Sri Lanka’s Trade Imperative – Analysis
December 6, 2017
As a small island economy with a population of 21 million, Sri Lanka depends heavily on
foreign direct investment (FDI) and the export sector to catalyse economic growth.
A noted economist, Professor Razeen Sally, who chairs the country’s Institute of Policy Studies, said recently that Sri Lanka simply does not have the market size to generate and sustain economic growth at a reasonable rate without external trade, inward investments and the lowering of barriers to competition in key domestic sectors.13 He estimates that Sri Lanka, as an emerging economy, realistically needs to grow at 7-8 percent annually, which is the level needed to increase real incomes across the population and boost other economic indicators. To support this, he estimates that FDI of between US$3-5 billion (S$4.1-6.8 billion) a year is needed, as opposed to the US$500 million (S$681 million) it currently attracts.14
The tight control on key sectors of the economy by local business elites and the cumbersome bureaucratic red tape for foreigners to invest are strong barriers to enticing greater foreign investments. Sri Lanka’s FDI slumped 54 percent last year to reach S$610 million, compared with S$1.3 billion in the previous year.15
Not only is FDI lagging, it has almost entirely been confined to the construction and real estate sectors, while manufacturing and services have been largely neglected. An important reason for Sri Lanka seeking to attract such capital is the belief that such inflows, besides enhancing foreign exchange reserves in the short run, would enhance the competitiveness of its industry, such as exportable manufacturing, which will increase exports and render the balance of payments (BOP) sustainable in the medium and long term.
In recent years, much of the FDI has come from China for massive infrastructure deals. An unexpected setback to the country’s BOP account was the suspension of expected Chinese investment in the Hambantota development projects, following the election of the new government in 2015. President Maithripala Sirisena initially sought to put distance on the cosy relations with China developed by the previous Rajapaksa regime. However, the dire debt situation has brought a recalibration in thinking, as evidenced by the green-lighting of the S$2 billion capital injection from Chinese companies to finance Hambantota, which has brought some relief to the government’s debt servicing efforts. Going forward, Sri Lanka can expect substantial investments as part of China’s One Belt One Road Initiative. 16
The government is increasingly turning towards broader engagement with East Asia and, in doing so, recognising the country’s pivotal position as a strategic asset to both India and China. Considerable measures have been taken over the past two years to demonstrate a willingness to balance both Indian and Chinese interests by granting China access to an industrial park and management of the Hambantota Deep Sea Port and International Airport, while working with India to develop a war-era oil tank farm in Trincomalee, a strategically- located port to the east of the island.17
It is also hoping to finalise free trade agreements (FTAs) with many of the major regional powers in the next six months. Among these are the Economic and Technology Cooperative Agreement with India and FTAs with China and Singapore. If these succeed, Sri Lanka will have preferential access to India, one of the fastest-growing economies in the world, and it will also be a key investment hub for the Chinese maritime silk route.18
Speaking in Singapore last year, Sri Lankan Prime Minister Ranil Wickremesinghe promoted the idea of a tri-nation economic pact between Sri Lanka, Singapore and the five southern states of India. This idea is based on Sri Lanka’s proximity to these five southern Indian states and their 300-million strong consumer market and supply chain clusters.19 For India, Sri Lanka’s unique geo-strategic location at the crossroads of major shipping routes is important. For Singapore, the proposed arrangement will help to expand its importance and capacity for business networking in the region. The Singapore-Sri Lanka FTA is expected to be signed by early next year20 although progress has been slow, mainly due to capacity limitations amongst Sri Lankan policymakers – Sri Lanka has not negotiated an FTA in over a decade. Yet, there appears to be enough goodwill on both sides to get the deal done.
The Colombo Port City is the most ambitious of the myriad infrastructure projects bankrolled by China. Since renamed the Colombo International Finance Centre (CIFC), it aims to be a special zone along the lines of Dubai’s International Financial Centre. At an initial cost of S$2 billion and rising to S$11 billion, the CIFC is expected to be the largest FDI project in the country to date. The financial backing and development is provided by the state-owned China Harbour Engineering Corporation, although, in what could signal a new phase in Sino-Indian economic relations, China has invited India to also participate. The offshore financial centre aims to attract more than S$17 billion21 in FDI from investors, including international banks, hotels and malls, with China being the lead promoter.
India has also been a leading investor in Sri Lanka, with investments topping US$1 billion since 2003, although this pales in comparison to the size of China’s involvement in Sri Lanka over the same period. Indian interests are in such diverse areas as petroleum retail, information technology, financial services, real estate, telecommunication, hospitality and infrastructure development (railway, power, water supply). A number of proposals involving Indian companies are still in discussions such as the Tata Housing Slave Island Development project, done in cooperation with the Urban Development Authority of Sri Lanka. A landmark development is the ‘Colombo One’, ITC’s S$540 million hotel, residential and leisure complex which is under construction.