Assessing the FDI Opportunities in Sri Lanka

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Located at the heart of Indian Ocean, Sri Lanka is a country that has a potential to be a tourist destination because of its numerous beaches and rich culture. However, the long-standing civil war and ethnic conflict has marred its chances to obtain several foreign direct investments (FDI).As Encyclopædia Britannica (2007) described, it was in 1948, after nearly 150 years of British rule, that Sri Lanka became an independent country and was also admitted to the United Nations seven years later. The country is a member of the Commonwealth and the South Asian Association for Regional Cooperation.

Its main urban area is Colombo, the capital of Sri Lanka. For administrative purposes, the country has been divided into nine provinces and subdivided into 25 districts. As a densely populated nation, majority of its people are poor, live in rural areas, and depend on agriculture for their livelihood. Gifted with the geophysical environment of wide-ranging diversity makes Sri Lanka one of the world’s most scenic countries. However, this diversity has been also reflected in several ethnic groups, each with its own cultural heritage.

This is why Sri Lanka also has a highly varied cultural landscape and its inevitable political conflict emerge from here.In the late 1970s, Sri Lankan government had envisioned the transformation from an inward-looking socialist system to a market economy based on liberalized trade, foreign exchange and investment. Despite a devastating 20-year civil war started in 1983, healthy economic growth has been maintained, with GDP growing at around five percent annually for over two decades even during the conflict years. During the past years, however, excessive emphasis on social welfare measures, deterioration of terms of trade, and closing of the economy through import-substituting industrialization contributed significantly to the retardation of economic growth from 1960 to 1977 (Kelagama, 1998).

  Despite this performance, most commentators on the Sri Lankan economy, including the World Bank, saw Sri Lanka as a success story in terms of social welfare achievements and growth performance compared to other low-income countries (World Bank 1980, p. 90).  A radical departure from social welfare-oriented and inward-looking policies occurred in 1977, when the government initiated economic liberalization and various new policy measures to increase economic growth. Key features of the new policy regime included promotion of export-led industrialization by offering incentives to domestic entrepreneurs, and encouragement of foreign direct investment in the newly established export processing zone.Fortunately, the new liberal policy environment in the 1980s encouraged some large multinational companies to invest in Sri Lanka.

The international media soon dubbed Sri Lanka “the new investment center of Asia.”  Tourism picked up and tourist arrivals exceeded 400,000 in 1982. Export growth accelerated, with the garment sector accounting for much of the momentum. In fact, the only five-year period since independence in which Sri Lanka’s average growth rate exceeded 6 percent was from 1977 to 1982. All economic indicators during the 1977-82 period showed that, even though Sri Lanka had not shown a satisfactory growth performance vis-à-vis the high-performing East Asian countries during the period 1960-77, it was now on a correct course for rapid economic development.

In fact, many economists at that time believed that Sri Lanka would be able to catch up with some of the high-performing East Asian nations by the early 1990s.(Kelegama, 1999, p. 72).

The international reputation for Sri Lanka has summoned negative all through the years, its civil wars have often hogged the news globally. For instance, Clifton (1999) reported that for several decades, the island nation of Sri Lanka has been the scene of a violent ethnic conflict between the minority Tamils, who are mostly Hindu, and the majority Sinhalese, who are primarily Buddhist. The Tamils want to establish an autonomous homeland in the eastern and northern provinces of Sri Lanka, but the Sinhalese are strongly opposed to this idea. In the following selection, Tony Clifton describes the devastating effect the Tamil-Sinhalese conflict has had on Sri Lanka.

According to Clifton, more than 80,000 Sri Lankans have been killed or have disappeared in a war of attrition that is robbing the country of its young men. In addition, he wrote that war costs have stunted the economy of this nation, which otherwise has the potential to become one of the wealthiest in the region.As a result of the political and social conflicts, GDP saw a negative growth of 1.5 percent–the economy’s first hurdle since the country’s independence.

This decline further dragged down due to a combination factors including power shortages, severe budgetary problems and the global slowdown. Since 2002, the economy has recovered to stable growth. Recently, the U.S. Depart of State Commercial Guide (2007) issued a report described Sri Lanka as a lower-middle income developing nation with a population: 19.

9 million; GDP at $27 billion and per capita GDP at $1,375. The report furthered that compared to other South Asian countries; Sri Lanka is relatively open to foreign investment. It offers a relatively open financial system, moderately good infrastructure, and generally capable workers. FDI could take a hint with its economy as it is based on imports (food & consumer items, oil, raw material and machinery), exports (apparel, tea, rubber), services (including tourism), agriculture and remittances of low-skilled workers abroad.As it issued its last year growth figures, the Sri Lankan economy had expanded 7.

