Sri Lanka's construction sector sees increased investment and development

The construction industry has been a major beneficiary of Sri Lanka’s rapid economic development over the past six years. Since the end of the country’s civil war in May 2009, the country has rushed to make up for more than two and a half decades of intermittent building activity across most segments, from high-end residential housing to commercial and office space to a variety of key infrastructure segments. According to NDB Securities (NDBS), a brokerage based in Colombo, in 2014 Sri Lanka’s construction sector expanded by more than 20%. Indeed, since 2009 the industry has grown twice as fast as the nation’s GDP, which has increased by just over 7% on an average annual basis over the same period. According to NDBS data, in 2014 the construction industry accounted for 9.6% of Sri Lanka’s GDP, which represented a significantly greater proportion of the economy than most other countries in Asia.

As observers and local players have pointed out, these figures suggest that despite the flurry of recent building activity, there remains considerable demand for new buildings of all kinds, not to mention roads, highways and various other kinds of infrastructure.

Issues To Address

Nonetheless, Sri Lanka’s construction sector faces a number of key challenges moving forward. Negotiating the country’s complex network of overlapping regulations is a key issue. Contractors have traditionally pointed out that obtaining the necessary approvals from the federal-level Urban Development Authority (UDA), the Ministry of Housing and Construction (MHC) and various local entities – such as the Colombo Municipal Council – remains a key challenge, particularly in regard to land and procurement, though strides have been taken in this regard. Additionally, building in Sri Lanka remains relatively expensive as compared to the cost of construction in India and other nearby markets.

While high sale and rental rates (stoked by strong demand across most segments) mean that so far the market has remained lucrative for most builders – despite the high price of materials and other inputs – this may not always be the case, particularly as some segments reach saturation in the coming years. As in a number of other sectors, the construction industry faces a skills shortage, with many contractors struggling to source well-trained labourers – particularly for skilled positions – from the local populace, many of which are employed overseas.

“Profit margins here are higher than in many neighbouring countries,” Kishore D Reddy, the managing director of Platinum 1, a Colombo-based real estate development company, told OBG. “But the cost of construction is also higher, particularly the costs associated with regulation, materials and workers.”

Public Works

The government will likely continue to generate the bulk of construction activity in the country in the short and medium term. According to a Department of Census and Statistics (DCS) report on the industry issued in mid-2015, as of 2012 – the most recent year for which official government statistics are available – public sector contracts accounted for more than 94% of the total value of contracts issued. While private sector involvement in the country has clearly increased since then, the state has likely remained the key player in construction. Given the considerable amount of work that has yet to be done, this situation bodes well for local players.

Oversight & Legislation

A variety of entities are involved in regulating Sri Lanka’s construction industry. At the federal level, the MHC has a mandate to ensure that the construction sector operates according to international standards in terms of planning, environmental impact and human resource management and hiring practices. Additionally, it has a mission to ensure that low-income Sri Lankans are able to afford housing. The MHC was reorganised under the new government in an effort to streamline its regulatory capacities. The ministry’s responsibilities include the “regulation of [the] construction sector, conducting research and development activities, training and developing those involved in the construction sector and providing engineering services to public sector institutions”.

On the housing side, meanwhile, the ministry was responsible for “housing development, development of underserved settlements, community empowerment and regulatory activities pertaining to the condominium sector”. The ministry also oversees or is affiliated with a variety of other federal-level authorities, including the Construction Industry Development Authority (CIDA), which maintains the official role of registered contractors in Sri Lanka; the State Engineering Corporation; the State Development and Construction Corporation; and the Building Materials Corporation, among others.

Established in 1978 as part of the launch of an integrated master plan for Colombo, Sri Lanka’s capital, and the surrounding region, the UDA has grown to take on a central role across the country. With a remit to “prepare development plans and to promote, implement and regulate development activities with a view to achieving the position of a financially independent and globally admired creator of fully-fledged, sustainable urban centres”, the authority is empowered to undertake capital investment plans in urban areas, develop and implement land use policy, formulate and enforce environmental standards and improvement policies, carry out work related to the development of urban infrastructure, and undertake housing schemes of any size. The UDA works alongside the MHC, the newly incorporated Ministry of Megapolis and Western Region Development, and other entities in many of these areas.

In Figures

Comprehensive, up-to-date construction data is not available in Sri Lanka. As of early 2016 the most recent official statistics available were from 2012, as reported in a DCS publication issued in mid-2015. A handful of local private sector entities regularly release more recent market data on the sector, though much of this is based on estimated results or surveys. The lack of a full set of recent statistics is widely regarded as a key challenge for the industry. “The business environment is challenging for many companies, particularly smaller contractors,” Sidath Kalyanaratne, the assistant vice-president and head of research at NDBS, told OBG in October 2015.

According to DCS data, as of 2012, the total estimated value of all types of construction activity in Sri Lanka was LKR113.43bn ($816.7m), some LKR102.8bn ($740.2m) – or around 90.6% – of which was chalked up to public sector activity. Buildings, or structures, made up LKR58bn ($417.6m) of work done in 2012, which was equal to 51.1% of total work.

