Cost of the war on FDIs

* Sri Lanka has lost Rs. 3,000 b due to terrorism directly

* Private sector must support Govt. to make SL competitive with policy reforms

The recent hot topic in Sri Lanka has been on the FDIs that have not come into Sri Lanka post the war. But a point that people miss out in the debate is that Sri Lanka has been plagued with a war on terror in the last 30 years and the focus has been more on survival mode rather than on the competitiveness agenda.

I remember when I was serving the country at the height of the war from 2006 to 2009 on overall economic policy and driving revenue on different fronts, there were days when while a meeting was in progress focusing on policy reforms, we would hear of a terror attack close to the very building in which we were sitting. This gives us an indication of the mindset that policy makers worked with at that time.

Post 2009

Then the question that can be asked is, post 2009 what progress have we made as a country? Whilst the economy has grown from 3.5% GDP growth to a commanding 8% performance in 2010, what we see is that policy reforms have been slow on the uptake. Budget 2011 was the first statement that the country made on the policy reforms that are to shape a new Sri Lanka and that was in November last year.

My hands-on analysis is that for policy reforms to happen amidst a political economy like Sri Lanka, it will take at least three to five years, which is why we hear many investors complaining about issues such as approval taking time and bureaucracy that exists when they comes into Sri Lanka with dollar investments.

Whilst complacency cannot be tolerated in a high growth agenda like today, in my view we also need to be mature to understand for systemic changes to be make like what’s happening at the BOI as we speak, can be very painful and has to be executed with a lot of tact especially in a political economic climate we live in. A point to note is that the whole of South Asia is dogged with this issue of a political economy and not just Sri Lanka. The only way out as I see it is for the private sector to keep the pressure on so that the key policy makers can instil the ‘culture change’ even amidst many challenges.

Sri Lanka – Against odds

If we take the combined profit of 221 companies in 2010/11 we see that profits have swelled to a commanding Rs. 123 billion at a growth of 140%. Whilst being up beat of 2011 from an internal perspective, we can also see that that the world is on a spin with all indicators pointing towards a double dip recession.

The La Nina phenomenon that ravaged South Asia, leaving an economic bill of around 50-75 million dollars in the North East of Sri Lanka... Then the economic turmoil in North Africa and Middle East that has shot the barrel of oil past $110... And now the tsunami in Japan, which is estimated to cost the country a 10 billion dollars... All these are very unfortunate as growth globally is yet very fragile in nature.

The question now is, how we can ride the wave of growth this year amidst all the shocks hitting us from different ends?

FDI flow SL – Fluctuating

If I may take you back on the FDI inflow to Sri Lanka, it has been fluctuating widely during the last 24 years with the overall performance being below the set targets and way below the performance of regional counterparts. It is estimated that Sri Lanka has lost around US$ 3 billion on FDIs during the last 24 years mainly due to the war.

If one digs deeper it could be said that there is a strong relationship between the security situation and the FDI flow into the country. Especially in the 1987-1989 periods, the trend was very evident but thereafter in the 1990 there was a surge in the inflows due to the higher business confidence experienced. But, after the TNT laden truck of the LTTE rammed the Central Bank in 1995, there was another drop experienced in the flow of FDI.

Driving investment in Industrial sector

If we analyse the sectoral contribution to the Sri Lankan economy, I would strongly suggest that we focus and drive ourselves to be stronger in the Industrial sector through FDIs and investment in R&D. Currently only 27% of the GDP comes from the Industrial sector with around 1.8 million people being employed (which is 24% of the population).

A point to note is that the average annual growth rate in the Industrial sector has been 6.2%, whilst it contributes a mammoth 78% to the total exports, which explains the importance of this sector for the future. Hence any investment that Sri Lanka can attract in this area will help drive the exports industry and help in attracting foreign exchange to the country.

Even though the Industrial sector is strongly diversified, it is skewed heavily to the garments sector, which has around 800 factories providing employment to 300,000 workers.  In my view we need to spread the risk in the Sri Lankan economy by way of export earnings given the double dip recession that might hit the US and the EU in 2011 and given the many shocks we have already experienced.

One option is to increase bilateral trade with India under the Indo-Lanka FTA banner which accounts for just 4% of our exports and also carefully architecture how the proposed CEPA can be used to drive exports in the service sector. Separately we also need to watch the ‘APTA’ agreement that is taking shape as this can provide many opportunities in driving FDI growth as well as export diversification. The good news is that the Ministry of Industry and Commerce is already working on this.

The truth – Very low on R&D

Believe it or not, only 5% of Sri Lanka exports are with new R&D capacities. If we take a country like South Korea, this number is as high as 65%. This gives an indication of the need for FDIs which are R&D driven. I believe that the real cost of the war is on aspects such as these rather than just the disparity between the set target and delivery in the last 24 years.

