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Beware: FDI flows to Sri Lanka may decline and depress prospects for income growth


 Lloyd F Yapa
Sri Lanka (SL) has ambitions of doubling the present level of per capita income to about US$4000 per person by 2016 (Mahinda Chintana – Idiri Dekma) and alleviating poverty (currently about 42.0 % of the population in terms of earnings of less than US$ per day per person). Economists have pointed out such growth needs annual investments in the range of 35-40% of GDP.
The problem here is that the current level of national investment is about 28 % of GDP, (the private and the public components being 22.0% and 6.0%, respectively). Therefore there is a large gap in investments to be filled. Furthermore domestic investors are mostly SMEs who cannot achieve economies of scale to reduce unit costs and do not possess the required capital, technologies, management expertise and access to global markets; access to global markets is vital as the domestic market in SL is small. Therefore the alternative is to attract Foreign Direct Investment (FDI), which possesses all these capabilities. FDI in addition need not be repaid unlike debt. They could also provide the employment opportunities we badly need to alleviate poverty. In this connection employment in manufacturing industries and services has to be provided particularly in rural areas to absorb excess employment in agriculture (about 33 % of total employment), that depresses productivity, in order to increase incomes. Additional jobs in industries could also help in reducing the unproductive over-employment in the public sector and the Middle Eastern employment, most of which borders on slavery.

Quantum of FDI flows
But what do we see in SL? A declining trend in recent years. The country was able to attract only $827 million, $581 million (net) and $516 million worth of FDI in 2008, 2009 and 2010, respectively though 2011 has seen an increasing trend in tourism. In comparison Hong Kong, Singapore, Thailand and Malaysia had attracted US$ 62.6, 37.4, 6.8 and 7.0 billion, respectively after suffering a slight dip in 2009 due to the recession in the US. It is to be noted that such South East Asian countries routinely succeed in attracting billions of US$ in FDI and not in millions as Sri Lanka.

What is wrong?
The question that arises is what’s wrong with us? The short answer is ‘risk’ to investments. Witold J Henisz and Bennet A Zelner, the authors of an article titled “Hidden Risks in Emerging Markets”, Harvard Business Review, April 2010, divide risk into ‘expropriation risk’ and ‘policy risk’.The authors state in their article that “today this risk (referring to expropriation risk) has largely disappeared” from most countries of the world. But sadly not from Sri Lanka, as a law to expropriate ‘underperforming and unutilized assets’ was approved by Parliament.

The authors say that “the risk that a government will discriminatorily change the laws, regulations, or contracts governing investment- or will fail to enforce them- in a way that reduces an investor’s financial returns is what we call policy risk”. This writer would include threats to property and persons and weaknesses in governance also in this category. The authors reveal that a 2001 Price –Waterhouse Coopers study concluded that an opaque policy climate could be equivalent to 33.0% increase in taxation.

Reasons for decline in FDI flows to SL
The rest of the paper deals with various types of Policy Risk and other constraints to investment/FDI in SL. They are:

1. Security of property and persons
Although there is political stability, there are question marks over the independence of the judiciary, law and order (the conviction rates in courts is reported to be 4%; the ‘Ease of Doing Business’ report 2010 of the World Bank had stated that it takes 1318 days to enforce a contract in SL vs. 150 days in Singapore), the neutrality and efficiency of the public service (mainly on account of replacement of the 17th Amendment to the constitution and its independent commissions with the 18th Amendment), that could lead to uncertainty in the minds of investors regarding the security of property, persons and the profitability of their enterprises. In addition, even after several years of the defeat of LTTE, solutions to the causes of the ethnic problem which created terrorism in the first place continue to elude the leaders of the country. Therefore investors may fear that the conflict may flare up again and affect their businesses. Where security of property and persons is concerned, it has been reported that the OECD’s Country Risk Classification Report had given SL a score of 6 from a range of 0-6 along with Angola, Uganda and Iran!

2. Disincentives
i. Labour Laws
The labour laws, especially the Termination of Employment Act, are extremely complex with numerous statutes and court orders to interpret in case of a dispute with the workers and expensive lawyers have to be engaged for such purposes.

ii. Numerous Taxes, Cumbersome Procedures and Documentation
The Ease of Doing Business Report of the World Bank 2012 ranks SL at 89 out of 160 countries (ranked 98 in 2011), an improvement of nine ranks due mainly to the implementation of proposals in the Budget 2011 for the reduction of taxes and simplification of procedures and documentation including ‘e-governance’.

The number of forms to be filled has come down to two per month from the earlier 8 or 9 due mainly to the reduction in the number of payments to various government institutions.

