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Why don't investors like us?

21 Feb 2021

If investment is water, a country is a land and plants are the respective country’s resources and infrastructures. A country without investment is basically like a land full of withering plants longing to be watered and nurtured. If a country is to be developed and reach its full economic potential, there is no second question: It requires investment, be it public, private, domestic, or foreign.    Investors are undoubtedly a crucial part of a developing economy. In particular, such economies require Foreign Direct Investments (FDIs) as companies in developing countries often need multinational funding and global expertise if they are to reach international markets. Further, FDIs increase the standard of living as recipient businesses receive “best practices” management, legal guidance, and accounting guidance from their foreign investors as The Balance puts it out. By adopting these practices, employees’ lifestyle gets enhanced and improved.    In addition to this, one of the main advantages of FDIs as economists opine is that it offsets volatility created by “hot money”. According to Investopedia, “hot money” signifies currency that quickly and regularly moves between financial markets that ensures investors lock in the highest available short-term interest rates.    Being a developing nation, all these benefits in every way applies to Sri Lanka. Gifted with abundance of indigenous natural resources, jaw-dropping landscapes, and a geostrategic location, attracting FDIs into Sri Lanka would be a piece of cake you might say. But the reality proves otherwise as still we are lagging behind many other developing countries in the region in terms of FDIs. This week, The Market Mine of The Sunday Morning Business is taking a look at FDIs into Sri Lanka, what has been holding them back, and what are the measures taken by the current and preceding governments of Sri Lanka.    Stats prove FDIs into SL have not been really ‘impressive’    Malaysia, the Philippines, Thailand, and Indonesia are a couple of developing countries in the Asian region. According to the International Monetary Fund (IMF) classification, Malaysia is an emerging and developing nation. As per World Bank statistics, FDIs and net inflows as a percentage of Malaysia’s Gross Domestic Product (GDP) in 2019 was 2.09%, while it was 2.3%, 2.9%, 4.4%, 3.2%, and 3.1% respectively in 2018, 2017, 2016, 2015, and 2014.    Meanwhile, Indonesia, another developing country in the Asian region with a population of over 270 million, received FDIs and net inflows of 2.2% as a percentage of GDP in 2019 while it was 1.8% in 2018, 2.0% in 2017, 0.4% in 2016, 2.2% in 2015, and 2.8% in 2014.    On the other hand, the Philippines’ FDIs and net inflows as a percentage of GDP in 2019 was 2.04%. It was 2.86%, 3.1%, 2.5%, 1.8%, and 1.9% in 2018, 2017, 2016, 2015, and 2014, respectively. In terms of Thailand, it was 1.1% in 2019 while it was 2.6% in 2018, 1.8% in 2017, 0.6% in 2016, 2.2% in 2015, and 1.2% in 2014.    When it comes to Sri Lanka, FDIs and net inflows as part our GDP was merely 0.9% in 2019, the lowest among these five countries. In 2018, it was 1.8%, less that Indonesia, Malaysia, and the Philippines achieved in the said year. In 2017, Sri Lanka’s FDIs and net inflows as a percentage of the GDP was 1.5%, again the lowest of all these countries. In 2016, it was 1.0%, highest only to that of Indonesia and the Philippines while in 2015 and 2014, it was 0.8% and 1.1%, lowest of all five countries.    Here is where we have gone wrong   
  1. Lack of global promotion
  As a local blog mentions, many people do not know what Sri Lanka is and where it is. I have seen videos of Sri Lankans overseas asking foreigners whether they know about a country named Sri Lanka. While many opt for “I do not know”, some of them presume it is some sort of an annexure to India possibly because of shared cultural values. But strangely, many of such people seem to be familiar with the name “Ceylon”, mainly due to Sri Lanka’s world-famous Ceylon tea. For foreigners, Sri Lanka is more of a “place to go for a vacation” rather than a “place to invest”. In short, this proves Sri Lanka lacks global promotion.    Marketing a country plays a paramount role in strategically positioning the respective country amongst potential foreign investors. According to “Marketing a country: Promotion as a tool for attracting foreign investment”, written by Louis T. Wells, Jr. and Alvin G. Wint, promotional techniques consist of providing information to potential investors, creating an attractive image of the country as a place to invest, and providing services to prospective investors.    In fact, promotion is only one of several tools available to countries eager to attract foreign investment. Governments offer tax incentives and grants; provide industrial estates, export processing zones, and other infrastructure; and attempt to simplify the bureaucratic procedures facing potential investors, for example.    “They negotiate bilateral tax, trade, and investment treaties with countries from wherever investments might come. They attempt to create a favourable environment by guaranteeing repatriation of profits, assuring access to imported components, and promising not to expropriate property without compensation. Further, governments recognise the importance of political stability, realistic exchange rates, and rapid growth in attracting foreign investment. Although attracting foreign investment requires efforts in many areas, promotion techniques provide an important mechanism for communicating all these efforts to potential investors,” the book stated.    Sri Lanka has always been keen in promoting its tourism. Likewise, it is imperative for the country to market itself for potential investors as well.   
