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President Gotabaya Rajapaksa has pledged he would make the country safe, secure and attractive for foreign investment. This is indeed crucial for the country’s rapid economic growth.   The government must pursue policies that would make the country attractive to investors to achieve this objective.

Target

The government hopes to attract foreign direct investments of US$ 2.5 billion. While the achievement of this target is crucial for a higher trajectory of economic growth, increasing FDI is a challenging task in the current global context. Domestic economic policies too should be outward looking and attractive to foreign investors. Strong macroeconomic fundamentals and certainty of economic policies are vital to attract foreign investors.

Importance of foreign investment

The importance of foreign investment is accepted by all political parties. It is a significant driver of economic development. Foreign investment fills the savings-investment gap and contributes towards a country being able to supplement its savings with foreign savings and enhance its capacity for investment and thereby increase economic growth.

FDI contributes to improving work ethics, discipline, skills and knowledge of workers. It is an important means of technology transfer and transmission of management practices. FDI’s also bring with them international markets.

While the quantum of foreign investment is important in determining the country’s economic growth, the nature and type of such foreign investment determines the long term development of the country.

Other countries

It is the realisation of these economic benefits that has made former communist countries like China and Vietnam, and the formerly inward looking Indian economy to actively seek foreign investment. These three countries attract a large amount of foreign investment with China leading the world as the largest recipient of foreign investment. In recent years Bangladesh too has received much FDI that has raised her economic growth to the highest in South Asia.

Past

The inadequate inflow of foreign direct investment (FDI) has been an economic concern for many years. When the country was well poised to attract FDI in 1982 and many important multi-nationals like Motorola had decided to invest in the country, the ethnic violence of July 1983 and the subsequent terrorism and civil war resulted in the country being unattractive to foreign  investors.

Post-war expectations

Much was expected by the way of foreign investment after the end of the war and terrorism in 2009. However, in the ten years after the end of the civil war when FDI was expected to increase, there was inadequate FDI. Once again in 2015 the change of regime was expected to attract FDI. This too did not materialise.

Reasons

The pertinent question is why foreign direct investment was low in the past. The modest level of foreign investment during the period of terrorism and war was understandable. With the conclusion of the war it was widely expected that there would be large inflows of foreign investment.

In fact many investors arrived in the country and expressed their satisfaction about the conditions in the country and articulated the view that Sri Lanka was now a good location for investment. These intentions have not materialised. FDI has been very slow. It was as low as $375 million in 2010, a fraction of what other Asian countries were receiving. In 2018 FDI was only US$ 1662 million and  fell to only US$ 772 million last year.

Causes

Factors determining foreign direct investment are many. The government must look into the reasons and provide a climate for enhanced foreign direct investment. Without a larger inflow of foreign investment, sustained economic growth of 8 percent or more is unrealistic.

Foreign Investment Inflows

The inflow of foreign investment to Sri Lanka is particularly low when compared to what other countries have been able to attract. Countries like Vietnam, have attracted FDI many times what Sri Lanka has attracted. Clearly there is much to be done to increase FDI.

It is encouraging that the government is focusing on the factors that would improve the business environment. It is also imperative that the macroeconomic environment is stable to attract  investors. This key factor is a challenging one to achieve.

Types of FDI

The types of foreign investment too, raise several pertinent issues. FDI is much needed in high technology manufactures and service industries. Such investments would contribute more towards technology transfer and domestic manufacturing capacity.

Factors Deterring FDI

Foreign investment is influenced by political and economic stability, tax and other incentives, labour regulations, work ethics, social and economic infrastructure, costs of production, potential domestic market and an overall assessment of political and economic conditions. Some investments are deterred by corruption and difficulties of obtaining approvals.

For one or more of these reasons, the international investment community has not considered Sri Lanka a favourable destination for investment. It is vital that these constraints are removed quickly.

Investors are primarily concerned about the safety of, and return to, investment. Therefore these factors are not an adequate explanation though they may influence some investors’ decisions.

Macroeconomic fundamentals

High fiscal deficits, a large foreign debt,  and debt servicing costs, potential inflation and instability in currency value, among other macroeconomic indicators may be dissuading investment.

There has to be certainty regarding government policies on foreign private investment. Labour legislation is another area where investors find the lack of freedom to hire and fire an inflexibility. The foreign reserves are inadequate, the large trade deficit and foreign borrowing leaves some doubts about the external finances of the country.

Costs of production play an important Lanka is no longer a cheap labour country. There are other countries such as Vietnam and Bangladesh, where labour is probably cheaper. Labour regulations in the country also affect investment. Sri Lanka is perceived as a country where labour regulations do not permit labour discontinuance either owing to changing market conditions or on disciplinary grounds. Several production costs too are high; this is especially so with respect to energy costs.

Further the possibility of selling in the domestic market is limited. Large countries like India and China offer good prospects of local sales. This is why countries such as India and China are one where reputed manufacturers of cars such as Benz and others have manufacturing plants in these countries. Since Sri Lanka is a location for export manufacture, the recession in western countries offers poor prospects for exports.

Summary

A much higher level of foreign direct investment than what has been received in the past is needed to propel the economy to rapid economic growth. FDI in export manufactures are especially needed. The  government must look into the reasons for tardy foreign investment in the past and take remedial action to provide a climate for enhanced foreign direct investment. Macroeconomic stability, investor friendly economic policies and certainty in policies are vital to enhance FDI. Without a larger inflow of foreign investment, sustained high economic growth is unrealisable.