8 percent between June and September last year in spite of the ongoing escalation of violence in the north-east battle zones between the government troops and the Tamil Tiger rebels. The economy had recorded a 6.9 percent growth in the corresponding period of 2005. The revised overall growth of 7 percent for 2006 tallied with the forecast of the International Monetary Fund (IMF) (Xinhua News Agency, 29 December 2006).

However, the agricultural sector still contributes about 20 percent to GDP and employs over one-third of the workforce. Manufacturing is the most dynamic sector, including textiles and garment, food and beverages, and chemical and rubber-based goods. The combined services sector generates more than 50 percent of GDP, including transportation, communications, financial services and tourism.Although talks between the government and the Liberation Tigers in February 2006 improved the overall climate, the situation again deteriorated by mid year when fighting resumed. The infrastructure and human resource bases have to be upgraded markedly.

For example, only 2% of young people attend university, substantially lower than the South-Asian average. Poor roads and expensive, intermittent power cost hinder development of the private sector.Since the turn of the century, growth has been driven by that part of the services sector not related to tourism (import-related trade, mobile telephony and financial services). However, the sector’s contribution to growth has changed, as increased demand for services and imported consumer goods have become a major force for economic expansion. Domestic demand in turn has been fuelled by low real interest rates and by a rapid expansion in inflows of workers’ remittances. Poverty affects almost a quarter of the population but is much higher in the areas controlled by the Tamil Tigers.

Sri Lanka was also hard hit by the devastating Indian Ocean tsunami in 2004. With support from the international community, the Sri Lanka government has since provided the initial stages of tsunami relief efficiently. However, a key ongoing challenge will be to manage the reconstruction activity in an efficient and transparent manner so that it can mobilize donor assistance effectively and maintain macroeconomic stability.Medium-term prospects depend critically on the government’s plans to encourage growth by significantly raising FDI as well as public and private domestic investment.

The authorities intend to offer substantial additional tax benefits to companies investing outside Colombo and the western province. Known as the “300 factories” program, the hope is to boost economic activity in the less-developed provinces in the north and east where poverty rates are substantially higher than the national average of 22% (Rajapaksa, 2006). Growth in the past was driven largely by consumption, but private investment and privatization, mainly coming through FDI should play a growing role over time.No large infrastructure improvements have been made for at least 20 years, resulting in bottlenecks that are a heavy drag on the economy.

Rebuilding the infrastructure is crucial for rapid development in the medium term. For example, poor roads in Sri Lanka have been associated with 44% lower total factor productivity, and lack of access to the power grid with a 35% reduction, relative to firms with access to good roads and to power supply.Euromonitor International (2 November 2006) had criticized that over the last five years labor productivity has fallen by a cumulative 10% in agriculture and 3% in services, but has risen by 1% in manufacturing. Agriculture’s weak performance is unlikely to be reversed without decisive policy shifts.

The pattern of growth is dangerously imbalanced and fragile. Led by the city of Colombo, the western province is booming. Its share of GDP has risen to 48% from 40% less than a decade earlier. Meanwhile, the east and north remains an economic backwater.Despite the grim scenarios in Sri Lanka, it is recommended that FDI can be beneficial in the sector of IT and telecommunications. As the U.

S. Commercial Guide (2007) reported, the private sector is the engine of the Sri Lankan economy, fuelled by services (telecommunications, transport, international trade, banking, tourism) and export industries (apparel, ceramics, gems, tea). There is a growing IT industry, small compared to India. Sri Lanka’s strategic location on container routes in the Indian Ocean is still to be fully exploited.

Also, Sri Lanka offers tax incentives to investors. Also, exports are projected to grow at about 8% annually over the medium term. This is a slightly slower rate than in recent years as the clothing industry continues to consolidate, and smaller, less efficient producers close down or are absorbed. Crucially, it also assumes that the existing conflict does not worsen.On the over all, Sri Lanka is still juggling its long-term challenges including fiscal consolidation, the implementation of structural reforms aimed to enhance investment climate, and the revival of the peace process.

Despite the early establishment of strong democratic and judicial systems, Sri Lanka continues to lag when it comes to governance and public institutions. The highly politicized and economically favored public sector have distorted the labor markets and hampered private sector growth. Furthermore, the country needs to reduce social and economic disparities and distribute economic benefits more equitably to maintain the social and political stability needed for lasting peace. If the government will be successful in its peace talks, then Sri Lanka will be a viable place for foreign investments.;

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