A recent press release by the Finance Ministry in response to the downgrade of Sri Lanka’s sovereign rating by Fitch Ratings expresses the government confidence in overcoming Sri Lanka’s short-term economic challenges. In the same statement, the Finance Ministry emphasises that foreign direct investment (FDI) is expected to play a key role in overcoming the country’s current economic distress.
Sri Lanka heavily focuses on FDI to bridge the country’s investment-savings gap and to support balance of payment (BOP). But historically, the actual FDI inflow into the country has not been sufficient and the country’s investment case is seen rapidly changing. The government appears to be betting on the Port City project and Hambantota Port to act as catalysts in attracting FDI in the short to medium term.
The Hambantota Port has good potential to support to overcome the country’s short to medium-term economic hurdles, as there is a strong case for port-related industries. The sale of the Hambantota Port to Chinese investors also helped Sri Lanka to overcome the BOP crisis in 2017/18. However, the expected contribution from the Port City project in attracting FDI and to support BOP in the short to medium term appears not as significant as the port.
The root cause of Sri Lanka’s economic problems is the country’s inability to attract/retain sufficient foreign exchange to sustain itself. Sri Lanka has been facing cyclical BOP problems, which act as a growth constraint. The BOP problem magnifies during internal and external shocks such as the COVID-19 disruption experienced at present.
FDI could help fix this problem, if FDI result in generating sustainable foreign exchange to the country from stable and diversified sources and if FDI ventures utilise significant local input or value addition.
FDI is not all foreign funds coming to country
There is a widely held misconception that (all) FDIs are foreign funds coming into the country. But in reality, the actual foreign ‘cash’ coming into the country (in the form of FDI) represents only a fraction of total FDI.
For example, out of the total US $ 345 million FDI reported for the first half of 2020, the actual net foreign ‘cash’ inflow into Sri Lanka is estimated around US $ 152 million. During the five-year period up to 2019, Sri Lanka received US $ 5.3 billion (total) FDI. But actual net cash inflow into the country is estimated to be around US $ 3.5 billion (inclusive of estimated US $ 1.4 billion received for the acquisition of the Hambantota Port). In the recent past, the FDI-backed ventures have been taking funds out of the country (in the form of dividends, etc.) at a much faster rate than what Sri Lanka has been receiving as FDI.
For the first half of 2020, Sri Lanka’s FDI declined by 35 percent, compared to the same period last year. Although this is better performance compared to the overall 49 percent decline in global FDI for the first half of 2020, Sri Lanka has performed below average compared to the developing countries and Asia region, which have recorded 16 percent and 12 percent declines, respectively. This probably hints that Sri Lanka may receive less FDI in the short term because FDI realised in 2020 are probably planned before 2020 and unlikely have been significantly impacted by the COVID-19 pandemic.
However, Sri Lanka will probably hit the target of US $ 750 million total FDI for 2020, primarily due to the existing FDI ventures opting not to repatriate profits. (Tax concessions offered in the 2021 budget proposals are likely to encourage foreign-owned companies to delay repatriation of profits.)
Port City and potential FDI?
In import-dependent countries like Sri Lanka, FDI in non-tradable industries like real estate could weaken BOP although having a positive impact on the economy. This is because real estate development is highly dependent on imported inputs (including labour).
Furthermore, large profits made by FDI-backed real estate projects are usually repatriated. The higher inflow of FDI into the non-tradable sector during the post-2009 period probably contributed to the BOP distress Sri Lanka started to experience in the recent past (before COVID-19). The Port City is primarily a real estate project and is expected to attract total US $ 9.6 billion FDI during the initial infrastructure development phase (currently ongoing) and subsequent 20-year project development phase (inclusive of receipts from sale/lease of land). The estimated positive contribution to the country’s BOP is US $ 5.5 billion during both phases (assuming 100 percent completion and 75 percent FDI funded with foreign inflows).
Foreign investors own 65 percent of the sellable land at the Port City and it is likely that foreign investors will repatriate the profits made by selling/leasing land during the early stages of the project development phase, resulting in significant foreign outflows from the country. However, the government is also expected to earn around US $ 1.8 billion from the sale/lease of land.
The Port City is expected to have 24,000 housing units, over 13 million square feet of rentable office space, 2,400 hotel rooms and over nine million square feet of retail space. When we compare the real estate absorption patterns in cities like Singapore, we can estimate that it will take 10-20 years for full occupancy/utilisation of the Port City’s capacity. Global developments post COVID-19 may also delay in new property project implementations. Commercial operations planned at the Port City are also highly dependent on tourism.
The Port City will definitely add great value to Sri Lanka in the long term. Nevertheless, in the short term, the economic impact of the Port City towards meeting FDI and BOP support are likely to be mixed.
However, in the short to medium term, Sri Lanka has great potential to attract port-related FDI and post-COVID-19 trade disruptions also could boost Sri Lanka’s attractiveness.
(Indika Hettiarachchi, an independent consultant in project, venture and private market investment, can be reached via Indika.h@jupitercapitalpartners.com)
