• Current crisis is temporary transitional turbulence: Thulci Aluwihare
• Domestic inflation, policy rate hikes to not have an impact on raised capital
• Country’s image matters to attract FDI, hence political stability required

By Shenal Fernando Sri Lanka is currently facing its worst economic crisis since independence, which has been exacerbated by the collapse of its gross official foreign reserves from $ 7.5 billion in November 2019 to $ 1.8 billion by end May 2022 as per data published by the Central Bank of Sri Lanka (CBSL). Furthermore, it has been widely reported that a significant portion of Sri Lanka’s existing foreign reserves is composed of volatile short-term swaps maturing within 12 months. Therefore, building up Sri Lanka’s foreign reserves via non-debt creating inflows such as Foreign Direct Investment (FDI) and current account surpluses is a priority for Sri Lanka’s economic recovery. Considering the roadmap for the realisation of this objective, the Port City Colombo Development Project (Port City Colombo) is being developed by the Government of Sri Lanka and CHEC Port City Colombo (Pvt) Ltd. (CPCC) under a Public-Private Partnership, and will prove to be one of Sri Lanka’s greatest assets for attracting FDI inflows.  This is supported by a report published by PricewaterhouseCoopers (PwC) Sri Lanka in November 2021, which provided that the land reclamation and common infrastructure development stage of Port City Colombo was expected to attract $ 5.4 billion in FDI, including an initial investment of $ 1.4 billion by CPCC and the proceeds attributable to the lease or sale of land. The report further provided that the construction stage of the project was expected to attract $ 8.7 billion in FDI inflows. Once operational, the project was expected to add $ 13.7 billion to Sri Lanka’s GDP as per PwC Sri Lanka.  Considering the significant economic benefits linked to the project, the success of the Port City Colombo will be directly linked to the speed of Sri Lanka’s economic recovery. Therefore, ensuring its success must be considered by the Government in formulating its economic recovery plan. The Sunday Morning Business sat down with CPCC Deputy Managing Director Thulci Aluwihare to discuss how the current developments in the country impacted the outlook and success of Port City Colombo.       Impact of current political and economic crisis   While Aluwihare admitted that the current crisis has had an impact on Port City Colombo, he also pointed out that Port City Colombo was a long-term project, spanning around 25 years. Therefore, the current crisis is viewed as temporary transitional turbulence, which they are confident that Sri Lanka will successfully overcome. He further pointed out that Port City Colombo was economically ring-fenced from the macroeconomic shocks of the country under the Colombo Port City Economic Commission Act No. 11 of 2021 which provided for the establishment of Colombo Port City as a Special Economic Zone, giving adequate independence in terms of governance and the regulatory framework. Explaining further, he stated: “Port City is economically ring-fenced from the macroeconomic shocks because the Port City Act [Colombo Port City Economic Commission Act] clearly states that the capital required for developing Port City or for doing business in Port City must be raised outside Sri Lanka. This means we are not tapping into any foreign currency funding available locally, so domestic inflation and interest rates will not have an impact on the capital we are raising within Port City.  “Regarding currency risk, the Sri Lankan Rupee has depreciated by over 50% during the past three months, and naturally, any investor would be quite concerned. However, the currency risk is completely hedged in Port City because the currency of transaction within Port City is any designated foreign currency and Sri Lankan Rupees are not permitted. This means that as an investor you will invest in US Dollars or any other designated foreign currency and the return for your investment will also be in foreign currency because all transactions within the Port City will be in foreign currency. Therefore, investors can repatriate their returns without any conversion happening.  “When considering demand risk, the positioning of Port City is such that the cash flows for the business conducted inside the Port City will originate outside Sri Lanka, since Port City is predominately for the export of services and to attract FDIs. Therefore, Port City is not dependent on demand arising from Sri Lanka’s population of 20 million to succeed. In that sense, demand risk is also mostly negated, which is why I say Port City is largely economically ring-fenced from the macroeconomic issues Sri Lanka is facing.” However, Aluwihare admitted that the country’s image matters to foreign investors, and favourable sovereign ratings and political stability must be in place to attract FDIs. “It is important that political stability is established and that some economic direction is set. At the moment we do not have access to capital markets because we are in default, but if Sri Lanka can reach a staff-level agreement with the IMF – which requires certain negotiations with bilateral lenders – then it will restore some confidence in the country. If the debt restructuring happens our rating may improve.”    According to Aluwihare, as a result of the current political and economic crisis in the country, the CPCC has held a few one-on-one interviews with investors at certain forums in Singapore, Dubai, and more recently at the Commonwealth Business Forum at Kigali in Rwanda to instil confidence and particularly to reassure investors that the funds they bring will be secure and will not be subject to normal foreign exchange rules applicable in Sri Lanka.     Impact of Sri Lanka’s sovereign default   Following the 12 April 2022 decision of the Finance Ministry and the CBSL to temporarily halt its foreign debt payments and Sri Lanka’s subsequent default on two coupon payments due on ISBs issued, global rating agencies have downgraded Sri Lanka’s sovereign rating to default levels.  