As India solidifies its position as the world’s fifth-largest economy, Sri Lanka finds itself at a strategic crossroad. The rapid economic ascent of India’s southern states, notably Tamil Nadu and Karnataka, presents both promising opportunities and considerable challenges for Sri Lanka’s economic integration. Yet, translating geographical proximity into meaningful participation within India’s regional value chains demands more than optimistic forecasts; it necessitates deliberate domestic reforms, targeted policy interventions and proactive diplomacy.
As India cements its position as the world’s fifth-largest economy, Sri Lanka faces the critical question of how effectively it can integrate into India’s growing economic ecosystem. Indian and Sri Lankan economists Dr. Sanjay Kathuria, Prof. Sachin Chaturvedi and Subhashini K. Abeysinghe told a Verité Research conference titled ‘Riding the Indian Wave: World’s 5th Largest Economy on Sri Lanka’s Shores’, held on March 27 in Colombo, said for Sri Lanka, proximity to India—particularly its southern states—presents an avenue for deeper integration into regional value chains, enhanced trade, investment flows and improved connectivity. The three Economists added that domestic reforms must enable closer cooperation.
Economic proximity with Southern India
Non-Resident Senior Fellow at the Institute of South Asian Studies, National University of Singapore, Dr. Kathuria highlighted the growing economic importance of India’s southern states—Andhra Pradesh, Karnataka, Kerala, Tamil Nadu and Telangana. These five states now contribute over 30 percent of India’s GDP, while accounting for a declining share of its population. Together, they form a market of over 265 million people with an economic output nearing USD 1 trillion.
He said that these states offer a logical focus for Sri Lanka due to their geographic proximity and existing cultural and linguistic ties. Sectors such as tourism, port services, IT and manufacturing-related supply chains were identified as potential areas of collaboration.
Kathuria said that Sri Lanka’s trade openness has declined significantly over the past two decades. According to World Bank data, Sri Lanka’s trade-to-GDP ratio dropped from 88.6 percent in 2000 to 42.3 percent in 2023. This trend, he said, is unusual for a small economy and may have contributed to reduced external competitiveness. To address this, he recommended that Sri Lanka revives discussions on a deeper free trade agreement with India. Talks on the proposed Economic and Technological Cooperation Agreement (ETCA) have remained stalled, partly due to concerns from Sri Lankan businesses. Kathuria said that such agreements should include modern chapters covering services, investment facilitation and labour mobility.
He also pointed to the link between trade and FDI and said that Indian exporters operating in Sri Lanka could be targeted for conversion into long-term investors. Likewise, Indian firms with regional headquarters in cities such as Chennai and Mumbai could be encouraged to expand into Sri Lanka. He said that lowering informational barriers for investors would be more cost-effective than offering fiscal incentives.
Leveraging Sri Lanka’s regional position
Kathuria also said that Sri Lanka could serve a broader regional role in fostering South Asian cooperation. It is the only country in the world to have FTAs with India and Pakistan. This, he said, could enable Sri Lanka to act as a neutral facilitator in reactivating stalled regional trade dialogues, especially within SAARC, which has seen little progress in the past decade.
He emphasized that Port and Logistics infrastructure in Sri Lanka could support intra-industry trade and supply chain integration. Rather than viewing Indian trade as a threat, Kathuria advocated for recognising potential complementarities.
Research Director at Verité Research, Subhashini Abeysinghe focused on the need to remove domestic barriers that hinder Sri Lanka’s trade and investment environment. She pointed to procedural inefficiencies, outdated regulations and low adoption of digital tools by border agencies as key issues reducing competitiveness.
She outlined three priorities: (1) Removing domestic barriers to trade and investment; (2) Pursuing trade agreements to reduce external tariffs and non-tariff barriers (3) Strengthening economic diplomacy through better-resourced commercial sections in Sri Lankan embassies, particularly in India.
Abeysinghe said that Sri Lanka’s limited capacity to support exporters and investors in India stands in contrast to the efforts of other countries, many of whom deploy hundreds of commercial officers to assist their firms in navigating the Indian market.
India’s role in enabling regional integration
Director General of the Research and Information System for Developing Countries (RIS), Prof. Sachin Chaturvedi, India, spoke on how India could support regional integration through trade, technology and development partnerships.
He highlighted India’s use of digital public infrastructure (DPI)—such as the Unified Payments Interface (UPI)—as an example of inclusive growth policies. UPI has recently been linked to Sri Lanka’s LankaPay system, improving financial connectivity between the two countries.
Chaturvedi also called for increased collaboration in agriculture, including research and innovation and for expanding India’s technical cooperation programs. He reiterated the importance of maintaining asymmetrical provisions in trade agreements, whereby smaller partners like Sri Lanka are granted greater flexibility in liberalising their markets. He said the need for mutual recognition agreements in food safety testing and other regulatory areas. Delays caused by lack of such recognition have been a barrier to Sri Lankan food exports entering the Indian market, despite low or zero tariffs.