  1. Lethargic and cumbersome bureaucracy and regulations 
  The Ease of Doing Business Index (EDBI) explains it all. The Doing Business project by the World Bank provides objective measures of business regulations and their enforcement across 190 economies and selected cities at the subnational and regional level. Under this project, in 2020, Sri Lanka was ranked 85 in terms of starting a business, 66 in terms of dealing with construction permits, 89 in getting electricity and a shocking 138 in terms of registering property, 132 in getting credit, 142 in paying taxes, and 164 in enforcing contracts – these numbers are not something Sri Lanka should be proud of.    The United Nations Conference on Trade and Development (UNCTAD) said that the sanctity of contract and the rule of law are generally accepted in Sri Lanka and disputes can be taken to the courts, and the judiciary is independent in business matters. It adds that however, justice is slow and investors report that court proceedings are fraught with injunctions, postponements, and other delaying tactics. Thus, business generally prefers to avoid this route.    UNCTAD adds that retention of strong powers of the Government to compulsorily acquire land for the purposes in current vogue is another factor foreign investors are not very fond of.    “The Land Acquisition Act remains in place. It authorises the Government to acquire land from private holders for any ‘deemed’ public purpose. There is no right of appeal (except in relation to compensation), although an aggrieved party can seek judicial review of the administrative action taken. Compulsory land acquisition powers have been extended to statutory bodies,” it added.    The Board of Investment (BOI) can compulsorily acquire land for any deemed public purpose. Moreover, the compensation for the unimproved land value is fixed as at the date of the inception of the BOI in 1978. The 2003 amendment to the BOI Act extends this power to the Regional Economic Development Commissions.    A second constant in the history of land regulation is a lack of proper records and clear title, especially in rural areas. It appears that successive governments have lacked the capacity to issue adequate titles. The current system of ascertaining the legality of tenure entails the cumbersome examination of a series of transactions spread over decades. The Registration of Title Act (1998) provides an appropriate legal framework, according to UNCTAD.  Further, UNCTAD adds that investor interviews suggest that there are some areas of relatively poor governance as revenue administration – both income tax and customs – was singled out.    “The BOI was created in part to provide an alternative solution to governance issues that seemed intractable at the time. However, it is not sufficient to provide a solution only for BOI clients. All private investors ought to be able to function in a climate of good governance,” it added.     
  1. Inefficient taxation / tax structure
  As the UNCTAD report points out, a minimum investment is usually required in order to qualify for incentives and tax benefits announced by a respective government. Eligibility is assessed by the BOI, which directly administers the import and excise duty concessions and monitors adherence to the investment obligations that give rise to the incentives.    In terms of comparative tax survey implications, UNCTAD had the following to survey:    
  • In manufacturing,Sri Lanka’s standard regime is highly competitive with the comparator standard regimes. Corporate taxes are moderate, and customs duties on industrial plants and machinery are low. However, many countries have introduced a special regime for export manufacturing that includes extensive customs duty relief and, sometimes, lengthy tax holidays. Sri Lanka has broadly followed suit, although it is relatively more reliant on taxing dividends than corporate profits. There is no scope for increasing the tax burden on export manufacturers.  
  • In hotels, competitors frequently provide special regimes with low direct taxes but high indirect taxes. Sri Lanka's standard and special regimes are more competitive in this regard. There could be scope to remove the income and dividend tax holiday, possibly in return for improved buildings depreciation, while remaining competitive and making the scheme available to all investors.  
  • In business and professional services, the standard and special (services exports) regimes are competitive within the region. The principal special scheme for export services is aimed largely at the garment and transportation industries. Services exports could also aim to attract foreign investors to base themselves in Sri Lanka in order to provide services in the region. There should be scope for harmonising the taxation of domestic sales and exports of business and professional services at a lower common corporate tax rate.  
  • In information and communication technologies (ICT), India has led the race, providing exceptional ICT incentives. In Sri Lanka there is no minimum investment threshold, although 15 technically qualified people must be employed or 300 students enrolled in training. 
 