The reduction of duties and other levies on raw materials on account of the 2011 budget proposals has resulted in the lowering of unit costs apart from the reduction in the number of forms to be filled, though some of the suppliers to manufacturers still have to bear some of the burden. It is the exporters who have benefited most from the reduction/cancellation of duties and taxes at the point of import, although earlier, rebates of taxes on imported inputs involved some delays and much paper work.

Money tied up with the Inland Revenue Department as refunds and work involved in getting them back still involve long delays and cause liquidity problems, though some improvement here too is discernible.
BOI approval for FDI is simple enough. But long delays are incurred in getting environmental, coast conservation, building and other permits from a plethora of government and provincial agencies.
An Electronic Data Interchange at the Customs to simplify import procedures and documentation has at last been introduced, though it is still not complete.

iii. Overvaluation of the currency
The inflows of foreign exchange mainly in the form of foreign grants and short term loans have led to the appreciation of the rupee. This makes SL exports uncompetitive. Large foreign enterprises when established here have no alternative but to export as the domestic market is small. All the other reasons mentioned in this paper also make exporting from SL uncompetitive.

iv. Corruption
The level of corruption in the public and private sectors is stated to be high with allegations that politicians and officials demand commissions from contractors (of infrastructure works the quality of which is then reduced to retain profit margins) and even from investors. The Transparency International’s Corruption Perception Index 2010 ranks SL at 91 out of 178 countries with a score of 3 out of 10.

Poor infrastructure
The motoring time between Colombo and most other towns in the country has not come down. The railways also have not been developed to speed up trains and transport cargo.
The result is only the three districts close to Colombo get developed, though the Colombo- Matara expressway and other expressways under construction or planned would be a relief in this connection. The quality of power and water supplies is poor especially in the areas outside Colombo ; the cost of a unit of electricity for an industrialist in SL is very high; this tariff which went up by about 15% sometime ago is due to rise again soon.

Social infrastructure like education particularly in maths, science, technology, IT, management and English does not produce the skills sought after by investors.

Low productivity and competitiveness
Productivity or output of labour in SL is quite low due to all these constraints and the number of public holidays, which is highest in SL is 147 vs. 98 in Malaysia. The World Fact Book 2011 ranks SL 147 out of 226 countries vs 5 and 75, respectively in relation to Singapore and Malaysia on the basis of per capita income- proxy for productivity. In SL low productivity exists side by side with continuous price increases due mainly to government budget deficits, leading to increases in costs of production and narrowing of profit margins.

According to the 2011/12 Global Competitiveness Index, SL is ranked 52nd out of 142 countries, whereas Singapore occupies 2nd place and Malaysia 21st place, respectively. Foreign investors may therefore wish to invest in Malaysia or Singapore in preference to SL as they could realize higher profits. Competitiveness consists of achieving higher productivity plus innovation for addition of value on the basis of customer preferences and differentiation of goods and services for earning higher returns and for preventing imitation by competitors, aided by a supportive national environment.

Although the ease of doing business in SL has improved to a certain extent some of the main constraints still remain. It is the private sector that could help SL to achieve the targets of income in the Mahinda Chintana. The role of the state is to provide an environment that is conducive to such investment especially reputed FDI (from South and South East Asia like Sony and Samsung as the West is close to another recession) with predictable policies and incentives, an open/ liberalized regulatory system to maintain competition among firms to motivate them innovate to reduce costs and make higher earnings, and to safeguard the rights of the customers and the workers. An independent judiciary, a neutral public service including a police force to ensure the security of their property and persons supported by the necessary infrastructure both physical and social is also necessary. In addition the state has to resolve the above mentioned constraints while monitoring the entire system constantly to ensure the achievement of targets. This is the approach adopted by the governments of the ‘miracle’ economies of South East Asia with great success.

Expropriation of the assets of private firms has never been a tool in the armoury of these governments; the reason being that such a law delivers the unmistaken message that investment by the private sector is not welcome. Besides leading to a failure to achieve the income targets envisaged, such expropriation is bound to lead to massive losses by the enterprises due to politicization and be a burden to the Treasury and the tax payer.

So the writer’s plea as a concerned citizen is to rethink the entire strategy of private investment, particularly the proposed expropriation, give it the highest priority and go after FDI with unceasing determination like the South East Asian nations by adopting the above approach, which sometimes is contemptuously treated by our socialist oriented policy makers as being ‘neo liberal’ or ‘capitalist’. The architect of communist China’s spectacular success, Deng Tsiao Ping’s very practical advice in this connection comes to mind- “it does not matter whether the cat is black or white, as long as it catches mice”!

(The writer is an economist and can be reached at

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