In second place was highways, on which LKR30.4bn ($218.9m) was spent over the course of the year, or 26.8% of the total. This was followed by bridges, with 9.2% of the total value of work done in 2012, irrigation and land drainage, with 5.9%, and water supply and drainage, with 0.9%, according to DCS data.

In terms of the value of all contracted work – which includes the cost of completed work plus the value of existing construction contracts – market complexes accounted for 45.4% of the total value of contracted construction work on buildings. The DCS’s designation “market complex” includes commercial buildings of various kinds, plus mixed-use projects with considerable commercial components. Office buildings accounted for 18.5% of contracted building construction, followed by hospitals (10.8%), repair and maintenance work across all kinds of buildings (4.2%) and schools (3.8%), according to DCS numbers.

More recently, according to data from NDBS, in 2014 the construction sector accounted for 9.6% of Sri Lanka’s GDP, up from 8.7% in 2013, 8.1% in 2012, 7.1% in 2011 and 6.7% in 2010. This figure has grown even as the country’s GDP rose at an annual average rate of 7.4% from 2010 through 2014. Furthermore, over the past five years the sector’s contribution has exceeded by a considerable degree other markets in South Asia. In the Philippines, for example, the construction sector contributed around 5.8% of GDP in 2014, while in Singapore the figure was closer to 4.8%, and in Malaysia it was around 3.9%. Similarly, since 2011 Sri Lanka’s construction sector has outperformed other South Asian markets in terms of growth. In 2014 the industry expanded by 20.2%, as compared to 11.6% in Indonesia and 8.5% in the Philippines, for example, according to NDBS data. This most recent growth spurt follows on from Sri Lankan construction sector expansion of 14.4% in 2013, 21.6% in 2012, 14.22% in 2011 and 9.3% in 2010.

Rankings

Sri Lanka came 107th in the world in the World Bank’s 2016 “Doing Business” list, which ranks countries on various metrics related to the ease of setting up and running a small or medium-sized business. The country’s 2016 rank represents an improvement of six spots on the previous year, when it was rated 113th in the world. This rise can be attributed in no small part to streamlined regulations in regard to processes measured by the World Bank’s “dealing with construction permits” metric. Indeed, Sri Lanka’s place on this index jumped from 106th to 77th from 2015 to 2016, which was the single largest improvement in any metric for the country in the most recent “Doing Business” report. According to the World Bank, to build a warehouse in Colombo in 2016, a business must carry out 12 procedures, which would take a total of 116 days. These figures compare favourably to the South Asia regional averages of 15.1 procedures and 194.6 days.

Shape Of The Sector

More than 681,000 people were directly or indirectly employed by Sri Lanka’s construction industry in 2012, according to government data. The majority of these labourers worked for one of the more than 2500 contracting firms that were registered in the country as of early 2016, as tracked by CIDA. These domestic firms are at least 51% owned by a Sri Lankan national, as required by law. Under CIDA’s national registration and grading system, local contractors are categorised on a scale from C1 to C10, according to a system that takes into account a firm’s financial assets, technical ability and field-specific experience. Just two construction firms are listed on the Colombo Stock Exchange, namely MTD Walkers and Access Engineering. The former, which was established in 2001, has carried out more than 100 civil engineering projects across a wide range of segments, including roads, bridges and flyovers, water infrastructures, marine work and telecoms projects. MTD Walkers came into operation in 2006, when MTD Capabought a stake in a Colombo-based holding firm that was active in the industry.

In addition to the two listed firms, unlisted domestic C1-ranked construction firms include Maga Engineering, Orient Construction, the International Construction Consortium, Sathuta Builders and Sierra Construction, among others.

A steadily growing number of major foreign players have also moved into the industry, including the Chinese state-owned China Communications Construction Company and Sinohydro Corporation, which are involved in the delayed Colombo Port City project and the Moragahakanda power project, respectively; China Merchant Holdings International, a Hong Kong-based conglomerate that has participated in projects to upgrade port facilities at Colombo and Hambantota; and National Thermal Power Corporation (NTPC) of India, a state-owned company and India’s largest power utility, which has worked on the construction of a coal power plant in Sri Lanka.

Most foreign firms carrying out work in the country have a joint venture (JV) with a domestic contractor or other local entity. NTCP, for example, entered into a JV with the state-owned Ceylon Electricity Board, the largest electricity firm in Sri Lanka.

Recent & Upcoming Activity

Numerous construction segments have driven activity in the sector in recent years. Under a range of short- and medium-term master plans, the government has invested heavily in infrastructure of all kinds in recent years, as suggested by the fact that more than 90% of construction activity through 2012 was state-led.

The Ministry of Transport and the Ministry of Higher Education and Highways, for example, have carried out a considerable amount of road and expressway development and refurbishment in recent years. Between 2010 and 2014 the government constructed around 160 km of new expressways and 240 km of new roads, most of which fell under the umbrella of the state’s 10-year National Road Master Plan, which was launched in 2007 and has been under way since then. Nonetheless, rising car ownership rates and a relatively low rate of road and expressway development despite a high-density network as compared to many other South Asian nations means that Sri Lanka still has some way to go in this area, which bodes well for the construction industry (see Transport chapter).

