Daily Editorial Analysis for 19th June 2021

India must step up engagement with Lanka

Colombo Port City Economic Commission Bill

• The Sri Lankan Parliament, on 19^th May, 2021, passed the Colombo Port City Economic Commission Bill.
• After the Bill becomes an Act, China will obtain an additional 269 hectares of reclaimed seafront off the Colombo port in the country’s south­west with little oversight from the Sri Lankan government.
• Colombo assumes importance for India since almost 70% of all container cargo for and from India is trans­shipped there, mostly at Chinese operated terminals. This not only has security implications, but also results in delays in transit and loss of revenue for India.
• New Delhi, conscious of this serious lacunae, seeks to create trans­shipment hubs in south India; which however, will have a gestation period.
• Further, India, Japan and Sri Lanka had signed a deal in 2019 for India’s Adani Ports Group to lead the development of Colombo’s East Container Terminal (ECT). However, labour protests, most certainly China orchestrated, have put a spanner in the works.
• Sri Lanka however has offered India the West Container Terminal for development in lieu, to which India is yet to respond.
• China had earlier secured the use of Hambantota port on a 99 year lease from Sri Lanka as a collateral for a huge outstanding loan.
• Leasing of Hambantota and the Port City project makes it almost certain that the Chinese People’s
• Liberation Army (PLA) will soon have a presence in these waters which may include bases for warships/submarines as well as a staging post to sustain longer naval deployments in the Indian Ocean.
• Therefore, a permanent PLA (navy) presence in the Indian Ocean will be worrisome for India’s national security.
• The Chinese navy will be able to easily monitor Indian naval activity in the Indian Ocean. It will certainly inhibit the Indian Navy’s deployment options and neutralise the geographical advantage it enjoys in these waters.
• Now, India will have to adapt to the presence of its principal adversary practically in its backyard and shape its preparedness and response accordingly.
• Moreover, a joint Sino­Pakistan axis, with China also sitting in Gwadar, will be a major problem for India.
• The Chinese will no longer be constrained by the tyranny of distance, from the South China Sea to the Indian Ocean.
• China imports about 80 per cent of its oil from West Asia which passes south off Sri Lanka before moving on toward the Malacca Straits. With Beijing’s first overseas base in Djibouti and a foothold in Sri Lanka, China is better placed to protect her sea lanes of communication.
• India will need to continue to work on the Kankesanturai port in Jaffna and the oil tank farm project in Trincomalee to ensure that China does not make any further inroads in Sri Lanka.
• Other measures will include militarisation of the Quadrilateral Security Dialogue and countervailing bases in other South-east Asian countries such as Vietnam.

India­Sri Lanka relationship

• The India­Sri Lanka relationship is vastly different from China­Sri Lanka ties. India shares an ethnically blurred maritime border with Sri Lanka owing to Tamils across
• either side of the Palk Straits and is, therefore, involved with the island nation’s domestic politics.
• Also, the majoritarian Sinhalese community is unhappy over perceived Indian interference in Sri Lanka’s internal affairs.
• China’s involvement in Sri Lanka’s domestic dynamics differs from India’s — due to its distance from the island and absence of ethnic linkages with its people.

Strategic significance

• Sri Lanka, located at the crossroad of global shipping lanes, enjoys an unrivalled strategic significance in the Indian Ocean This geopolitical reality has a bearing on Indian security interests.
• China’s military ties with the Sri Lankan government have grown over the past four decades, regardless of which political party was in power.
• In the post­Sri Lanka civil war (1983­2009) phase, during which India backed the Tamil secessionists, China gained limited military influence in Sri Lanka. For instance, China gifted a naval frigate to the Sri Lanka navy after then President visit to Beijing in May 2019.
• Importantly, it also included finalisation of security protocols and a $14 million deal for counter­insurgency surveillance technologies.
• The December 2004 Tsunami and the Final War against LTTE (April 2006­May 2009) gave China the platform to achieve its mission.
• Chinese presidents and premiers since 2001, after their visits to Sri Lanka, have made many joint statements which allude to their entry into the island state’s infrastructure sector.
• In a sense, the proposed Colombo Port City with greater devolution of Chinese interests is akin to what Beijing is doing to Hong Kong.
• Accordingly, Indian foreign policy towards Sri Lanka, as part of its ‘Island Diplomacy’, will have to evolve in tune to the emergent realities and threats.

