An island of opportunity

fDi Magazine Deputy Editor Jacopo Dettoni talks to Daily FT about 

investment opportunities after 

Sri Lanka tops the global rankings of ‘Island Economies of the Future’ 

By Uditha Jayasinghe

Q: What is the significance of Sri Lanka heading these rankings?  

A: We looked at five different categories including economic potential, business friendliness, human capital, connectivity and cost-effectiveness. Basically Sri Lanka ranked first in economic potential, first for business friendliness and seventh for connectivity, which led Sri Lanka to win the overall ranking for ‘Island Economies of the Future’. The rankings assist to gauge an island’s ability to attract inward investment. This does not necessarily mean the country is already making the most of this potential. 

Sri Lanka is interesting in this aspect because levels of FDI remain pretty low when compared to GDP and net FDI has been decreasing but at the same time there are two components here. There are definitely positive signs emerging on equity investment, especially locally produced earnings by foreign companies, so basically from this perspective there is a growing amount of equity by foreign investors into Sri Lanka and rising investment earnings. Pure investment by foreign companies into equity of Sri Lankan companies there is definitely a big jump and there is an upward trend in earnings. In terms of debt and issuing bonds, the 2016 level is half that of 2012 so this narrative matches our rankings. But there is obviously room for improvement. 

Q: At a time when countries are moving more and more towards specialisation, what can Sri Lanka gain from diversification? 

A: Diversification is a measure for the resilience of the economy against a global phenomenon that can disrupt the economy but it is not necessarily a recipe for a country like Sri Lanka. Economies across the world are moving towards specialisation. Sri Lanka is trying to move into more advanced manufacturing, services and sectors with more value addition; and definitely if you look at the scale Sri Lanka cannot produce everything from biscuits to steel. 

Sri Lanka, like many other countries around the world, will have to figure out what its excellencies are and adjust with the right policies accordingly. So there is definitely scope for light manufacturing and to leverage its position in the Chinese Belt and Road Initiative. There are plenty of ships passing Sri Lanka but how can they be encouraged to stop? There could be a very convenient gateway to India and Pakistan through the Free Trade Agreements (FTA) and this does not only need to be for China, it could be for anybody. China is certainly paving the way there and if their infrastructure projects materialise, especially Hambantota port and the free trade zone, definitely there could be space for other investors to try and make the most of the same geographical location and privileged relationship with India and Pakistan. 

Q: How can policymakers use this study to create a more investment friendly climate? 

A: It can definitely be used as a reference to understand where there is potential. For example we look at five different categories and Sri Lanka definitely has economic potential. At the end of the story this is the most important element for local or foreign investors. They invest where they see potential for profit. But then there is a whole set of enablers of investment that has room for improvement.

Infrastructure is one such area. A few weeks ago when there was a collapse of the garbage dump just on the outskirts of Colombo that obviously makes headlines and it’s not a single story. If you have been to Colombo you know waste management is an issue, as it is an issue in South and East Asia or as it is an issue in developed countries. But this is an issue that can capture the imagination of investors. Governance can also be improved. If we take this specific example it is not just about a landfill it is also about having someone pick up garbage and take it somewhere; basically the operation of governance. It seems to me there has been a lot of emphasis on creating the right kind of environment for foreign investors, which includes the latest round of fiscal incentives that also target them, so from a policy perspective there is an interest in pushing investment but at the same time you have to look at the whole picture. When it comes to connectivity there is definitely a gap when compared to other countries in the rankings. 

Q: Do you feel that enough emphasis has been placed on Sri Lanka’s debt challenges in your rankings? How does that challenge get factored into growth?

A: There is definitely a big challenge. If you think of economic potential it is not necessarily a measure of the financial stability or financial resilience of a country. Debt could be rolled over, if the creditor keeps rolling over its debt it can be a different story. 