Whilst we see that countries like Vietnam and Cambodia being able to attract this kind of investment, Sri Lanka has been totally internally focused to find a way to solve the LTTE issue.

We must note that R&D is the ‘key’ to making an economy marketing-oriented. Current spending on R&D in Sri Lanka is only 0.16 per cent of GDP, down from the 0.30 that was spent way back in 1996. This is also way below the investment by our competitor countries like Bangladesh, Vietnam and South Korea.  What we see is that these countries have experienced phenomenal growth in the last two decades by investing almost 2.8 per cent of GDP on R&D. This explains the strategic thinking required to make a country ride the industrial revolution. Scandinavian countries spend nearly four per cent of GDP on R&D whist reports coming in say that India has increased its investment to 1.5 per cent of GDP. The India Prime Minister once made a comment that R&D is the only way to make a country compete with the Western world. I guess the nano car is ample testimony to this statement.

Global learnings – R&D

Discussing further these best practices of R&D driven FDIs, we see that countries like in Japan and South Korea use R&D and the ‘commercialisation of the innovation’ as separate functions in a country. The research agencies are linked to the university system whilst the development houses are linked to the business world.

This cycle makes the university system align their curriculum to satisfy the business needs. Hence, naturally the graduates churned out by the universities are the most sought after by the business world. This is capacity building at its best.

Sri Lanka needs to take a cue from this if we are to solve the unemployment issue of graduates and make the economy marketing-oriented. The recent policy reforms that are being induced to the education system by the new Minister are a welcome sign. I hope the country supports these unpopular decisions that are being made for the betterment of the country.

Another pick up is that the development houses are funded by the government so that strategically the government can direct industry to be developed with focused FDIs like what we see in Brazil in the coffee industry.

Sri Lanka needs to do the same with a strategic focus on the tea industry, apparel industry and perhaps the niche BPO/IT sectors. We also must take the global learnings on which investment will bring the best returns to Sri Lanka before venturing out.

For instance, the ceramics industry, where power and energy zaps up almost 40% of its cost, needs to be thought through before any future investments are made. A point to note from a social economic angle is that the return does not have to be only from a monetary sense but also from a social economics perspective; namely, employment and poverty reduction.

Way forward

A way forward for the Industrial sector is for Sri Lanka is to have a base of vibrant, competitive and world-class manufacturing industrial firms that could generate higher economic value-added products that can drive up profits and create sustainable employment for a wider array of people to alleviate poverty. This is where FDIs must be focused.

Tourism related FDIs that we have experienced are great, but carrying cost must be calculated. This includes sewerage systems required, storm water planning and the requirement of human resources so that we will not create a situation where unplanned development can lead to bigger issues in the country.

We need to proud that Sri Lanka has stellar infrastructural growth with projects like the Upper Kotmale Hydro Power Plant, the Puttalam and Trincomalee Coal Power Projects and the Kerawalapitiya Power Plant to address the key issue of power.  On the other hand, to drive stronger logistics and accessibility, it has the Colombo South Port, Galle Port, new international airport and national road projects like the Southern Highway and Northern Expressway to name a few. Now the challenge is to make Atchuweli and Mannar Industrial Zones operative with focused FDIs.

We also need to drive the existing engines of growth by introducing technology so Sri Lanka keeps abreast of the changing global arena. Some may call this the knowledge based economy. Whatever term used, the end result is making a particular industry more competitive globally.

How to attract FDIs

Some of the key strategies we can have ready to drive in the near future to attract FDIs should be high quality infrastructure projects like special economic zones, export processing zones and technology parks whilst developing the supply chain aligned to the booming Indian market.

We must also launch a special incentive package aimed at selected export industries so that global FDIs can be directed to Sri Lanka. South Africa did this successfully in the aluminium industry a few years ago.

Sri Lanka must enter the IT and knowledge-based industry and perhaps target a BPO in the Jaffna District as World Bank research in 2007 revealed that the youth of Jaffna have a higher education standard than the national average.

Perhaps in the medium term we must build our own nuclear power plant; ideally a 500 MW nuclear power plant, which can cater to the electricity demands of the future. Nuclear power is the most cost effective and environmentally clean source of power in the world. This will result in Sri Lanka acquiring invaluable knowledge and technology, bring down the electricity price drastically, create thousands of jobs, make Sri Lanka a modern country with state-of-the-art equipment and technology and help reposition the country in a different perspective in the South Asian region. In my mind, Sri Lanka has never been short of ideas and strategies. What the country requires is gold standard execution with passion, but the private must sector support the State to make this a reality. After all, we have already lost Rs. 3,000 billion worth of FDIs into Sri Lanka and it is possible that the hidden cost of the war can shoot up to even Rs. 5,000 billion.

(The author is actively involved in the growth agenda of the country and serves the country at the highest level of decision making in the areas of business/economic development in the private and public sector. Rohantha has a double degree in marketing and an MBA and is currently a doctoral candidate in business administration.)