Getting adequate foreign direct investment (FDI) of the right types has eluded the country for many decades. While former communist countries like Vietnam have attracted sizeable amounts of FDI, Sri Lanka continues to get an inadequate flow of FDI.
The statistics of the amount of FDI received are flawed as they contain other capital inflows. Even the exaggerated figures are low and inadequate. The country has reached a turning point when the attraction of much higher amounts of FDI is vital to sustain the growth momentum.
Obtaining much higher amounts of the right types of FDI will determine the pace of economic growth in the next decade. Much higher FDI is essential as the country’s investment resources are limited and technological capacities have to be augmented to capture export markets.
Rapid economic growth cannot be achieved in a resource scarce, technologically inadequate, limited domestic market without significant FDI. FDI brings with it export markets, advanced technology and management skills. In due course there would be a transfer of technology that would increase the economic efficiency and capacity of the country. Therefore an investment climate that is attractive for foreign investors is vital for the country’s economic development.
Despite this paramount need, the country has on several times in the past taken backward steps towards making the business climate less attractive to both local and foreign investors. From time to time there have been hopes and expectations of higher amounts of FDI that have turned out to be illusory. At times the imminent flow of FDI has been dashed to the ground by developments in the country such as the ethnic disturbances, the prolonged civil war, statist policies, arbitrary actions of the government and the law and order situation. The economic policies of the previous regime after the war were not at all conducive to attracting FDI.
Countries of East Asia obtained large amounts of FDI at a time when we were following inward looking statist economic policies that were hostile to foreign investors.FDI that was a vital source of growth of East and South East Asian economies were not attracted by us.
A new opportunity arose after the liberalisation of the economy in 1977 when Sri Lanka became the first South Asian country to liberalise trade, finance and investments. The country adopted investment friendly policies and was poised to receive substantial FDI. However this hospitable environment changed with the ethnic disturbances of July 1983 and its aftermath.
The country missed many opportunities to attract foreign investments in industry owing to the ethnic conflict. In his book, Development under Stress, Dr. Saman Kelegama has pointed out that: “1983 was a turning point in regard to missing big international investors and all hopes of becoming the new investment centre of Asia faded away.” In the mid-1980s, “we missed the chance of attracting some portion of the Japanese surplus due to the war related uncertain political climate.” Dr. Kelegama contends that “The South East Asian economies really made a kick-start from this recycling surplus during the mid-1980s”.
He has pointed out very specifically the impact of the war on foreign investment: “The uncertainty created by the war was the main deterrent to foreign investment – which acted as a catalyst to the growth process. Some examples would suffice to indicate the missed opportunities. Two major electronic multinational companies – Motorola and Harris Corporation – had finalised plans to establish plants in the Export Processing Zone prior to the change in the political climate in 1983. Harris Corporation even started building a plant with an initial employment capacity of 1850 workers. Both these companies withdrew from Sri Lanka after the 1983 ethnic riots. Motorola shifted to Malaysia and Harris Corporation went elsewhere leaving a half-built plant in Sri Lanka. Besides these two Corporations, Marubeni, Sony, Sanyo, Bank of Tokyo and Chase Manhattan Bank, were in the pipeline to invest in Sri Lanka in the early 1980s.
All these big Companies decided against investing in Sri Lanka after 1983. Sri Lanka lost a major opportunity of taking a big leap forward because, if these investments had materialized, they would have given a strong signal to other large multinational companies to start industries in Sri Lanka.”
The security situation was the single most important factor in the country’s inability to attract substantial foreign direct investment. Tax concessions, financial incentives and assurances hardly offset this drawback of insecurity. The fact that the Japanese, the highest aid givers and an important trading partner, are not large investors in Sri Lanka is a telling example, as it is counter to the usual practice of aid, trade and investment moving in tandem.
This lost opportunity has been very costly as it is much more difficult to attract FDI today when a large number of countries are offering attractive incentives and there is a global downturn. However now that there is peace and security, the biggest hindrance for attracting foreign investments has been removed can the country attract higher amounts of foreign direct investments?
Whether the expectation of higher FDI flows would materialise now depends on the stability of the economy and the soundness, certainty and continuity of economic policies. In as far as law and order and the rule of law and foreign relations are concerned the government has restored conditions that are favourable for investment. While these are necessary conditions, they are not sufficient. Economic stability and macro economic fundamentals must be strong to make the country attractive for FDI. Assessments of the country as a risky destination for investment would deter foreign investors.
What are the other conditions that must be fulfilled to attract FDI? It is important to ensure an attractive investment climate. Consistent macroeconomic policies, good governance, economic stability, guarantee of property rights, rule of law and absence of corruption are among the conditions required to attract FDI. Consistency and predictability in economic policies and political stability are preconditions to attract FDI. These conditions are yet to be achieved.