Hambantota Port and Porter’s Diamond Model

Hambantota Port

By Waruna Singappuli CFA

70 years since claiming independence from British rule, Sri Lanka remains a developing country with various explanations as to why the country couldn’t take off. Various theories are spelt out as to how it could be developed, without a proper basis or rationale.

Diamond Model explains how countries developed. It is worth referring to the ‘Diamond Model’ developed several decades ago by the American Strategy Professor Michael Porter. Simply put, it is a way to figure out which industries of a country could thrive in the global market place. A key aspect of this model is the ‘factor conditions’ of a country which refers to the competitive advantages a particular country would enjoy for a certain industry in comparison to other countries.

What competitive advantages were possessed by the countries that achieved ‘developed’ status in the past? A technological revolution that the rest of the world didn’t have access to, was the prime reason why Europe and USA developed a couple of centuries ago. Possession of valuable commodities (Crude Oil) is the reason for the rich nature of Middle Eastern economies. Japan possessed a hard working population and came up with amazing management techniques such as Just in Time (JIT) and Total Quality Management (TQM) in the 20th century. Technological innovations – initially as a low cost base and thereafter as a quality supplier of Electronics items drove South Korea.

Then there is Singapore. Being a small country with very little natural resources, how did it develop? The key competitive advantage for Singapore was its location as a port city – right in the middle of the shipping lane that connected Europe with East Asia. It is an amazing story as to how the country, which is the size of Colombo, exploited this seemingly insignificant competitive advantage over decades to reach the ‘developed’ status, as its port became one of the top two ports in the world.

Diamond Model on Sri Lanka

What are Sri Lanka’s competitive advantages? The natural beauty and the small size is possibly a key competitive advantage which could be utilised by the Tourism industry (although rivalry exists in the region in Thailand, Malaysia and Maldives). The knowledgeable workforce would continue to drive IT/KPO industries (although bigger countries such as India will always be ahead of us). We do possess limited natural resources such as gems and fertile soil which produces agricultural crops such as Tea and Rubber, although gravely insufficient to drive us to a ‘developed’ status. In my view, similar to Singapore, Sri Lanka’s best asset or competitive advantage is its location. We sit right in the middle of the shipping lane that connects East and West and in close proximity to the emerging economic giant, India.

According to the Diamond Model, it will be an uphill task to develop industries where Sri Lanka does not possess a competitive advantage. Although automobiles and electronics industries sound fashionable, and countries such as Japan and South Korea actually developed through those industries, it is difficult to envisage Sri Lanka making significant strides because neither does it have a competitive advantage currently, nor those industries are at early stages unlike many decades ago. Our competitors are miles ahead of us. Even the garments industry which played a crucial role over the last 20 years may gradually lose its significance over the next 20 years as the industry shifts to low cost destinations. Our leaders in the industry such as MAS and Brandix have already made significant investments in low cost bases such as India and Bangladesh.

Even Singapore focused on a handful of industries in its early stage of development and discouraged industries that did not possess competitive advantages. Lee Kuan Yew in his book ‘From third world to first’ says, “In early days, our investment promotion efforts were concentrated on four industries: ship – breaking and repair, metal engineering, chemicals and electrical appliances and equipment. We did not hesitate to let factories shut down and remove the tariffs and phase out protection for the assembly of refrigerators, air-conditioners, television sets, radios and other consumer electrical and electronics products”.

Tourism, KPO and Commodities (Tea and Rubber etc) based value added industries could supplement the growth thrust of Sri Lanka, although the key development driver should be based on its main asset, its location. Similar to the real life case study of Singapore, this should be initiated by the development of Ports (both Sea and Air).

The Colombo port is already predominantly feeding India as a transhipment hub and it can grow further as the Indian economy expands. Hence the rapid expansion of the Colombo port could be a wise move.