GS PAPER – III                

Are our forex reserves adequate?

Why in News

• The growing foreign exchange kitty has created a problem of plenty for the Reserve Bank of India. It’s attracting unwanted attention, along with calls for using the reserves to fund infrastructure expenses, capitalize state-owned banks and better management of the assets in the reserves.

RBI’s latest monthly bulletin

• Recently, the RBI released its latest monthly bulletin pointing out that the reserves may not be as robust as perceived.
• The report, while highlighting the $600 billion milestone for forex reserves, pointed out that India currently holds the fifth largest foreign exchange reserves, twelfth largest holding of US treasury securities and tenth largest gold reserves.
• Two other observations have also been given:
• One, it stated that the import cover for 15 months provided by our reserves compares poorly with other countries with large forex reserves such as Switzerland (39 months), Japan (22 months), Russia (20 months) and China (16 months).
• Two, that the net international investment position of -12.9 per cent of GDP needs to be taken in to account while assessing the adequacy of reserves.
• It is not easy to assess the adequacy of forex reserves of a country. As the IMF states, “Assessing the appropriate level of reserves to hold is challenging — not just because of the multiple roles played by reserves, but also because of the complexity of quantifying external risks and vulnerabilities, and the opportunity cost each country faces.”
• Conventional ratios used to gauge adequacy of forex reserves show a vast improvement now, compared to two years ago. Also, given that the central bank will have to continue market intervention in order to maintain rupee stability, the reserves are likely to grow further.
• There is however no need for the RBI to get defensive about the growing reserves. It should instead look for ways to put the reserves to optimum use.

Are reserves adequate?

• The metrics used to gauge the adequacy of reserves purpose have evolved with the changes in the composition of the external account over the years. Many committees set up by the RBI have deliberated and improved upon these, suggesting the most relevant measures for the country.
• While trade-based metric such as import cover was the most popular pre-2000, use of debt-based indicators became more relevant as external debt grew. The predominance of foreign portfolio flows in the capital account called for gauging the reserves in the context of these flows as well.
• If we consider the import cover provided by forex reserves now, it was 15 months towards the end of last month. While the RBI has pointed out that the cover is much lower when compared to other countries, a better way to analyse the number will be by comparing it with past data.
• Current import cover is a vast improvement from the cover enjoyed historically. For instance, the import cover in March 2019 was 9.6 months and in September 2013, it was at an abysmal 6.6 months.
• Another metric used to measure forex reserves — the ratio of short-term debt (based on original maturity) to reserves — has also improved of late. This ratio has declined to 17.7 per cent towards the end of December 2020 from 26.3 per cent in March 2019. It stood at a high of 34.2 per cent in September 2013.
• While the RBI is not wrong in pointing out that we have more external liabilities than external assets in the IIP, the higher holding of reserves currently, give comfort on one of the most volatile components of our external account, portfolio flows.
• The ratio that takes into account more volatile portfolio flows — ratio of volatile capital flows (including cumulative portfolio inflows and outstanding short-term debt) to reserves — has improved to 67 per cent in December 2020, from 7 per cent in March 2019 or 97.3 per cent in September 2013.

Reserve accretion may continue

• Given the stance of global central banks to continue their bond purchases and to maintain interest rates at ultra-low levels, global investors are likely to remain flush with funds, at least until first half of 2022 and the hunt for higher yield and better growth will bring these investors to Indian equity and debt market in the near future.
• The RBI will have to continue buying dollars in this scenario to maintain stability in rupee movement.
• The reserve accretion is therefore largely due to the policies of other central banks and there is no need for the RBI to be defensive about the growing pile of reserves.
• In order to mitigate global spillovers, they have no recourse but to build their own forex reserve buffers, even though at the cost of being included in currency manipulators list or monitoring list of the US Treasury.
• Also, with most central banks likely to begin monetary policy normalization by 2022 or 2023, de-leveraging and risk-off trade can cause volatility in financial markets and the reserve buffer will be handy to absorb such shocks.
• The central bank should however begin to seriously consider diversification of assets held in its reserves away from US treasury securities which do not yield any interest and also carry risk of capital loss.
• Engaging an external consultant to recommend apt allocation is the way forward to make the most from the reserve holdings.