  • In health, there is scope for rationalising the standard and special regimes in a single competitive regime, as few regional competitors have provided special regimes, with the exception of Singapore. 
 
  • In regional logistics, Sri Lanka has a special regime for Export Trading Houses, including re-exporters. However, this scheme does not capture the exceptionally low tax regime required to be competitive in freeport activities. Location of these activities is highly tax sensitive and competitive, and Sri Lanka should review its approach – possibly in conjunction with the proposed development of a transhipment port on the south-east coast. 
 
  • In international financial services, Sri Lanka does not have a specially calibrated fiscal regime designed to attract such services, compared to countries that have seriously attempted to develop an offshore financial sector. Sri Lanka has permitted foreign currency banking units for many years, but these have not developed fully into true offshore services.  
  • In regional headquarters schemes (RHQs), Sri Lanka has a dedicated special regime, but this is probably not competitive with aggressive alternative locations.
  In addition to these three main issues, there are also corruption-related issues coupled with lack of labour and skills available locally for foreign investments to incorporate them into their projects.    Measures taken so far by the current Government    During a recent Parliament session, responding to a question raised by a fellow parliamentarian, State Minister of Money, Capital Market, and State Enterprise Reforms Ajith Nivard Cabraal elaborated a couple of measures taken by the current Government in attracting FDIs into the country.    The aforementioned fellow Parliamentarian was Hesha Withanage and his first question from the State Minister was whether necessary infrastructure to attract FDIs in Sri Lanka has been improved over the years. The response from Cabraal was that the infrastructure has been developed compared to how it was 10 years ago but added that at some places, investors get discouraged due to a couple of pitfalls and even those pitfalls are analysed thoroughly by Ease of Doing Business Index.    The next question was asking whether quick services have been introduced for investors. The response from Cabraal for this particular question was a yes.    “You might have seen recently that the President himself has appointed a commission directing them to investigate bureaucracy that hinders further progression of an investment or a business. He has also asked the committee to come up with viable alternatives for laws that obstruct investments into the country,” added Cabraal, a former governor of the Central Bank of Sri Lanka.    He went on to say that the committee comprises Presidential Advisor Lalith Weeratunga and John Keells Holdings Chairman Krishan Balendra to ensure that both private and public sectors are covered under this committee. According to him, a Cabinet Sub-Committee on Investment Promotion too has been appointed.    “Even though they are given direction to follow, impracticality issues appear only when following those directions either because of those directions being unclear or not implemented properly. We are sorting this issue as well,” he added.    “We need new investments for that, we need new laws and we are planning to submit a new set of investment laws to the parliament in the coming weeks. SMEs are the backbone. We are taking measures to revive them. To do that, the country’s economic indicators have to be in a stable position and for that measures have been taken already such as maintaining low interest rates, strengthening the currency, introducing payment facilities for example Lanka QR, and digitalising stock market.”    What more should be done ideally?    A World Bank article suggests Sri Lanka a couple of ways it can improve its FDI flows into the country. They are:     
  • Reworking trade policy
    More trade will help diversify the economy and exports and lift a burden off of the public sector to drive growth. It can also actively promote technology absorption, skill upgrading, and increased competitiveness; workers, consumers, producers, and the State will benefit in the long-run as a result.    
  • Promoting investments and enabling regulations while avoiding policy uncertainty
    Reforms are needed to address critical challenges in areas like land ownership. Currently, land is primarily state-owned in Sri Lanka, and land administration is weak and cumbersome. Anecdotal evidence points to discouraged FDI projects due to land issues. A large share of exports and most export innovation has occurred in a few Export Processing Zones, primarily in the Western Province, that are now generally at capacity, new Special Economic Zones (SEZs) are being planned. Long-term policy strategies can serve as path-setters and expressed commitment to policy continuity in support of the Government’s vision.                      
  • Addressing labour-related issues and getting women to work
    Efforts are also needed to expand the pool of labour, relax constraints in labour laws such as lengthy and costly termination procedures, and equip Sri Lankans with skills in demand in the marketplace. In particular, Sri Lanka can benefit tremendously from boosting its female labour force participation rate by addressing issues such as a lack of quality childcare, skills mismatch, unsafe transport, and poor working conditions that keep women away from the labour force.    
  • Providing enabling logistics and the right infrastructure environment
    Nationally, Sri Lanka needs to address transportation shortfalls, which have seen inequitable development with some regions disconnected from growth, increasing issues of congestion, and inadequate safety for women. Different areas face different transportation gaps in roads, air travel, and marine transportation infrastructure while rail infrastructure is outdated and limited, especially for the transport of goods.   Why should we care?    Answers for this question have been thoroughly explained by World Bank Programme Leader for Sri Lanka and Maldives Tatiana Nenova, in a World Bank blog post. First, it is because FDI and domestic investment are at the heart of economic growth.    “FDI could help accelerate Sri Lanka’s arrival at upper middle-income country status. Annual real GDP per capita growth averaged a bit above 4% in Sri Lanka over the past three decades. Accelerating this to 6% would speed up reaching upper-middle-income status – imagine reaching Singapore standards of living roughly a generation early. To get there, higher investment is needed,” Nenova stressed.    In addition to this FDI undoubtedly boost economic growth, drive technology, and innovation.    “Sri Lanka’s public investment is still low when compared to its peers. The island’s fiscal budget is rigid with almost 60% of the expenditure being predetermined. Public investment is low and private investment needs to take up its share of the burden. FDI and private investment from domestic sources can help accelerate growth and create jobs. FDI can enable the introduction of new technologies and innovative ways of production and service provision, which can then be replicated by local firms increasing their productivity and competitiveness and plugging them into domestic and global value chains. Greater FDI would enhance the access of Sri Lanka’s producers to global production networks and facilitate the development of new activities within existing value chains, thereby increasing added value in production and accelerating economic growth,” Nenova’s list of benefits to Sri Lanka goes on.    It is high time for Sri Lankan governments to work on addressing pitfalls in attracting FDIs into the country instead of the usual blame games. Again, it is unavoidable for a developing country to attract FDIs if it is to become a ‘developed’ country decades down the line.


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