By Shenal Fernando
A significant component of Sri Lanka’s path to economic recovery involves the building up of our official foreign reserves. During the disastrous former Rajapaksa regime, Sri Lanka’s official foreign reserves fell by around 76% from $ 7.6 billion in December 2019 to $ 1.9 billion in June 2022, of which foreign currency reserves amounted to $ 1.8 billion.
However, it is widely known that such foreign currency reserves include the ¥ 10 billion (equivalent to $ 1.5 billion) currency swap from the People’s Bank of China (PBoC) which is unusable. The utility of this swap is limited to boosting reserves statistics on paper, as the conditions of the swap require that, for it to be utilised, Sri Lanka must have sufficient foreign reserves to cover imports for at least three months.
Therefore, building up Sri Lanka’s official foreign reserves through non-debt, sustainable inflows is a priority for the country in its economic recovery going forward.
One of the most popular non-debt, sustainable inflows of foreign exchange recognised globally is Foreign Direct Investment (FDI) which has routinely been identified as a panacea to Sri Lanka’s economic woes by economists and business communities. However, Sri Lanka has historically struggled to attract FDI in comparison to its Asian counterparts.
FDI in the current climate
Sri Lanka is facing the most severe economic crisis in its post-independence history and the situation has been aggravated by a political crisis. Since April 2022, the country has been rocked by several large public protests that managed to topple the powerful Rajapaksa regime. In our current context, while foreign inflows to build up reserves is a priority, there is also an important question as to whether such an approach is feasible considering the current environment in the country.
Speaking to The Sunday Morning Business, University of Colombo Faculty of Arts Department of Economics Senior Lecturer Dr. Shanuka Senarath emphatically claimed that attracting FDI in the current climate was impossible. He shared that considering the prevailing turmoil, he would be surprised if a foreign tourist arrived in Sri Lanka, let alone an investor.
“When our politicians are openly corrupt, what kind of investor would want to come and invest in Sri Lanka?” he questioned.
According to him, the only investors who will arrive in Sri Lanka given the current environment are unsolicited investors earmarked through backchannel negotiations involving underhand commissions. He further provided that clean and open foreign investors of international renown were unlikely to be interested in making an investment in Sri Lanka due to our culture of open corruption.
While acknowledging that FDI was important for developing countries like Sri Lanka, Dr. Senarath noted that focusing on FDI under the prevailing circumstances was meaningless and that we must first achieve political stability with a stable government and a degree of economic stability before focusing on attracting FDI.
Elaborating further, he stated: “Our political leaders have lost the confidence of the people. Therefore, we must hold a parliamentary election. Even if the same party comes into power, it is perfectly fine because it would be legitimate. Currently, people are not prepared to recognise anybody – the leaders keep changing but the people are still not willing to accept anybody until a leader is appointed through an election.
“Therefore, political stability should be the priority, followed by some degree of economic stability in order to ensure predictability of economic conditions. Without such changes there is no point in discussing FDI.”
Similar sentiments were expressed by Economist and former Deputy Governor of the Central Bank Dr. W.A. Wijewardena, who stated that he saw no prospects for Sri Lanka to attract FDI when considering the current commodity shortages, foreign exchange shortage, exchange control regulations, and import controls. Addressing such issues should be the priority in the short term, he stressed.
Barriers to FDI
Speaking to The Sunday Morning Business, University of Colombo Department of Economics Senior Professor Sirimal Abeyratne stated that there existed significant barriers to FDI in Sri Lanka and that if Sri Lanka wished to become a hub for FDI in the South Asian region, it must first establish a conducive environment for FDI and build investor confidence.
“Doing business in Sri Lanka is very difficult. A potential investor will have to wait weeks or months or sometimes years to clear things and gain necessary regulatory clearance, while being forced to meet various bureaucrats and politicians to obtain approval, which may in certain instances require the offering of bribes. Furthermore, there is no policy consistency in Sri Lanka and policies are routinely changed overnight without warning,” he explained.
He also indicated that Sri Lanka could no longer be considered an open economy. When compared to the other countries in the region, Sri Lanka possesses a highly regulated economy with tariff and non-tariff barriers against imports, which is simply not a conducive environment for FDIs. Instead, FDI requires that the State subscribes to free market principles in order to derive any benefits from FDI.
Similar sentiments were expressed by Dr. Senarath, who pointed out that considering the significant bureaucratic red tape involved in establishing an FDI in Sri Lanka, it was meaningless to target FDI without addressing such shortcomings.
Elaborating further, he stated: “The process of establishing a business in Sri Lanka is overly complicated and there is a lack of certainty as to the exact criteria that is required to be fulfilled in establishing a business. The same complication arises when a foreigner seeks to establish a business in Sri Lanka. If you go to the regulatory authorities, it becomes manifestly clear that there is no methodology, clear regulation, nor an efficient way to find relevant information.
“If you consider the Ease of Doing Business index which measures countries based on the ease in commencing a business, New Zealand is ranked as the world’s easiest country to start a business while Sri Lanka is ranked at 99 out of 120 countries.”
Dr. Senarath stated that Sri Lanka’s laws, regulations, and attitudes were simply not conducive to attracting FDI. He also pointed out that the attitudes and inefficiencies of Sri Lankan bureaucrats was one of the major reasons for the lack of FDI inflows to Sri Lanka.