Indeed, from 2010 through 2014 the number of cars on the road increased from just over 410,000 to nearly 567,000, which represents an uptick of more than 38% in total. Year 2015 saw an even more dramatic increase, with vehicle imports rising 55% over the previous year. Similar pressures are being felt on various other domestic infrastructures. For example, while nearly 94% of the population had access to improved drinking water as of 2012, as of 2014 only 44% of this water was delivered directly to homes via pipes. This situation suggests considerable scope for continued construction work in this and other areas.

Building Up

In terms of buildings, various real estate segments were in demand as of early 2016, including grade-A office space, hotels, affordable and luxury residential space and commercial space. While a substantial amount of ongoing work is currently taking place in many of these segments – luxury apartments and office space, for example – other, such as affordable housing, have yet to get under way.

Key projects in this space include new, large-scale mixed-use commercial, residential and hotel projects currently being developed by Hyatt Regency, Shangri-La Hotels and Resorts, and Mövenpick Hotels and Resorts, among others (see Real Estate chapter).

New Priorities

In late November 2015 Ravi Karunanayake, Sri Lanka’s finance minister, announced the new government’s budget priorities for 2016. His closely watched speech included a series of construction-related policies. According to the announcement, the state plans to streamline existing legislation in this area, with an eye towards facilitating increased cash flow throughout the industry, particularly for small and medium-sized enterprises.

“I propose the construction companies who seek overseas markets to be granted the opportunity to continue with the tax exemption on the income generated outside Sri Lanka,” said Karunanayake in the speech, as reported by local media. “Further, any foreign contractor entering Sri Lank to undertake construction work should enter into a joint venture agreement with a local contractor.”

In addition the state announced plans to reduce import duties on a range of construction materials and machinery, and also to introduce a new education scheme in conjunction with private contractors, wherein the government would take on some of the cost of training young Sri Lankan carpenters, plumbers, electricians and other related workers.

Facilitating the continued growth of the construction industry has been a key area of focus for the new government, which came to power in early 2015. The Ministry of Megapolis and Western Development, which was formed by the newly elected government in mid-2015, has a mandate to oversee the long-term development of Sri Lanka’s Western Province, which includes Colombo, and had a total population of around 6m as of late 2015. “In the commercial and financial sectors, 90% of wealth generation happens here,” Patali Champika Ranawaka, the minister of megapolis and western regional development, told local media in December 2015. “The land area is 6% of the island, but it has 28% of the population.” In an effort to ensure the area remains a site of wealth generation, the ministry is implementing the Western Region Megapolis Planning Project, which includes projects aimed at boosting the supply of low-income housing, streamlining waste management and ramping up investments in public technology.

Materials

Sri Lanka’s contractors are well supplied with materials, though at a relatively high cost compared to many other South Asian markets. The government has made efforts to reduce the cost of inputs recently, primarily by lowering or cancelling import duties on a variety of products, including bulk cement. Indeed, cement, along with iron and steel, sand and bricks, is one of the major materials in use in the country, according to NDBS data. As of mid-2015 the nation’s cement capacity was 7.5m tonnes, according to industry data supplied by a local cement producer, some 70% of which was imported in dry bulk, primarily from India and other nearby markets. Domestic demand stood at around 5.5m tonnes.

While the cement industry grew rapidly for a few years when the civil war ended in 2009, since 2012 it has slowed dramatically. While the government has allowed for duty-free imports, it has simultaneously maintained price caps on domestically manufactured cement, which has resulted in steadily tightening margins for many producers. Formed as a result of the July 2015 merger of the cement producers LaFarge and Holcim, the newly formed LafargeHolcim has a market share in Sri Lanka of more than 50%, followed by Tokyo Cement, with around 37%.

A majority of the iron and steel in use is imported, though the country produces a significant percentage of domestically consumed floor and roofing tiles and paint, among other products. The nation’s largest paint manufacturer is AkzoNobel, which produces Dulux-branded paint in Sri Lanka. Other major paint producers include Nippon Paint Lanka, a Japanese-controlled brand, Causeway Paints, a Singapore-Sri Lanka JV, JAT Holdings and Asian Paints.

Outlook

Despite a variety of challenging issues, most local players remain broadly optimistic about the future of the construction industry in Sri Lanka, in large part due to the government’s ambitious spending plans. While the state has invested heavily in developing infrastructure since 2009, much work remains to be done, particularly in the areas of road development. According to Asia Securities, a Colombo-based equities brokerage, in 2016-17 the state plans to spend around LKR590bn ($4.2bn), primarily on road and other types of infrastructure projects.

Furthermore, population growth and rising per capita income across the country has resulted in growing demand for housing, particularly at the affordable end of the spectrum (see Real Estate chapter). “The growth in the construction industry we have seen recently has really been just a rebalancing, or a catching up after years of very slow growth,” NDBS’s Sidath Kalyanaratne told OBG. “There is still huge demand for all kinds of new facilities – office space, affordable housing and infrastructure– which suggests continued growth for contractors as well.”