New initiatives in Sri Lanka set to refocus efforts on increasing foreign direct investment

After decades in which Sri Lanka underperformed in its substantial potential as a foreign direct investment (FDI) destination, there is a growing sense that change is afoot that will allow the country to make up for lost time. In January 2016 Malik Samarawickrama, the minister of development strategies and international trade, told the global press that Sri Lanka aimed to attract $5bn-6bn in FDI over the following three years, with the government focusing on policy consistency to attract foreign investors from the US, China and India.

However, the scale of the challenge that Sri Lanka faces is clear from figures for 2016, which indicated that FDI dropped by around 50% – coming in at $450m from $970m in 2015. Samarawickrama admitted that this was “extremely low by any standard”, and said that the government would look to enhance investment promotion and any possible reforms of regulations and rules to draw in more FDI. This sentiment is echoed by others. “The government is committed to institution building and capacity building, and a better working bureaucracy and judiciary,” Dilip Samarasinghe, director of media and publicity at the Board of Investment of Sri Lanka, told OBG. “There’s a focus on transparency, predictability and a level playing field.”

Private Engine

While some investors have grown frustrated by the slow pace of change in Sri Lanka, the government justifiably points out that it has focused on macroeconomic stability and administrative reform – including combating corruption – as a foremost priority in its first two years in power. Now attention is turning to enhancing the business environment and which projects to prioritise to develop the country.

The government’s strategy for attracting FDI, and making the private sector the main engine of economic growth, has started to emerge. In April 2017 Ravi Karunanayake, then-minister of finance and current minister of foreign affairs, told the press that means of harnessing private investment would include public-private partnerships (PPPs) to bring more private capital into infrastructure development, and privatisation of non-core state assets. Addressing the fiscal deficit and government debt to underpin macroeconomic stability are also at the centre of the government’s programme. The government is due to establish a special PPP unit to pioneer partnerships, which to date have been relatively under-utilised in Sri Lanka, with little tailored legislation to encourage them. Ministers are keen to shift Sri Lanka’s FDI model away from an over-reliance on tax holidays to a greater focus on optimising the country’s competitive advantages in location, skills base, and a growing range of free trade agreements with both developed and emerging markets.

Catching Up

There are several reasons why FDI has lagged behind that of the “Asian tigers” to the east, most notably the devastating 1983-2009 civil war, from which parts of Sri Lanka are still recovering. While other countries were able to focus on pro-business reform, and align education policy and infrastructure investments to attract FDI, Sri Lanka’s government was preoccupied with the conflict. A legacy of top-down socialist economic management and its scepticism to private investment also has had an effect. Even when zones were set aside for investors and industrial development, detailed planning was often lacking, leaving the projects falling short of potential.

Aswin De Silva, chairman of National Savings Bank, told OBG that after years of underperformance, factors are aligning to strengthen Sri Lanka’s position as an investment destination. “FDI needs political, economic and social stability,” he said. “But now we also need to look at the legal framework to make the environment more conducive to investment, including examining incentives, land ownership rules and foreign exchange controls.” De Silva sees particular potential in four areas. The first is construction, which is already performing well (despite a setback when the new government froze or slowed some big-ticket projects it had inherited from its predecessor), with rising demand for housing and industrial real estate in particular. The second is tourism – one of the fastest-growing and most dynamic sectors in the economy – which showed arrivals rising by 14% in 2016 to a record 2.1m, up from 1.8m in 2015, according to the Sri Lanka Tourism Development Authority. This followed 17.8% of growth from 2014 to 2015. The third is the financial sector, where banks are increasingly cash-rich and able to lend, and the fourth is leveraging Sri Lanka’s geographical location to develop the logistics and trading sector, particularly with trans-shipments.

Infrastructure Opportunities

Samarasinghe noted that infrastructure development’s role in FDI should not be overlooked. Completed projects have enhanced Sri Lanka’s competitive advantages, and future projects will create further opportunities for investors. Power shortages are far less common than in India or Pakistan, for example, meaning that manufacturers less frequently have to rely on expensive generator power. Meanwhile, the development of important infrastructure such as Trincomalee Harbour and the E01 (Southern) Expressway has eased bottlenecks.

Forthcoming projects that should draw investors and further strengthen Sri Lanka’s investment proposition include the Colombo-Kandy highway, connecting the capital and one of the island’s major tourist centres, and a new highway to Jaffna, better connecting the capital to the economic centre of the north. The Colombo Megapolis project will be another locus for investors in the medium to long term.

However, Kapila Sri Chandrasekera, head of transaction and telecoms advisory at M Power Capital, a corporate finance advisory and private equity business, told OBG that a range of challenges continue to hold back investment in Sri Lanka. One is long and complicated court processes that hamper the enforcement of contracts. Another is a lack of good data that would be useful to investors, including a land database. There is also the legacy of asset seizures by the last administration, that under a 2011 act allowed the state to take control of under-performing businesses, including sugar plants that had been privatised a decade before.

Regional Hub

Sri Lanka’s position on the sea route between the booming markets of Asia and the developed, high-income ones of Europe gives it a distinct advantage as a global transportation hub, which it has not leveraged as effectively as it could have until recently. The development of the Port of Hambantota, while stop-start and not without political controversy, is indicative of recent moves to try to better capitalise on location. Sandbanks between Sri Lanka and India make the movements of large ships from Mumbai and other west coast cities to ports on India’s east coast difficult; and Sri Lankan ports such as Colombo, Hambantota and Trincomalee are well-placed to increase their trans-shipment business.

Chrisso De Mel, vice chairman of the Sri Lanka Shippers’ Council, told OBG that Sri Lanka is presented with a “wonderful opportunity” and could even rival Singapore as a regional logistics and transportation centre. Chandrasekera in part agreed and said that Hambantota has a future as a cheaper alternative to Singapore in the areas of bunkering and refuelling, though plans to develop the region as a manufacturing base may face challenges due to a shortage of labour, the country’s comparatively small domestic market and relatively limited usable land area. He instead sees greater potential in developing service sectors such as tourism that can capitalise on Sri Lanka’s proximity to India, including logistics and trans-shipment.

Trading Improvements

Criticism from businesses on the pace of reform sometimes overlooks concrete progress in certain areas. Ongoing modernisation of the Customs service should strengthen Sri Lanka’s competitive advantages as a place to do business for importers and exporters alike. Sri Lanka Customs already has a fully-automated Customs processing system, with online Customs declarations, duty assessments and payments (with settlements via two major state-owned banks and plans to extend the system to more). The number of documents required to receive Customs approval has been reduced and is now on par with many other countries in the region.

Plans are being discussed to better integrate the processes of different agencies involved in Customs procedures via a single window. There are 13 agencies that already interact closely on Customs procedures, including the Ministry of Finance, Ministry of Health and the Department of Motor Traffic. However, in total there are around 30 agencies that are occasionally involved in Customs procedures, from the Department of Archaeology (monitoring imports and exports of historical artefacts) to the National Intellectual Property Office, which is a body that needs to be integrated further into Customs processes. At present, more than 80% of consignments are approved within one day of the submission of a Customs application. Sri Lanka Customs is now looking at ways to accelerate the processing of the remaining shipments, which may take up to seven days to be approved due to various delays.