Government pushes panic button on FDI?

Recently, the government announced a plan to obtain the services of a foreign constancy firm to promote foreign direct investment (FDI). This development comes as FDI has reached a negligible level, in comparison to the size of Sri Lanka’s GDP. However, this plan appears to be an attempt to address the inefficiencies in the FDI process, rather than a policy intervention for a sustainable FDI growth.

Sri Lanka lags behind other Asian counties 
Global FDI fell sharply by 42 percent in 2020, due to the COVID-19 pandemic. While the developed countries experienced a major 69 percent decline in FDI, the developing countries in Asia only experienced a marginal 4 percent decline. However, Sri Lanka recorded a 33 percent decline up to the third quarter of 2020, compared to the same period in 2019.  

Sri Lanka attracts very few new FDI ventures  
Up to the third quarter of 2020, Sri Lanka has received US $ 350 million total FDI, compared to US $ 523 for the same period in 2019. Another trend seen in Sri Lanka’s FDI is declining ‘new foreign cash inflow’. Out of the total US $ 350 million FDI, the actual new foreign cash inflow into the country was US $ 191. 

New equity investment for the period was a negligible US $ 11 million, indicating very little new venture activity. This trend is probably a big concern for the government, as FDI has been identified as a main source of foreign cash inflow to bridge the current account deficit. 

SL’s existing FDI ventures appear to be little impacted by COVID-19 
Interestingly and on the positive side, data shows that for the first three quarters of 2020 (which includes almost the two-month COVID-19 lockdown), Sri Lanka’s existing FDI ventures have not experienced a significant decline in earnings. As evident from the available data, the FDI ventures have reported only a 10.8 percent decline in earnings compared to last year. 
Moreover, the existing FDI ventures have taken US $ 302 million out of the country as dividends during the first three quarter of 2020, compared to US $ 312 million for the same period in 2019. 

Slower replacement of maturing FDI ventures 
High profit repatriation and low new FDI inflows are clear indications that a large share of Sri Lanka’s existing FDI stock is reaching last (maturity) phase of the FDI cycle. Unless fresh FDIs are attracted (to new ventures), it is inevitable that FDI-related cash flows are going to be a burden on the current account. Sri Lanka has been experiencing negative FDI-related cash flows for several years. 

SL attracted productive FDI in past
Sri Lanka attracted productive FDIs in the past for industries such as garments and textiles, information technology (IT) and telecom. When we analyse these successful industries, we can observe substantial policy interventions (often associated with reforms) targeted at these industries. 

Also there were initiatives to encourage local entrepreneurship to act as the catalyst. A good example is the programme to encourage local entrepreneurs (mostly at regional level) to venture into garment manufacturing through the 200 garment factory programme. This programme put in place a good foundation for the garment industry to develop where it is today.

 Another example is policy initiatives to develop the IT industry in early 2000s through programmes such as popularising IT education, creation of IT parks, etc. The telecom sector reforms in the late 1990s are another example of industry reforms leading to high FDI. The telecom industry continues to attract a good level of FDI, even at present. 

Investors discouraged by Ease of Doing Business Indexes?
Sri Lanka’s low scores in various (international) business indexes, including the Word Bank’s Ease of Doing Business Index, are often highlighted as a barrier to attract FDI. However, many countries such as Nigeria, Ethiopia and Bangladesh, with much lower score than Sri Lanka, attract much higher FDI volumes (also as a percentage of GDP). This suggests that, in reality, FDIs are driven by factors other than what are often highlighted in academic-like analysis.  

Building capacity to absorb FDI
An important determinant often ignored is Sri Lanka’s capacity to absorb investment. In order to absorb productive FDI, there must be a healthy local industrial base, supporting infrastructure and foundation to develop value chains. It is possible to develop the FDI capacity by developing the local industrial base and developing a foundation for the value chain like the 200 garment factory programme. Absence of a scalable industrial base often diverts potential FDI into non-productive industries – like what Sri Lanka experienced in the post-war investment boom in the 2010-12 period, where lot of foreign investment went into real estate-related projects.   

Moreover, when we analyse the FDI trend in Sri Lanka, we can observe that Sri Lanka attracts larger FDI through the merger and acquisition (M&A) route, compared to the Greenfield route. Hence, it is vital to develop the local businesses as a catalyst. In order to do so, there have to be programmes to boost local entrepreneurship and capital market ecosystem.   

(Indika Hettiarachchi, an independent consultant in project, venture capital and private equity investment, can be reached via Indika.h@jupitercapitalpartners.com)