Sri Lanka dressing up for the wrong bride

Most FDIs since the ending of war in 2009 had been to the tourism sector to exploit Sri Lanka’s natural beauty. Policies have not been devised to attract technology-related investments which are essential to elevate Sri Lanka’s position in the global economy – Pic by Shehan Gunasekara

“Passing the new Monetary Law Act is essential as Sri Lanka looks to borrow about $ 3 billion annually for the next three years” is a headline that flashed yet again last week. This is a continuation of the argument that fiscal consolidation and independence of Central Bank, etc. are the pillars of macroeconomic stability and thereby the catalysts to attract more borrowings.

Could more foreign borrowings solve the debt problem?

As I highlighted in the last week’s article, Sri Lanka’s debt problem is almost entirely to do with foreign borrowings. The simple question arises, “Would more foreign borrowings reduce the foreign debt burden?” 

The disturbing factor is the absence of a plan to reduce the need for foreign borrowings in the long run. The mentality is entirely short term, fire fighting in nature to simply survive today. Talk about taking one day at a time!

The need for equity investors

There is a reason why start-up companies predominantly rely on angel investors, venture capitalists or private equity instead of debt. The equity investors unlike lenders, do not become a financial burden on the company in the initial years. The only cash outflow from a company for such investors is in the form of dividends once the business becomes profitable. In other words, those are the patient and more risk taking investors who believe in the long-term prospects of the business.  

The same applies for a developing country as well. Having policies and measures in place to attract equity investors is critical for a sustainable development trajectory. Reliance on debt along with short-term debt servicing obligations would become a burden as Sri Lanka has found out. The need to repay principal and the interest in foreign currency adds up to the list of problems for a developing country.

Equity investors seek growth

The “long-term prospects” are more often witnessed in the growth rates in a business. It is this factor which attracted investors to companies such as Facebook and Amazon in their early years. Although they were making substantial financial losses, the growth rate was very high. Such high growth meant they were well and truly ahead of competition and was wiping out competition in the process. Had Facebook or Amazon relied on debt financing in their early years they would have been history by now.

The same applies for a country as well. It is the high growth rates that would attract the more risk taking and patient equity investors and the FDIs. Such investments flow in when the investors are confident about the long-term direction of the country and the prospects of long-term high returns for their investments. In the process, we would attract investors who may have otherwise gone to countries such as Vietnam, Thailand and Bangladesh and ensure we “lock them” in Sri Lanka and thereby get ahead of the other competing economies.

What the lenders seek

Unlike the equity investors, lenders are more risk averse and short-term in nature. They are most concerned about safely getting their money back. It is for this reason that they are less concerned about growth and more concerned about lower fiscal deficits and financial discipline. Basically they seek the cash flow situation of the country to be capable of servicing the repayment of the funds they have lent along with the interest.

It is the typical conservative bank’s mentality where a bank would ensure there is ample collateral to recover their funds in case the borrower fails to service the debt.

Failure to attract equity investors

We often hear of obtaining foreign loans as a major achievement. We also hear the officials reiterating that various measures should be implemented to continue to attract lenders. However what should be realised is what we really need are equity investors and also the fact that what they seek are different from what the lenders seek. Unfortunately this critical part in terms of setting policy had been missing pretty much throughout our post-independence history. 

The reality is that the inflow of equity investors or FDIs had been abysmal. Most FDIs since the ending of war in 2009 had been to the tourism sector to exploit Sri Lanka’s natural beauty. Policies have not been devised to attract technology-related investments which are essential to elevate Sri Lanka’s position in the global economy.

Golden opportunity over the next 5 years

The golden opportunity presented with the trade war between USA and China for over a year now has been completely missed by Sri Lanka, while competing economies such as Vietnam, Indonesia and Malaysia have exploited it to attract FDIs. I have tried to explain this aspect more in detail in my recently published book ‘A Simple Plan for Sri Lanka’.

With President Trump likely to be re-elected next year, there is an excellent five-year window for Sri Lanka to exploit this opportunity. I hope that at least one of the serious presidential candidates and their advisors realise this golden opportunity.