By Marianne David
In light of the recent controversy over the latest Strategic Development Projects (SDP) Act project to be approved, the Committee on Public Finance (COPF) should do an investigation into how these projects were deemed to be ‘strategic’ in the first place, asserts Economist and Centre for a Smart Future Co-Founder Anushka Wijesinha.
“This is the problem with such poorly-designed schemes – there is no objective criteria to decide if it is strategic or not,” said Wijesinha in an interview with The Sunday Morning, asserting that the SDP Act must be frozen, similar to what was done in 2016 during the previous International Monetary Fund (IMF) programme.
Wijesinha also emphasised that it was important to de-emphasise tax incentives and focus more on the non-tax factors that investors look for.
Wijesinha was previously Advisor to the Minister of Development Strategies and International Trade and currently consults for the International Trade Centre on projects in Pakistan, Iran, and Myanmar.
Following are excerpts of the interview:
The COPF on 4 October approved the Order in Gazette No. 2291/25 under the SDP Act seeking to provide 12-year tax concessions to any company investing in Sri Lanka. You’ve called for the Act to be done away with entirely, terming it a ‘revenue black hole’. What would you list as the key issues surrounding the Act?
The origins of the Act were rooted in a good idea – to incentivise, through a special regime, the kind of investments that can have transformational impacts on Sri Lanka’s economy. However, it failed to live up to that promise. It should have been done away with after a few years, when it was clear that it was not meeting the policy objectives originally set out.
Instead, we now have multiple projects that have been granted very generous tax holidays under the SDP Act, in sectors that are not export-oriented, do not help truly diversify sources of growth, and do not contribute to plugging the country into global supply chains.
Many other competitor countries introduced special regimes with the explicit purpose of attracting transformational investments – for instance, Samsung in Vietnam and a cluster of electronic components firms around it, which has transformed Vietnam’s participation in the global economy. Instead, through the SDP Act, Sri Lanka has incentivised mostly domestic economy-focused activities – what economists call ‘market-seeking FDI’ that typically shouldn’t need extra incentives. If they are not seeing commercial value in making that investment in the domestic market, they should not be making it on the back of a massive tax expenditure borne by other taxpaying firms and individuals.
By so many measures the SDP Act has failed. Has it incentivised primarily large investments? No. Projects approved range from large sizes of investment of $ 1 billion and $ 700 million, to $ 30 million and $ 60 million. Has it incentivised mainly foreign investment? No. Approved projects include those that are 100% foreign financed, but also those that are only partially foreign financed, and even those that are 100% domestic financed.
This violates a cardinal principle of why a country likes Foreign Direct Investment (FDI) – to bring in foreign capital, to plug the domestic savings-investment gap. There are serious doubts about the policy objectives of the SDP Act and if those have been achieved, against the revenue foregone so far. A back-of-the-envelope calculation suggests that the combined number of years of tax holidays for approved SDP Act projects amount to over 250 years! The combined number of years of concessionary tax rate that follows the tax holiday periods is over 100 years!
In light of this recent controversy over the latest SDP Act project to be approved, the COPF should do an investigation of how these projects were deemed to be ‘strategic’ in the first place. This is the problem with such poorly-designed schemes – there is no objective criteria to decide if it is strategic or not. It is often left to the discretion of well-meaning bureaucrats, who are often subject to astute negotiation tactics of an investor, and ill-informed politicians, who don’t know any better.
Without a doubt, the SDP Act must be frozen, like what we did in 2016 during the previous IMF programme. In fact, this helped us in our investment promotion efforts back then because we were able to sit across from an investor and say, ‘sorry, the SDP is off the table – let’s move on and discuss what we could really do to help make your investment work’.
Moreover, the current investment relief incentive scheme, which is strictly written into the Inland Revenue Act, is plenty.
Tax incentives are nothing new in Sri Lanka; the country has been desperately offering investors all kinds of investments over the years, seemingly shooting in the dark. Have these had the desired benefits in diversifying the economy?
In its early years, both the Greater Colombo Economic Commission and its immediate successor, the Board of Investment (BOI) (early 1990s), did well to leverage tax incentives to attract investment. But this was coupled with other economic reforms and liberalisation measures, which reinforced the destination’s attractiveness.
In subsequent years, we did see some limited success in bringing in FDI in priority sectors, but these were more because of inherent advantages in the country (location, talent, trade preferences) and because foreign investors found good Sri Lankan partners that delivered quality and reliability.
The fact remains that the overall track record of FDI inflows has been quite disappointing. Post-war FDI, in particular, has been appalling. You’d think that after the end of a longstanding armed conflict, with so much optimism, that we would have seen a huge increase in FDI. Yes, we had a few instances of attention-grabbing investments here and there, but beyond that the aggregate numbers just haven’t shown that.
FDI inflows hovered under $ 1 billion for many years. In the last 20 years, it has never exceeded the $ 2 billion mark, except in one year (2018) in which the inflows for the Hambantota Port lease came in. Manufacturing FDI, which had consistently been one of the higher categories, was overtaken after the end of war by ‘housing, property development, shopping, and office complexes’. Look at the numbers – it’s quite stark. Before the end of the war, this category was between 2-5% on average, as a share of total FDI. Then it grew to 8%, 15%, 20%. And in the last 5-6 years, this has been as high as 38%.
There is an important reason why we must talk about all this now – because of the ongoing fiscal consolidation efforts. A key part of this is tax policy reform and in turn, a key part of that needs to be tax incentives reform.
Has any work been done on rethinking the tax incentives regime?
