Today for Sri Lanka to attract investment, we all know we need good institutions favouring economic freedom and the ease of doing business, market size and labour costs. Political risk does not lead to significant differences in foreign direct investment (FDI) across the region. We also know that the most promising reforms arise in the financial system, corruption, property rights and in some business regulations associated with starting up a business.
Increasing labour market flexibility also has a large impact on inward FDI but this reform comes at a comparatively higher effort. In 2015, global FDI flows increased by 25 percent to US $ 1.7 trillion, reaching the highest level since the global financial crisis began in 2007. Corporate and financial restructuring played a large role. On the other hand, Sri Lanka in 2015 attracted real FDI of less than US $ 500 million, the first quarter of 2016, around US $ 150 million. This must be far below the budget set for FDI.
The government unlike before is certainly making a huge effort to attract FDI because today FDI has become the major driver of economic growth. The effort made by the prime minister to attract new investment into Sri Lanka by showcasing Sri Lanka at global economic forums is a clear sign that the government is ready to do business with the world; his team therefore needs to follow up on the contacts he generates and convert them.
At the same time, those tasked in attracting FDI must also make an effort to retain the foreign investors who are already in the country. Getting the existing investors to expand should be our first priority before we try to woo in new investors into the country. The case of Holcim, the Swiss-based company, arguably one of the largest cement suppliers, is a case in point.
Therefore, the private sector needs to support the effort and the bureaucratic system that we have needs to be overhauled in line with other markets. The government must also ensure that attracting foreign investment is a formal part of the portfolio for our ambassadors and their teams around the world and ensure that they get the support that they need here at home.
Today, the most profound effect of FDI has been seen in developing countries where yearly FDI flows have increased. Today, China is at the forefront of FDI growth, followed by Russia, Brazil and Mexico. Generally FDI refers to long-term participation by one country in another country. It usually involves participation in a joint venture (JV), capital transfer, transfer of technology and expertise. There are two types of FDI: inward FDI and outward FDI, resulting in a net FDI inflow (positive or negative). There is substantial evidence that such investments benefit host countries. In Sri Lanka, during periods of relative economic and political stability, FDI inflows have responded positively. Sri Lanka expects FDI to more than quadruple to US $ 5 billion by 2020; currently we attract less than US $ 1 billion a year. Also with the advent and growth of the Internet, many traditional cases of FDI, which require huge amounts of capital and physical investments, are slowly becoming obsolete. Therefore, policymakers in developing countries must have the expertise to understand these new trends that have and will alter the playing field for FDI significantly.
For example, one of the largest FDI deals – which can help India maintain its top position in global FDI was inked in our neighbourhood recently with Foxconn Technology Group, the global electronics manufacturing giant, which makes iPhones for Apple, agreeing to invest US $ 5 billion over five years in a new manufacturing facility in the western state of Maharashtra.
Benefits of FDI
FDI generally benefits the host country. However, its potential impact should be carefully and practically accessed. FDI is viewed as the “good cholesterol” HDL, where as short-term debt is considered “bad cholesterol” LDL. FDI is thought to be “bolted down and cannot leave so easily at the first sign of trouble”. FDI has proven to be resilient during a financial crisis.
A good example would be the Mexican crisis that took place during 1994-1995 and the Latino crisis in the 1980s. The resilient of FDI during a financial crisis has led many developing countries to monitor it as a private capital inflow of choice, rather than in other forms of private capital such as portfolio equities, debt flows and in particular, short-term flows, which were all subjected to large reversals during a crisis.
Generally private capital flows across borders because it allows capital to seek out the highest rate of return. Countries often choose to exempt some of its revenue when they cut corporate tax rates in an attempt to attract FDI from other countries. FDI also allows the transfer of expertise and technology, particularly in the form of varieties of capital inputs, which cannot be given via financial investments or trade in goods and services.
However, there are many findings that show that FDI profits are relatively higher of the total inward investment, even when the risks are very high. This is because FDI tends to take advantage of the countries where the market is inefficient. It happens because foreign investors prefer to operate directly instead of relying on local financial markets, credit ratings, agents or legal arrangements.
The best solution for developing countries to increase their overall amount of inward investment of all kind is to focus on improving the environment for investment, ownership rules, strengthen the functioning of capital markets and also private companies improving their governance within their enterprises. By doing so, they are likely to be rewarded with increased investment as well as with more capital inflows.
The economic pressures in many of the developed markets is speeding up the shift of focus to frontier and emerging markets since they still remain the only source of growth in the world economy. Therefore, Sri Lanka under the new administration could very well attract more foreign investment and there by develop our industry faster, if we strengthen both our soft and hard infrastructure, workforce skills, have efficient capital markets, provide sustainable legal guarantees to protect investment and strengthen governance in both the public and private sectors. In the final analysis, if the government is serious about attracting new money, investment policies in Sri Lanka have to be further restructured. In addition, we need to make sure that for the first time, companies who want to do business in Sri Lanka have a single independent point of contact at ministry level to navigate national, provincial, local rules and regulations so that they can invest faster, open facilities faster and create jobs faster.
(Dinesh Weerakkody is a senior company director)