Sri Lanka’s FDI opportunity
The island country needs to translate the success of attracting commercial debt into higher FDI inflows
Sri Lanka has made a swift transition from concessional debt funding to commercial borrowing over the last decade. Since 2007, Sri Lanka has had 11 successful international sovereign bond issuances, with the latest offering in early May. The latest issue attracted the highest demand in terms of the final order book with over $11 billion in bids placed for a $1.5 billion issue. The island nation has raised $5.15 billion since 2015 from sovereign debt.
A key reason for the appetite for Sri Lanka’s debt could be investors’ hunger for higher yields during a period in which developed markets offered them low returns. But several country-specific factors could have played a part as well.
Sri Lanka has been able to post faster economic growth than its rated peers for quite some time now, and has a good standing in human development indices. The appetite for Sri Lanka’s debt, however, has not been matched by foreign direct investment (FDI) flows into the country.
FDI has been well below par, to put it mildly, when you compare it against countries like Vietnam, which has seen inflows in excess of 6% of gross domestic product (GDP). Sri Lanka’s FDI has been consistently below 2% of GDP with $1.6 billion recorded in 2014 being the highest in recent times. As a result of the FDI potential not being realized, Sri Lanka has relied on commercial borrowing to fund its deficits (i.e. the deficit in the balance of payments and the budget) and drive its infrastructure growth. This has not been sustainable and has seen steep adjustments in the currency and cyclical up and down interest rate movements in the last seven years or so.
Why has FDI not kept pace?
While the Achilles heel of Sri Lanka’s economy could be fiscal imbalances, the biggest drawback resulting in a lack of FDI growth has been policy inconsistency. The reasons for this are manifold. The lack of certainty in taxes, other incentives and policies on land have been a few key problematic areas in recent years.
While financial market transactions can be more quickly executed compared to physical investments, there is no shortage of interest from foreign investors. The problem has been in not converting this interest into real investment on the ground. There are signs that this could be changing. For instance, the Malaysian high commission in Sri Lanka is looking to capitalize on this interest and expecting inflows of $200-300 million in the next few years.
Sri Lanka has carried out plenty of roadshows in places ranging from Europe to Australia to highlight its investment case without too much success as yet. A few weeks ago, I had the good fortune of moderating an industry-level panel for the Investment and Business Conclave hosted by the Ceylon Chamber of Commerce which attracted potential investors from over 20 countries. From what I witnessed, the level of engagement and interest provides hope that sectors like export manufacturing, infrastructure, ports development and tourism (to name a few) will benefit from foreign investments.
It goes without saying that Sri Lanka’s unique competitive advantage is its location, which has not been fully harnessed. The island nation is situated close to one of the most active sea lanes in the world. Currently Colombo harbour handles about 30% of the total transshipment traffic volume of India. Ports in Colombo, Hambantota and Trincomalee can be positioned to attract more of the shipping volumes that bypass Sri Lanka’s shores.
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Stability in the economy will be a key driver as investors look for predictability in particular when it comes to key indicators like the currency. Since 2015, the local currency has depreciated close to 16% against the US dollar in the face of high debt repayments and high fiscal deficits. The rising interest rate environment in the US has not helped either. But now with an International Monetary Fund loan and reform package in place, there is some reassurance that the right steps can be taken to reduce the unpredictability factor.
A year of high expectations
Prime Minister Ranil Wickremesinghe has labelled 2017 as the year of FDI with an ambitious expectation of realizing $2.5-3 billion in FDI inflows. According to the United Nations Conference on Trade and Development, global flows of FDI are expected to rise 10% this year compared to a drop of 13% in 2016. While this is encouraging, there will be country-specific factors that will help the nation achieve the target.
Agencies focused on bringing in FDI, such as the Board of Investment (BOI), will need to be better streamlined and efficient so that investors spend less time caught up in bureaucratic red tape.
The success in attracting investors for commercial debt over the last decade shows Sri Lanka is on the radar of serious investors. However, the next wave of growth will have to be led by FDI flows and that remains a golden opportunity that should not be missed.
This is part of the Young Asian Writers series, a Mint initiative to bring young voices from different Asian countries to the fore.
Shiran Fernando is the lead economist with Colombo-based Frontier Research and a member of the steering committee on economic policy at the Ceylon Chamber of Commerce.