We did a lot of work on this during the 2009-’10 Presidential Tax Commission, with the late Dr. Saman Kelegama leading the investment incentives chapter. I was fortunate to be working with him as the Research Economist to the commission. We looked at the history and performance of Sri Lanka’s successive tax incentives regimes, alongside global evidence on efficacy and new thinking around new incentives design. We concluded that the tax incentives structure needed to be streamlined and the dichotomy removed. It is after that that the Government decided to write all incentives into the income tax law and remove BOI authority in granting incentives.
There were other proposals also made, some of which were implemented, and others were not. For instance, the shift from profit-based towards capital investment-based incentives (investment tax credits, investment relief, investment allowances, accelerated depreciation, etc.) was since adopted (except for the outlying SDP Act). This is also important because while tax holidays have a perverse incentive of encouraging new companies to be formed to gain from the tax benefit, investment-based incentives encourage investment in new capacity and new productive assets.
Other recommendations included stipulating a minimum foreign capital component, since we observed many projects by that time had borrowed domestically rather than adding new foreign capital to the country. We also proposed introducing time-bound incentives packages, to quickly catalyse FDI into priority sectors in post-war Sri Lanka, and priority regions that needed help with de-risking (for instance, the north and east).
It seems that Sri Lanka’s ‘go-to’ tool in attracting investment is always tax incentives, rather than creating an overall conducive environment. What are your thoughts on this?
This is absolutely correct. In fact, one of the major recommendations we made was to de-emphasise tax incentives and focus more on the non-tax factors that investors look for. Prospective investors are often more concerned about the problems in project approval, the multiple regulatory stops they needed to make, the uncertainty around informal payments to local politicians, delays in border clearances, and the onerous para-tariffs that often negates the Customs import duty exemptions that they would get.
Macroeconomic mismanagement will be the ultimate deterrent to foreign investment – no matter how generous the tax incentives are. An unstable currency, a precarious foreign reserves position, default sovereign rating, and runaway inflation – these are all serious disincentives.
In the past, Sri Lanka has tried to compensate for poor economic management, unstable policies, the lack of trade and business climate reforms, and the narrow pipeline of trained workers by granting ever more generous tax incentives. This is not a sustainable strategy – we must bite the bullet and fix the issues that investors really care about.
To attract the kind of FDI that will help boost growth, how should Sri Lanka reconsider FDI attraction and prioritise its focus?
In sectors where we really need to push investment – export-oriented manufacturing (for instance in electronic components) and in IT-BPM – the annual inflows are worryingly low. For IT-BPM, it is just $ 30-40 million on average in the last few years. Clearly, we are not attracting the FDI that we need to, in order to diversify our exports, plug into global supply chains, create the kind of quality jobs that young people are aspiring to, and in sectors that move the economy to the next phase of growth.
Shopping and office complexes and mixed property development is not going to get us there. It is export-oriented manufacturing and services like IT-BPM. And for this, our ‘offering’ to investors is weak. We have to stop over-relying on fiscal incentives. I think the enhanced capital allowance should stay and be streamlined. But beyond that, we must stop tinkering with tax policy every few years – it makes the regime unpredictable and unstable.
More than anything, we need to recognise that tax incentives are a very small part of the consideration that investors make when deciding to invest here.
I have spoken to dozens of current and prospective investors. Part of my role at the Ministry of International Trade was to join investment promotion missions and often on the sidelines I would ask them, “How important are tax incentives in your decision-making?” The answer I got every time and consistently from good investors (not the fly-by-night type) – whether it was Germans, Japanese, Koreans, British, or Indians – was: “It’s one of the last things we consider.”
Some other answers I got were: “The stability of your tax policy is more important to us”; “We hear bad things about your approvals process and interference of politicians”; “We are worried about informal payments – my company has rules in our home country to adhere to, and we simply cannot do this”. Another more interesting one was: “We would love to invest, but we don’t know if we can get enough talent, but we are willing to co-invest on that with the Government.”
What are your expectations for the forthcoming Budget?
First and foremost, putting a freeze on the SDP Act – no more new projects under it and writing this moratorium into the law by way of an amendment. The Act cannot be repealed because it will nullify the contracts made with existing investors and that would not be good. But the Government should endeavour to renegotiate the tax holiday periods and concessionary tax rate periods. A genuine and fair conversation between the SDP-grantees and the Ministry of Finance will be needed.
Secondly, recommit to only giving fiscal incentives under the Inland Revenue Act, where it is capital investment- and expenditure-based, not profit-based. Expand the currently applicable investment relief to cover expansions of existing investors for a time-bound period. Thereafter, prospectively adjust the regime to favour only foreign capital inflows, not domestically-raised capital – that is a cardinal principle in FDI, globally.
Thirdly, re-aligning our fiscal incentives regime to suit our contemporary and emerging policy needs – that is, remove any incentives offered to market-seeking FDI. If you are coming to cater to the domestic market, you shouldn’t be offered incentives; consider the commercial viability of being in Sri Lanka. If you are export-oriented, will help diversify our exports of products and services, contribute to innovation and technology advancement, bring in joint venture partnerships to make the economy future-ready, then yes.
We have to align our incentives to our medium-term policy goals. With the current revenue crisis, we cannot afford to have too much revenue foregone.
Finally, we must give the BOI the teeth it needs to actually facilitate investors and be the kind of agency it was when it was first established in 1990.
In fact, the whole institutional architecture for trade and investment promotion needs a relook – the BOI, the Export Development Board (EDB), and the Department of Commerce.