More importantly, Sri Lanka benefits significantly from the Colombo port as the terminals are shared by the Government, a local private entity and a foreign entity instead of being run by a foreign entity altogether. As the Port develops further, it is essential that ownership is diversified in a way that Sri Lanka benefits significantly. Piggy backing on India is just one aspect of exploiting the location advantage. The other, potentially even more lucrative aspect is how Sri Lanka could benefit from being in the middle of the sea route that connects the East and the West.

Hambantota Port could be Sri Lanka’s best hope

This brings us to the sensitive topic of the Hambantota port. Critics may say that another large scale port is not needed between Dubai and Singapore. However the distance of 3,450 nautical miles between Dubai and Singapore would be reduced by 50% if a well functioning port exists in southern Sri Lanka.

Hambantota provides the least deviation time for the ships sailing across the Indian Ocean to and fro from Europe to Asia. Although I’m not an expert on the subject, it is clear that Sri Lanka possesses a competitive advantage here, an asset that no country in the world has access to. When there is a competitive advantage, there always exists a strategy to exploit it, although it wouldn’t be clear or straight forward (which is the case with all business strategies). The challenge for us over the next several decades is to fine tune the right strategy so that we successfully exploit the best natural resource we possess.

How do we formulate a strategy to exploit this advantage? That is a task for the best entrepreneurs of the country who has already conquered world markets (e.g. – MAS, Brandix, Virtusa, Loadstar, Dilmah to name a few) and the best academics/economists who have a sound knowledge of how countries developed over the last few decades. We would need foreign expertise as well, although may not be through consulting expensive MNCs at a high cost. It is worth noting how Lee Kuan Yew describes the way they used foreign expertise: “Dr Albert Winsemius played a crucial role as economic adviser, serving for 23 years. We paid for his air tickets and hotel bills in Singapore but for nothing else. It was Singapore’s good fortune that he enjoyed working with us.” Clearly they didn’t hire expensive consultancy firms and didn’t blindly follow the advice of the advisors. 

While it is a task for the experts to formulate, several possible initial industries in Hambantota port could be Bunkering and Ship Repairing simply because the ships travelling a distance of 3,450 nautical miles are likely to have such requirements. It should be remembered that no strategy would guarantee immediate success and the current global market place is extremely competitive. Business plans and strategies should be fine tuned over time as one understands and experiences the changing business conditions. But a critical success factor should be continuity and consistent political backing.

Key success factor is the policy consistency of governments

The strategy formulated by the experts should be endorsed in principle by the major political parties.

There shouldn’t be a disagreement on which industries should be prioritised and encouraged. The rationale is, it is not possible to develop something valuable in a matter of weeks or months or even years. Most countries or businesses develop over decades by diligently following a sound strategy to exploit their competitive advantages. There is no way that we could develop a strategic asset if priorities change every time the Government changes.

Most importantly, since the development of the port related industries would depend on foreign direct investments (FDIs), the assurance that there is continued political sponsorship would facilitate the attraction of FDIs. Capital wouldn’t flow to projects or places which are plagued with uncertainty.

Hambantota port was not premature

“The Jurong industrial estate in the west of Singapore was empty in early 1960s in spite of the vast sums we had spent on infrastructure. We had more than our share of failures. Our break came with a visit by Texas Instruments in October 1968. Jurong was humming with activity by 1975.” are the words of Lee Kuan Yew. It wouldn’t be right to say that Hambantota port was ahead of times. In fact, it could be behind times and should have been developed decades ago, as it always had the potential of becoming the most strategic asset of the country. The fact that it is still vastly underutilised despite the completion of the first phase in 2011 doesn’t mean that it is a failure, going by the real life case studies across the world including that of Jurong in Singapore.

In large scale projects such as these, it is often a chicken and egg dilemma. Infrastructure such as Ports and Airports should be in place for Industries to be set up and FDIs to flow in, while on the other hand to justify the setting up of Ports and Airports, industries should be in place as otherwise the infrastructure would remain unutilised for long periods of time (which is what we are experiencing currently). This dilemma does not exist anymore as the basic infrastructure is in place and the focus should now be on attracting industries. Admittedly, the attraction of industries has been slow. Although it is not a disaster yet, probably we need to improve our strategy, work towards policy consistency among Governments and be patient for a bit of luck (or the “big break” as Lee Kuan Yew put it) that will definitely come our way sooner or later if we tread the right path.

