The India–Sri Lanka Free Trade Agreement (ISFTA) marks its 25th anniversary in 2026. But while the agreement has delivered gains, it is no longer fit for purpose. With the World Trade Organization projecting global merchandise trade growth to slow sharply to 1.9% in 2026, effective regional economic alliances are essential for sustaining growth and resilience.
Indian Prime Minister Narendra Modi and Sri Lankan President Anura Kumara Dissanayake agreed to continue negotiations on updating the ISFTA during Dissanayake’s inaugural state visit to New Delhi in December 2024. South Asia remains a relative bright spot amid a global trade slowdown driven by shipping distruptions in the Strait of Hormuz, rising protectionsim and geopolitical fragmentation.
India’s trade flows are at record highs, supported by a new generation of comprehensive free trade agreements (FTAs) with partners including the EU, UK and Australia. Sri Lanka’s National Export Development Plan 2026–2030 aims to more than double total export earnings to $36 billion by 2030 — in part to generate foreign exchange for external debt repayments and to consolidate the country’s recovery from its 2022 debt crisis.
Implemented in 2000, the ISFTA was South Asia’s first bilateral FTA and marked a decisive break from the region’s earlier inward‑looking trade regimes. Slow progress on regional trade liberalisation under the South Asian Association for Regional Cooperation made bilateralism increasingly attractive. Reflecting the enormous differences in India and Sri Lanka’s size and industrial capacity, the FTA limited market access for goods through asymmetric tariff liberalisation. The agreement included extensive negative lists protecting sensitive sectors in both economies, and while India liberalised tariffs on most Sri Lankan products within three years, Sri Lanka was granted up to eight years for Indian imports.
Even today, India excludes 429 product categories, while Sri Lanka maintains over 1,100 exclusions — limits that increasingly constrain deeper integration. But attempts to upgrade the partial goods-only agreement to a broader framework — including efforts to implement the Comprehensive Economic Partnership Agreement and the Economical and Technical Agreement — stalled due to opposition from professional associations and business pressures in Sri Lanka.
Sri Lankan exporters seem to face many non-tariff barriers in India. These include tariff rate quotas on apparel — Sri Lanka’s main export — as well as sanitary and phytosanitary regulations for agricultural and processed food exports, technical barriers relating to packaging, and customs clearance rules and delays. Domestically, Sri Lankan firms also face para-tariffs including Sri Lanka’s Commodity Export Subsidy Scheme levy, Port and Airport Development Levy and Special Commodity Levy, which drive an anti-export bias by artificially raising imported raw material costs and making the protected domestic market more profitable than exporting to India.
Despite these constraints, bilateral merchandise trade expanded almost ten‑fold under the ISFTA, reaching $5.4 billion in 2025. India is now Sri Lanka’s largest trading partner, while Sri Lanka is becoming an increasingly important regional trading partner for India. Trade between the countries has also diversified, with India’s exports now including refined petroleum, pharmaceuticals, textiles, vehicles and processed foods, while Sri Lankan exports include spices, boats, animal feed and consumer food products.
But there has been substantial asymmetry in the countries’ preference utilisation of ISFTA arrangements. The average annual share of Sri Lankan exports to India covered by ISFTA arrangements from 2001–2025 was 68.9%, compared to just 11.9% for Indian exports to Sri Lanka.
Though investment disciplines lie outside the ISFTA, improved business confidence linked to rules-based trade and sustained economic diplomacy has encouraged significant Indian investment in Sri Lanka. Cumulative Indian foreign direct investment to Sri Lanka reached $2.8 billion in 2025, spurred by various projects and joint ventures. Sri Lankan firms have likewise deepened their presence in India’s apparel sector.
Tourism represents another important spillover, with Indian visitors accounting for 23% of Sri Lanka’s total tourist arrivals in 2025. Despite ongoing travel disruptions due to the Hormuz crisis, India has accounted for more than 40% of arrivals during some of the months since the crisis began, providing much needed stability to the sector.
The global trading system has changed fundamentally since the ISFTA was negotiated. Trade in intermediate goods and services within global supply chains now accounts for roughly half of world trade. India has emerged as a key China+1 corporate hub as corporate derisking strategies reshape global supply chains. Apple’s shift of iPhone assembly to India is turning Chennai and surrounding districts into major centres for final assembly, testing and packaging operations.
For Sri Lanka to benefit meaningfully from India’s expansion into global supply chains, the ISFTA must go beyond goods. Several priority reforms — updating rules of origin from simple value‑addition thresholds to product‑specific rules and liberalising trade in services across information technology, maritime logistics and financial services — would enable Sri Lanka’s services sector to support regional supply chains.
A modernised ISFTA should be positioned as the institutional anchor of a deeper India-Sri Lanka economic partnership. Backed by political commitment and private‑sector support, an ISFTA 2.0 could underpin rules‑based regional integration and embed Sri Lanka more firmly in India‑centred supply chains. Complementary measures ranging from enhanced physical and energy connectivity to new export processing zones and stronger business‑to‑business linkages could amplify these gains. Indian support for climate preparedness and mobilising international finance for debt sustainability will help Sri Lanka tackle downside macroeconomic risks to bilateral trade integration. With decisive action over the next few years, bilateral trade could reach $10–12 billion in a decade or so.
Ganeshan Wignaraja is the Professorial Fellow for Economics & Trade at Gateway House and a Visiting Fellow at ODI Global, London.
This article was first published in East Asia Forum.