’s long-term economic resilience

 

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