Building complementary strengths
The panel observed that Sri Lanka’s services-oriented economy could complement India’s focus on manufacturing. While India is expanding its industrial capacity through schemes such as ‘Make in India’, Sri Lanka could contribute through logistics, financial services, education and professional services. Services currently account for over 60% of Sri Lanka’s GDP.
In addition, energy sector cooperation is expanding. India has announced plans to connect the electricity grids of both countries and supply liquefied natural gas (LNG) to Sri Lankan power plants. A proposed multi-product petroleum pipeline is also under consideration.
Such projects align with Sri Lanka’s aspirations to develop as a maritime and energy hub. They also reflect India’s broader infrastructure connectivity agenda under initiatives such as the PM Gati Shakti scheme. Abeysinghe said that a significant number of companies that leave China are likely to move their value chains to India.
Financing and strategic alternatives
Chaturvedi said that India could also play a greater role in regional infrastructure financing. He suggested that India and its development partners offer an alternative to the infrastructure funding historically dominated by China in Sri Lanka. Transparent and competitive financing packages, he said, could be used to support port development, logistics upgrades, and renewable energy projects.
According to data from the Indian High Commission in Colombo, India provided Sri Lanka with approximately USD 4 billion in financial assistance during its 2022 economic crisis, including credit lines and currency support. Discussions continue on long-term development cooperation in sectors such as health, transport, and education.
Can Sri Lanka benefit from India’s economic wave?
The panel at the Verité Research conference said that Sri Lanka could integrate into India’s value chains and benefit from its growth, particularly through southern Indian states. While the economic logic appears sound, a closer examination reveals both opportunities and challenges.
States such as Tamil Nadu and Karnataka contribute significantly to India’s GDP and are hubs for sectors such as manufacturing and IT. There is always a possibility that these sectors aligning with Sri Lanka’s capabilities in services and logistics. However, realising this potential requires overcoming longstanding non-tariff barriers and bureaucratic red tape on both sides
Many, over the years have also contemplated the possibility of India offering infrastructure financing as a credible alternative to China. However, Indian infrastructure assistance lacks the scale and speed of Chinese projects, which have been pivotal in Sri Lanka’s port and energy sectors.
Meanwhile, deeper integration with regional supply chains will benefit Sri Lanka, however a lot depends on whether global supply chains would actually pivot from China to India. Contrary to expectations, most multinational firms leaving China have relocated primarily to ASEAN countries, notably Vietnam, attracted by better-developed infrastructure, business-friendly environments and skilled labour. India’s share in absorbing these shifts has remained relatively modest.
In the past five years, India has sought to simultaneously reduce its dependency on China while increasing its share of the manufacturing markets as some companies tries to diversify their supply chains given the Sino-US trade wars. However, India is still heavily dependent on Chinese supply chain inputs, a dependency that has only grown as India needs machinery and other capital goods to develop domestic manufacturing capacity. China has been producing high quality capital goods that are significantly cheaper than their Western counterparts. Attempts to develop India’s domestic manufacturing have led to only marginal improvements in capacity and a ballooning trade deficit with China.
The intra-regional economic connectivity in South Asia is low and that is not due to a lack of trying. Regional economic integration initiatives such as SAPTA (1993) and SAFTA (2004) failed to achieve stated objectives as structural economic disparities.
This is mainly due to the lack of economic complementarities in the region, given our colonial past and the development path the respective countries have undertaken following independence. The dominance of India’s economy which accounts to around 80 percent of regional GDP, and trade barriers by nations who fear that Indian goods will flood their markets have kept intra-regional trade at around 5 percent lower than Sub Saharan Africa. In recent years, the economic disparity between India and other countries have only increased, due to economic instability in Pakistan, Sri Lanka, Maldives, Bangladesh, and Nepal, and further dampened any impetus for intraregional trade.
Thus, given India’s regional power and its economic might, India needs to take proactive steps to encourage Sri Lankan businesses into their markets and help facilitate them into regional value chains. Dr. Kathuria in fact did mention that the Sri Lankan economy is miniscule compared to India and that India should in fact facilitate Sri Lankan exports.
While our exports to India are miniscule, there is resistance from Indian companies. For example, despite the Indo-Lanka FTA being in force for over two decades, several Sri Lankan exporters—particularly in agriculture and processed foods—continue to face regulatory bottlenecks at Indian ports, including delays in product testing and lack of mutual recognition agreements. Given domestic industry pressures, the Indian Government faces limited incentives to lower barriers for Sri Lankan exporters.
For Sri Lanka, simply having an FTA or close political relations will not be enough. Structural issues—such as low productivity, limited industrial diversification, high energy costs and weak trade facilitation—need to be addressed to make use of whatever openings emerge in the Indian market or value chains. Sri Lankan industrial base remains marginal and has declined in recent years. If India, who is also out of the ASEAN and RCEP value chain develops an electronics/semiconductor/automobile ecosystem in South Asia in the coming years, Sri Lanka will be able to tap into this value chain only if it has the relevant industrial and skill capacity.
If Sri Lanka actually wants to tap into a possible manufacturing value chain in India in the coming years, the country needs to identify potential areas and develop the manufacturing capacity, while improving productivity across the economy while lowering energy costs.