Core competitive advantages are priceless

No country has an abundance of competitive advantages and specially a small country such as Sri Lanka should dearly hold on to such scarce assets. That is why it would be unwise to divest a vast majority of ownership of the Hambantota Port to a foreign entity. While it may not be practical and unwise to retain full ownership in the absence of technical know-how and financial strength to develop the asset successfully, a tie up would be essential with the right party. The Government should ensure that Sri Lanka would get close to 50% of the total benefit of the port related developments once it is in full flow in the decades to come.

It would be a misconception to think that assets such as the Hambantota port could be replaced by FTAs (Free Trade Agreements) which would ensure economic development. There is nothing that prevents two countries from entering into an FTA and hypothetically once the entire world is connected through FTAs, there ceases to be a competitive advantage in the long run. In the near term, we will be at a disadvantage if our competitors enjoy FTAs and we don’t. Therefore we do need to enter into such agreements which are formulated to benefit Sri Lanka as well as the counter party. However it wouldn’t be a competitive advantage and will only prevent us from being in a competitively disadvantageous position.

Suicidal to meet short term liabilities through strategic assets

A basic concept in Finance is that a business’s long term assets should be financed by long term funding sources and short term assets should be financed by short term funding sources to avoid a maturity mismatch. It is short sighted and suicidal in the long run to divest a long term asset to meet short term debt obligations. Effectively you will be letting go of your long term earning potential for short term consumption which would be a grave injustice for the future generations.

Further, when you seek the right partner to develop a key strategic asset, you should be in a position of strength at the negotiation table with sound macro economic conditions in the country and consistency in terms of Government policy. Then many potential partners could be attracted and you will get the best deal and the best partner for the country. On the contrary, if you have announced to the world that the country’s foreign reserves are weak and the short term debt burden is too heavy, you have showed your weak hand and desperation to the possible strategic partners and would naturally end up with a less than desirable deal.

Foreign reserves could be safeguarded through other means.

Although the purpose of this article was not to propose solutions to boost foreign reserves to successfully meet short term debt obligations, the article would be incomplete if at least few options are not pointed out.

1) Sri Lanka’s foreign reserve position seriously deteriorated in 2015 as over $ 1 billion foreign

outflows were witnessed in the Treasury market. What caused the foreigners to exit the

Treasury market in 2015? Is it the artificially low interest rates that prevailed along with the policy interest rates reduction in April 2015 (when the market forces suggested that the interest rates should actually be increasing) which provided attractive bond prices for the foreigners to exit? Is it the artificial stability of the Rupee around 131 – 133 per USD from October 2014 to August 2015 as the Central Bank spent well over USD 2 Bn of its reserves to defend the currency, allowing the foreigners to exit the bonds at an attractive price in USD terms?

An improved monetary policy and policy consistency of the Government could easily attract well over $ 1 billion foreign inflows to the Treasury market in a relatively short span of time.

2) The Government could take steps to divest non-strategic assets. The proposal to divest entities such as Lanka Hospitals and GOH are understandable although unlikely to raise sufficient funds. 

Significant stakes (of less than 50%) of other natural resources (such as the Phosphate and

Limestone deposits) could also be divested to the right partners who would be capable of developing those assets to become revenue generating assets.

3) The import bill in 2016 was almost $ 19 billion which has resulted in a trade deficit of $ 9 billion.

As a short term measure, although it is not the ideal solution, the Government could take steps to curtail non-essential imports and reduce the import bill by around $ 1 billion. This could be a case of belt tightening for certain industries and the population at large. However it would be a minor sacrifice for the future of Sri Lanka and the betterment of our sons and daughters.

(The writer operates a boutique, independent macro/equity research house and can be contacted on [email protected]).