Kick-Starting FDI – Industrial Zones with a Twist

Originally appeared on Echelon

By Ravi Ratnasabapathy

Liberalising Sri Lanka’s economy is a controversial topic. Different groups have different views on what this means or how far it should go, but most people will agree that attracting FDI and boosting exports is a good thing. One way to reconcile differing interests is to revisit the old concept of industrial zones – but with a twist; privately-run zones that are managed by international zone developers. The success of Japanese and Thai industrial zone developers in Vietnam and Thailand offer a model that may be replicated in Sri Lanka. Japanese zone developers offer investors a complete solution – not just the physical infrastructure but all the soft services: from company incorporation, tax registration and advice on visas for expats to introducing accounting and law firms.

COMPREHENSIVE ‘HARD’ INFRASTRUCTURE
The ‘hard’ infrastructure goes beyond just the land, power, water and waste disposal that Sri Lanka’s zones currently offer. Japanese developers offer housing (flats for expats), clinics, schools, banks, shops and even a Japanese restaurant (or canteen offering Japanese food) – sometimes even a golf course. With regard to power, the developers either have special arrangements with the utility to guarantee continuous power (with engineers dedicated 24×7 to deal with issues) or have a private power producer as a tenant in the zone. For example, in the Amata Nakorn Industrial Estate in Thailand, the developer has group companies that provide power, water, natural gas, logistics and transportation services to clients within the zone.

SUPPORT SERVICES
The developer also offers services: continuous support during factory construction, as well as ongoing operational support—logistics, customs, recruiting, banking, courier service, security guards and fire brigade. To deal with problems, they provide a 24-hour, 365-day helpdesk. They also disseminate information on changes in laws, wage levels, etc., and hold a monthly meeting with tenant firms to discuss any common issues. Critically, soft services are provided by Japanese staff (or fluent Japanese speakers who understand their business mindset). Japanese investors tend to be more risk-averse than others, and Japanese SMEs even more so. The advantage is that, if a zone is developed with the Japanese, the standards of service would be to such exacting levels that any other investor would find it a breeze.

Thus, what developers provide is a complete infrastructure and services model in which client companies can start operations almost on a plug-and-play basis.

GETTING LAND AND DEALING WITH RED TAPE
A recent paper on industrial zones and their link to economic growth notes that access to suitable land is one of the biggest problems faced by investors. Some 80% of the land is owned by the government, and difficulties in obtaining land combined with uncertainty over land policy (constantly changing tax rates, ownership restrictions) act as a deterrent.

Interviews with investors revealed that it was relatively common for FDI projects to be stalled or cancelled due to land disputes with the government; as a result, many investors report using middlemen to obtain approvals.

Likewise, smaller firms reported operating without a licence due to issues securing formal land approvals. Industrial zones offer easy access to land, which solves this problem. It is worth noting that Sri Lanka has not built any new zones since 2000 (although some are now underway), and all the existing 12 zones are full. The lack of land may as well account for low FDI flows. The other problem is red tape when obtaining approvals, unclear or contradictory rules, multiple agencies and delays. The current zones offer some blanket approvals: environmental and land clearance, electricity, water and telecoms. However, site, building plan, environmental protection license and certificate of conformity all need separate approval, though the EPZs do offer an expedited process.

Nevertheless, a further gamut of paperwork must go through the normal approval processes: preliminary investment clearance, work permit/visa, tax registration, import and export registration, import and export licence, rules of origin certificate, chemical materials approvals, and company registration.

There is room for further simplification or speeding of approvals, which the developer will need to work with the BOI to achieve. Even if the red tape is minimised, it will still be a problem. From an investor perspective, having the developer to guide them through an unfamiliar bureaucracy in a foreign language in a strange country is a huge plus.

The Japanese philosophy is to create the environment where the investor can focus on his business, leaving all the hassle to be sorted by the developer.

COMPETITIVE FISCAL INCENTIVES AND A STABLE POLICY ENVIRONMENT
Policies in Sri Lanka are driven by short-term political considerations. Ad-hoc changes in rules and tariffs cause uncertainty, deterring investors. An export zone can be better insulated from domestic policy upheavals as it has minimal local market impact.

Industrial zones in Thailand and Vietnam offer a complete waiver of all import tariffs and VAT, as well as time-bound income tax holidays. Currently, exporters in Sri Lanka are offered similar terms for raw materials but not for capital goods, placing Sri Lanka at a disadvantage.

While Vietnam and Thailand allow the import of all construction material in zones free of tax, Sri Lanka charges PAL, NBT and duty on capital goods. Worse, key construction materials are subject to high protective tariffs and are on a ‘negative’ list, meaning that they must be sourced from the local market, at a higher cost. This raises construction costs significantly, resulting in lower returns to investors.

Sri Lanka is only one among many destinations for FDI. To succeed, we have to make a competitive offering. A comparative analysis of the tax/tariff regime is needed with competing destinations to offer an attractive overall package to investors.

ATTRACTING INVESTORS
The zone developer not only develops but also markets the zone. The developer’s return is earned through rents and fees for ancillary services, so they have the incentive to ensure the zone is filled.

One of the problems faced by Sri Lanka is the lack of diversification in exports. Exports grow not only because of volumes, but also because of new products being added to the basket. Between 2000 and 2015, Sri Lanka added just 7 new products (worth $0.1 billion) to its export basket. In contrast, Thailand added 70 new products (worth $21.8 billion) and Vietnam 48 (worth $50.4 billion). The possibility of exporting related products within Sri Lanka’s existing export basket seems exhausted, so completely new sectors must be attracted. Attracting investment into a sector in which the country has little experience is difficult. Firms tend to cluster in close geographic proximity to each other to benefit from reduced transport costs, shared inputs and productivity spillovers due to learning and technology transfers. Getting a good anchor tenant who attracts a critical mass of related firms to move is important.

A well-connected zone manager already has relationships with potential investors and can encourage their clients from other countries to extend their production networks to Sri Lanka.

For example, the Thang Long Industrial Park (Vietnam) attracted Canon, which was followed by several dozen satellite Japanese businesses. Today, the park hosts 98 businesses, 78 of which are Japanese.

OWNERSHIP MODEL
There are many ownership options for industrial zones, public, private or JV, but the model best suited at the initial stage is a public/foreign joint venture. The government, represented by the BOI, provides the land and the private developer invests in the infrastructure. As the BOI has a stake in the venture, it has an incentive to make it work. The BOI works with the developer to secure all approvals and streamline the processes. The developer manages the zone, renting the properties and providing services, and the government takes a share of this.

The good news is that Sri Lanka is taking steps in the right direction. Currently, a logistics and industrial zone is being developed in Hambantota with Chinese investment, while Rojana Corporation of Thailand, a joint venture with Nippon Steel and Sumikin Bussan Corporation of Japan, is setting up an industrial zone in Kalutara. More must be done. As at September 2016, Vietnam had 220 zones in operation with a further 105 under construction. In Thailand, the central agency operates 9 estates, plus 39 more in conjunction with the private sector, while 50 more zones are entirely private owned and operated.

To work best, they should follow the full service model described above and offer a competitive fiscal package.