Is Sri Lanka the next hub for Indian Ocean trade?

Is Sri Lanka the next hub for Indian Ocean trade?
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Sri Lanka is set to become a destination of choice among businesses looking to tap opportunities in pan-Indian Ocean trade due to its strategic location. Maithripala Sirisena, the country’s new president, will have to carefully balance the conflicting interests of neighbouring India and the country’s largest business partner—China—to sustain economic momentum.

On 15 February, Indian officials welcomed the new Sri Lankan President, Maithripala Sirisena, to New Delhi. The four-day visit to neighbouring India was Sirisena’s first trip overseas since being sworn into office in early January.

Sirisena and India’s Prima Minister, Narendra Modi, signed four agreements, including a bilateral deal on civil nuclear cooperation. These diplomatic efforts underline the countries’ mutual intent to forge closer ties.

Relations between the two South Asian nations had turned increasingly sour during the presidency of Sirisena’s predecessor, Mahinda Rajapaksa. The failure by Rajapaksa’s government to establish reconciliation with the ethnic Tamil minority has resonated in India, which has a sizeable Tamil population itself.

Furthermore, the pursuit of closer ties with China has strained relations with India and put Sri Lanka at the centre of geostrategic rivalry in the Indian Ocean.

Sri Lanka’s appeal to investors

Sri Lanka is strategically positioned in the Indian Ocean along the major shipping route that connects (South) East Asia with the Indian subcontinent, the Middle East and Eastern Africa. In a bid to revive the “maritime Silk Road” (MSR)—referring to an ancient series of land routes that connected China to the Mediterranean Sea—Beijing became a key supporter of the island’s economy after the 26-year-civil war ended in 2009.

When the Sri Lankan government became the target of global protests over alleged human rights violations against the Tamils, Beijing stood by Colombo. China’s interests in Sri Lanka are largely strategic and commercial in nature, in particular the access to resources in the wake of burgeoning energy consumption.

However, the visit of a Chinese warship and two submarines at the port of Colombo in October 2014 fuelled India’s security concerns over China’s diplomatic push in the Indian Ocean. Modi’s administration has made no secret of welcoming the unexpected change in government and Mr. Sirisena’s decision to make his first official trip to New Delhi—not Beijing.

Infrastructure development an attractive business

The surge in Chinese investments and government lending has helped Sri Lanka to make significant progress in its infrastructure development. The Chinese government and state-owned firms have assisted Sri Lanka in the modernisation of railways, the construction of expressways and the expansion of the country’s maritime infrastructure.

Phase 1 of the $360 million project in Hambantota was completed in 2010. The project intends to transform the port into a major transhipment hub along one of the busiest shipping routes around the world. Moreover, the expansion of facilities is under way at the port of Colombo port.

In August 2013, the Chinese-owned Colombo International Container Terminal (CTCT) was added to the Port of Colombo at a total cost of $500 million. The new terminal makes Colombo the only port in South Asia that can accommodate 18-meter deep draft vessels, putting it in position to serve the Indian subcontinent, the Middle East and Eastern African states.

Two further terminals are currently under construction that will boost the port’s container-handling capacity 2.5 fold to approximately 12 million TEUs and make it one of the world’s largest container ports.

According to the World Economic Forum’s Global Risks Report 2015, the availability and quality of infrastructure are at the core of many of the challenges faced by developing countries, particularly in South Asia. Sri Lanka’s fairly advanced infrastructure in combination with its favourable location is hence a promising opportunity for emerging market investors.

What to expect from Sri Lanka’s new government

Mr. Sirisena has pledged to pursue a more global foreign policy: a shift from a China-centric policy towards a multilateral outlook. Thus far, the new president has taken a pragmatic policy approach, balancing relations between the two largest nations in the region, India and China.

Despite the rapprochement between Sri Lanka and India, the newly elected government assured China that Sino-Sri Lankan relations won’t change. President Sirisena will arrive in Beijing on 26 March to meet his Chinese counterpart, Xi Jinping.

In addition, Sirisena’s administration is sticking with the $1.5 billion Dubai-style “Colombo Port City” built by state-owned China Communications Construction Company, although perhaps on changed terms. Expectations that the deal would come undone after the regime change have failed to materialise.

The new government has promised to fight corruption and champion transparency in tender procedures of future investment projects. It is less likely that Chinese contractors will win major new infrastructure projects. Clearly, this represents an opportunity for investors from India, Japan or the West.

It is a good time for businesses to take a fresh look at investing in Sri Lanka. Realising the country’s ambition to become one of the most competitive maritime and logistic hubs in the Asian region will require a careful balancing act on the political front. Sirisena’s first weeks in office are cause for optimism.

About Author

Alexander Scherpf

Alexander focuses on political risk in Southeast Asia. Prior to joining Global Risk Insights as a contributing analyst, he worked with the Economic and Trade Section of the EU Delegation to Indonesia, Brunei, Darussalam and ASEAN. He holds a MSc degree from UCL’s School of Public Policy.