Most of this debt, at the moment, is in the hands of China. So China has no interest in pushing Sri Lanka off the cliff. If you look at the business side of things they are sorting out all the details. So from a more scenic kind of perspective there is no reason why they should pull the plug and say ‘give me the money back’. They have already shown that they are willing to convert debt into equity. 

Obviously this is something that you have to factor in but here we can also look at the details of the International Monetary Fund (IMF) program focused on reducing fiscal deficit, which is what is on the mind of the foreign community. The bottom line is that these levels of debt are a concern but if you put them into a context that most of this debt is owned by an investment and trade partner and if you put it into the perspective that the country, at least so far, has tried to stick to the recommendations of the IMF, the bright side could be that debt becomes more manageable. If things unravel and there is a possibility that things can unravel, obviously, that would affect economic potential.     

Q: The Sri Lankan Government has put a lot of focus on Public Private Partnerships (PPPs) as a way to attract investment. Do you think this would improve chances for growth? 

A: There is a big push by international organisations to engage more with the private sector to finance large-scale projects through PPP schemes but at the end of the story if you are China and you have no problem with your fiscal balances why would you give ownership or concession rights to private investors when you can do it yourself? 

So in this case Sri Lanka can definitely lift some of its pressure of fiscal deficit through engaging more with the private sector and through concessions you can develop yourself. It also gives more space for a country to manage its fiscal diversity in different ways, so in a way you are replacing public investment with private investment. 

It does not necessarily mean that in the growth trajectory of a country this will have a huge impact but definitely if you look at it from a foreign investment perspective, it can improve the business environment. But this a very long shot. Everyone wants to do PPPs but very few countries have been successful in doing PPP because it is a matter of governance, it is a matter of managing risk and a whole different range of factors. It’s a step in the right direction from the perspective of a foreign investor, but delivery and governance are key.           

Q: What are the top three things that successful island economies have done? 

A: This is a ranking that looks at the future, so it is about FDI potential. If you take the first three countries there is a reform push in all of these countries that overall sticks to accepted economic policies of liberalisation. 

This push for reform has been pushed by big disruptive events. For Sri Lanka we know it was the end of the war which gave a chance to return to business as usual. For Cyprus it was joining the European Union and the Dominican Republic was very successful in setting up the outsourcing and IT/BPO sectors. Reforms also give investment protection. I definitely think reform, secondly economic growth, which go hand-in-hand. Sri Lanka went through very troubled times and in 2009 everyone expected the country to grow because of the end of the war. Infrastructure and governance are also factors. 

At the same level as infrastructure there is also tourism. Tourism is also a very important push for investment. It sounds simplistic but there are many businessmen who travel as tourists and if they end up in a place they will look for opportunities. Tourism is good to develop an industry but also to promote opportunities that this country can specifically offer beyond tourism. This is very important. All the top three economies have done that very successfully.       

Q: What are the key insights from the 27 island economies evaluated for the rankings? Do you think that island economies can really be global contenders for investment? 

A: The islands that we considered for this study are very diverse but still all these fall into key points of our methodology. For a matter of scale they will never be $ 10 billion or $ 20 billion FDI but investors are after profits. 

Countries that excelled for FDI during the commodity boom like Kazakhstan, Turkmenistan are not famous for their quality of governance but there were other reasons for investment to pour into these countries. 

Sri Lanka cannot rely on oil or gas or mining resources but that doesn’t mean there couldn’t be opportunities for investors. Maybe the scale would be different, investment has to be compared to the scale of the population and the economy, and this is why I always tend to look at data like FDI to GDP ratios rather than the absolute figures. 

Sri Lanka has not done well on this front. In 2015 its FDI was 0.8% of GDP when the average for South Asia was 1.8%. So there is big room for improvement.  But having said that there is space for island economies to be attractive for foreign investment in their niche of excellence, obviously there are issues but every country has got issues. The key point here is investors are looking for opportunity and island economies can have as good opportunities as big countries.