Incentives key to avert FDI fall – Experts

A drastic fall in Foreign Direct Investments (FDI) is likely if incentives are rationalised as contemplated by the Government in the upcoming 2011 Budget later this month.

Experts said that in the first half of this year, the FDI figure amounted to less than US$ 200 million and the full year figure is forecast to be around US$ 400 million, the lowest in recent years.

“If incentives are rationalised, there is a danger of FDI flows falling to past annual average and a low of US$ 300 million,” they warned.

According to BOI data, the estimated FDI base in Sri Lanka is slightly over US$ 5 billion with an annual average of US$ 200 million. Of the US$ 5 billion plus FDI figure, over 40% had been attracted since 2006 and the highest figure of near $ 900 million in 2008, which is a credit to the President Mahinda Rajapaksa administration.

However, the estimated decline of FDI to $ 400 million this year is despite Sri Lanka enjoying a full year of peace, which suggests that despite no war or terrorism, the country has failed to be a magnet for foreign investor interest.

The dip in FDI is also partly due to after effects of the global recession whilst impending rationalisation of incentives, experts claimed, have sent wrong signals to prospective future investors. In that context, experts warned that unless Sri Lanka improves its incentives regime as a further attraction on top of the peace dividend, FDI flows would further dip in 2011 as well.

The much larger and robust economies of India and China of late have stepped up their appeal for FDI in addition to opening up new sectors for foreign investors.

Contrary to the popular belief that FDI is tax free or that the Government gains no revenue, experts pointed out that all Board of Investment (BOI) approved ventures since 2002 pay dividend tax of 10% though profits are tax free. If dividends are not declared and repatriated but retained it means reinvestment or a new investment.

More importantly though, duty free BOI companies imported capital goods and machinery are subject to around 13% tax in the form of other levies such as Port and Airport Levy.

“So there is taxation at the commencement of a BOI venture as well as if and when they repatriate profits,” sources pointed out. This alone shows that foreigners or FDI projects are subject to taxation already and contribute to Government revenue. Furthermore, BOI companies also pay/paid a 0.25% as economic service charge based on turnover during the tax holiday period and 0.5% during the concessionary tax period. After a specific tax holiday is over, BOI companies are also subject to 1.5% Social Responsibility levy.

Several BOI companies are also allowed to sell a portion of their products in the local market, which is subject to all levies and duties. Additionally middle and senior management local employees and expatriates are also subject to PAYE tax. In Bangladesh, for example, foreign employees are exempt from income tax whilst foreigners/firms also enjoy exemption from tax on interest on foreign loans taken.

Malaysia also provides reinvestment allowance and accelerated capital allowance.

Experts pointed out that majority of an estimated 1,500 BOI approved companies make a significant contribution to the Sri Lankan economy, apart from employing around 500,000 persons and accounting for the bulk share of exports.



BOI-approved investments have also made a critical contribution to improving infrastructure with the telecom sector being the best example. The Colombo Port too was modernised via the then biggest BOI-approved investment, South Asia Gateway Terminals Ltd., whilst in the same sector the country’s biggest investment of US$ 450 to 500 million is envisaged by China Merchant Holdings International and Aitken Spence for the Colombo South Harbour Project.

Apart from developing the manufactured and industrial exports sector, BOI projects have also expanded and improved the power and healthcare sector whilst emerging industries include IT/BPO and higher education.

In post-war Sri Lanka, tourism, leisure and entertainment as well as the services sector including maritime and aviation are likely to see higher foreign investor interest, provided incentives are intact, experts noted.

It was emphasised that whilst peace is certainly a positive factor in considering locations for FDI, foreign investors are also encouraged by several others such as good governance, consistent economic policies; sound macroeconomic fundamentals, low interest rates, easy access to finance, ease of doing business, minimal regulations, flexible labour laws, competitive electricity tariff (cost in Sri Lanka is said to be highest compared to Vietnam, India, Pakistan and Bangladesh), better infrastructure, foreign-friendly land laws, public sector reforms; law and order situation and low levels of corruption.

Since the domestic market and natural resources are limited, Sri Lanka has to lure FDIs which focus on manufacturing for export. Experts also said to achieve the envisaged development to meet socioeconomic challenges, a large inflow of FDI is critical for Sri Lanka.

In that aspect, manufacturing and the services sector to a lesser extent are the best sources as opposed to agriculture in creating adequate jobs to over 300,000 entering the labour market annually.

It is estimated that near 500 BOI ventures have completed their tax holiday period project whilst according to the IMF a sizeable portion of existing BOI concessions are set to expire over the next two

years (with nearly all expiring by 2015). Under the Government-IMF US$ 2.6 billion, a decision has been made to revamp the BOI as well as reduce the revenue erosion owing to granting of tax concessions to BOI ventures. In its recent Staff Report, the IMF said limiting new concessions and reforming the BOI would be the most significant base-broadening tax measure as part of the government’s tax reform strategy.

Analysts also said that BOI, which is an autonomous statutory institute by law thanks to the original powers vested under the GCEC, a brainchild of former President J.R. Jayewardene, is most effective provided procedures are simplified, efficiency improved and strategy and marketing focused.