Aluwihare admitted that Sri Lanka’s sovereign default may have impacted foreign investors’ ability to raise capital through capital markets. However, he stated that depending on the foreign investors’ appetite for risk they could raise the necessary capital from the balance sheets of their parent company. “When a rating agency assigns a particular rating for a project, it is specific for each project within the Port City. They will consider how much ring-fencing the project has got against the macroeconomic situation of the country. For instance, they will consider how much of the cash flows are dependent on the country and how much is derived from outside. Almost 100% of cash flows in Port City originate from outside the country, through the export of services. Then they will consider whether the cash flows, once received, are protected or whether they will be converted. The rating agency will issue ratings based on how sustainably debt can be serviced from this project. If the project cash flows originate outside Sri Lanka and the money received in foreign currency is ring-fenced, then sovereign risk can be managed suitably for most projects in Port City. Therefore, we hope that we will not be significantly restricted by the sovereign default rating and might be able to secure a rating which is a couple of notches higher for some of the projects.” Aluwihare further stated that there were certain inherent mechanisms in the Colombo Port City Economic Commission Act to limit the sovereign risk related to any project in Port City Colombo for the benefit of investors. Accordingly, the law provides that once an investor signs an agreement with the Port City Commission to operate a business with the Port City Colombo or once they have been granted a tax benefit, the said agreement cannot be altered or terminated arbitrarily. The law further provides that there shall be a dedicated international dispute resolution centre in Port City Colombo in the event of a dispute. He pointed out that the investment agreement possesses an economic equilibrium clause ensuring that in the event any law was changed or a new tax was imposed, following the signing of the agreement with the commission, the resulting negative impact on the investor’s operating costs would be compensated under the mechanism provided in the investment agreement.   Tax incentives vs. fiscal consolidation   Many economists and policy institutions have pointed to the November 2019 tax cuts as a watershed moment in Sri Lanka’s economic crisis. The severity of the impact of these tax cuts was reflected in the data published by the CBSL in its 2021 Annual Report, which showed that Sri Lanka’s revenue to GDP ratio fell to an all-time low of 7.4% in 2021.     Currently, Sri Lanka is in the midst of discussions with the IMF for a bailout package and it is widely expected that the staff-level agreement will involve severe fiscal consolidation measures covering tax increments and expenditure cuts. Therefore, in this environment, there is a reasonable doubt as to whether the tax incentives, including a potential five-year tax holiday which was expected to be granted to foreign investors in Port City Colombo, will be allowed.  According to Aluwihare, fiscal reform to increase Government revenue as well as reduce expenditure is necessary, however noting that such reform should be reasonable and not stifle growth. He further pointed out that granting tax incentives to foreign investors was pivotal for the success of Port City Colombo, because in the absence of tax incentives, there was no rationale for investors to invest in Sri Lanka, considering the risk premium associated with the country, Sri Lanka being ranked at 100 on the Ease of Doing Business index, and the presence of many countries in the region with much better rankings, lower tax rates, and/or attractive tax holidays. “Port City is a new asset that was created utilising 100% FDIs without any taxpayer money, and the income is largely generated overseas as well. Therefore, there is a significant economic benefit to Sri Lanka from Port City. With a default country rating, we do not have access to capital markets, hence attractive tax concessions and a much-improved business environment within Port City are a prerequisite if we are to have any meaningful discussions with potential investors and businesses. Furthermore, robust regulations will ensure that there are no tax leakages from Port City, and in keeping with other International Finance Centres, Port City should adhere to international standards such as BASEL, FATF as well as AML and CTF from inception. Thus, companies operating in Sri Lanka will not be able to set up in Port City and enjoy tax incentives.” He added: “It is pertinent to note that the economic impact and Government revenue (fiscal and non-fiscal) of Port City are much greater than the cost of tax concessions. This is reflected in the PwC Economic Impact Assessment of Port City which clearly shows that once it is operational, its annual GDP contribution to Sri Lanka will be over $ 13 billion and the annual fiscal revenue of the Government from Port City will be over $ 900 million.”   Port City regulations a must to attract FDI   According to Aluwihare, the Port City regulations which are a critical part of the regulatory framework governing Port City Colombo have already been drafted. He further provided that Port City Colombo required at least 12 regulations covering areas such as the incorporation of companies and banking laws to commence operations. Elaborating further, he stated that while they were hopeful that these regulations would be gazetted as soon as possible, the process had been delayed as Sri Lanka was currently engaged in talks with the IMF and therefore the tax incentives envisaged under the said regulations were being reevaluated.  “CPCC has engaged in soft market testing, where any discussions were made subject to the enforcement of the regulations. The regulations need to be published in the gazette soon to provide certainty to investors. There has been interest in Port City but to conclude any discussion, the publishing of the regulations is a must. The key ones are offshore company incorporation, tax incentives for businesses of strategic importance, visa and ring-fencing regulations,” Aluwihare revealed. Commenting on the recent controversy regarding the Development Control Regulations (DCR) of Port City Colombo, following allegations by certain parties who claimed that the Port City DCR was outdated, Aluwihare stated: “The master plan was developed by a Sweden-based planning consultant – Sweco, and then Singapore-based Surbana Jurong made some tweaks to it. So international consultants who have done this before were involved in developing this master plan over a few years. It was scientifically done considering urban principles, local climate, resource-efficient construction, and orientation of buildings to ensure a clear line of sight. The DCR is divided into four chapters – Urban Design, Utility, Landscape, and Sustainability. These DCRs were developed by Surbana Jurong in Singapore and Atkins, a prominent UK-based engineering consultancy firm. If there is local critique, we have passed that information to our consultant Surbana Jurong, who developed it. We will respond to each one of those allegations constructively.”