Dr. Wijewardena noted: “The International community believes that there is no rule of law in Sri Lanka. Therefore it is unlikely that a foreign investor would come to a country with such a reputation due to the possibility that their rights would be arbitrarily violated by Sri Lankan authorities.”
He further elaborated: “There are regulatory barriers to FDI in Sri Lanka. This includes the fact that foreigners cannot own land in Sri Lanka without paying 100% tax. The high cost involved in obtaining public utility services is also a barrier – the cost involved in obtaining public utility service connections is simply not conducive for FDI.
“Furthermore, we don’t have proper amenities, healthcare systems, and education systems to attract foreign expats. Why was Singapore successful in attracting FDI? It was because they respected the rules, established a corruption-free system, and a western oasis to attract foreign workers.”
Dr. Wijewardena further noted that the reform of Sri Lanka’s key weaknesses in attracting FDI were made essential conditions by the US Senate Foreign Relations Committee in order to obtain IMF financial assistance. Such requirements include independence of the Central Bank of Sri Lanka (CBSL), strong anti-corruption measures, and promotion of the rule of law.
Recommendations
Prof. Abeyratne stated that if Sri Lanka was serious about attracting FDI, it would require the formulation of a series of policies and regulations aimed at facilitating the FDI process. “However, I have not seen any political will to bring about such changes, and bureaucrats haven’t made any meaningful contribution in the area in the past 25 years as per my experience,” he shared.
Commenting on whether Sri Lanka should grant tax incentives or tax holidays to attract FDI, he pointed out that if the country had a good business environment there would be no need to provide tax incentives to draw investors. However, he noted that in the case of Sri Lanka, even tax incentives might not be sufficient to entice investors to bring FDI into the country without appropriate reform.
Similarly, Dr. Wijewardena stated: “If a country has a stable system of governance with good macroeconomic stability, then tax incentives wouldn’t be necessary to attract FDI. Consider the US, which is the recipient of the largest FDI inflows. Do they provide tax incentives? As long as we maintain the rule of law, good governance, and macroeconomic stability, FDI inflows will come.”
He noted that during the British colonial period, British planters established a Scottish oasis in Hatton, Bandarawela, Diyatalawa, and Nuwara Eliya in order to attract foreigners.
“We can still find these buildings in these areas. That is how they attracted FDI – by creating a western oasis and providing the necessary amenities such as good healthcare and education. This is what we should target if we want to attract FDI. We should provide them with a system where they can live in a particular area in a manner similar to their home countries.”
BOI response
Board of Investment (BOI) Director General Renuka Weerakoon told The Sunday Morning Business that, considering the global context, with a recorded $ 1.65 trillion, global FDI in 2021 had surpassed the pre-pandemic level. However, the recovery growth is significantly uneven when regions are compared, with an upscale recovery in developed economies and a modest recovery in both developing and least developing economies.
“Although South Asia increased its FDI inflows in 2020, it was the only sub region within Asia to mark a negative FDI growth rate in 2021, with total FDI inflows in 2021 dropping by 24% compared to the preceding year. Furthermore, the Ukraine factor has negatively changed the global economy with high oil prices, rising inflation, and negative economic impacts across countries and regions.”
She noted that contextually, Sri Lanka was also facing the same crisis situation which had created a challenging environment for attracting FDI. “However, we believe that these economic conditions and stability in the country will rebound with the establishment of political stability through a constitutional process as we have witnessed in recent times.”
Weerakoon added that with all the positive initiatives planned and implemented by the BOI within the first half of 2022 to ensure seamless services, such as establishment of the Investment Facilitation Centre (IFC), digitisation of BOI functions including Customs documentation, promoting re-investments, introduction of a partnership finder database, five-year resident visa programme, etc., they expected that Sri Lanka’s investment environment will be more favourable to attract much-needed FDI to the country.
“Being an island with a relatively small domestic market, it has been a challenge to attract a market seeking foreign investments. As such, we are leveraging neighbouring countries as well as large foreign markets by entering into Free Trade Agreements (FTAs), such as the FTA with China and the Preferential Trade Agreement with Bangladesh. We have also identified the manufacturing of niche products for high-end markets as a key strategy in attracting FDI inflows to the country.”
She added that another challenge that the country faced in attracting FDI for the manufacturing sector had been the lack of domestically-sourced raw materials, which was a problem that could be overcome through promoting backward integration – linking the small and medium sector with the global value chain.
“Having identified the importance of the role of the BOI in recovering from the current situation, we are looking at both short-term as well as long-term strategic measures which will result in increased FDI inflows to the country. As a short-term strategy to attract much-needed FDI, in line with the global trend of focusing more on attracting re-investments over greenfield investments, we need to focus more on attracting and facilitating re-investments by existing companies.”
Furthermore, having identified the importance of expediting the investment approval process both internally and externally, there should be improved line agency coordination, which is expected to be implemented through the recently-established Investment Facilitation Centre (IFC) at the BOI, Weerakoon added.
This unit is expected to function as the central facilitation unit to grant all necessary approvals in an expeditious manner with the active participation of relevant line agencies. Re-positioning Sri Lanka as a high-tech FDI destination based on Industry 4.0, developing new zones dedicated to priority sectors, and digitisation of the entire investor experience to ensure seamless delivery of services to investors can be categorised as identified long-term strategic initiatives.