Back to the Basics: Achieving our FDI targets?

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

By Aneetha Warusavitarana

As we enter the middle of February, Sri Lanka does not appear to have a clear plan in place for foreign direct investment (FDI) for 2020. Last year, the Government set a target to attract Rs. 3 billion in FDI by the end of the year; this however did not come to pass. After the Easter Sunday attacks, the Government downgraded the target to Rs. 1.5 billion, reflecting the drop in investor confidence following the terror attacks.

Attracting FDI should be a priority for Sri Lanka right now. As a region, growth in South Asia has slowed down, and we are no longer the fastest growing region in the world. In Sri Lanka, we will have to face challenging economic realities; the tax cuts introduced as a stimulus for the economy may or may not pan out as expected, and it is likely that government expenditure will continue to rise in the lead-up to parliamentary elections.

Our recent graduation to upper middle-income status has also shed light on the living standards of many in the country. The poverty line for upper middle-income countries is far higher than the official poverty line used in Sri Lanka. When the country’s poverty numbers are recalculated for the new poverty line of $ 5.5 per day, our poverty rate skyrockets from a respectable 4% to a horrifying 40%. Of course, this number should not be taken at face value; a little under half of our population did not suddenly plunge into poverty at the point of our transition to upper middle-income, and living standards are similar to what they were last year. However, it is a good indicator of how far we have to go as a country for Sri Lankans to have economic realities associated with upper middle-income countries.

Economic growth

The solution to our woes is of course economic growth; the catch is that growth appears to be quite elusive at this point, with GDP growth for 2020 estimated to be 3.7%. The country is also a little strapped for cash with debt repayments and uncertainty as to what our tax revenue will look like. What Sri Lanka needs at this point is FDI.

Attracting FDI into Sri Lanka should be a priority for the Sri Lankan Government, not simply because it is a source of foreign exchange for the country, but because the benefits of FDI go far beyond that of increasing inward capital flows. FDI is a link to international markets that Sri Lanka would otherwise have limited access to, and with that link comes the transfer of knowledge, skills, and knowhow. Entry into global value chains through FDI forces firms to improve productivity and increase competitiveness. The World Bank succinctly captures the benefits of FDI for high-growth firms in developing countries by identifying two main channels: (a) Contractual linkages between foreign and local firms that promote the formal transmission of knowledge and practices that may help domestic suppliers upgrade their technical and quality standards, and (b) the demonstration effect, where domestic firms imitate foreign technologies or managerial practices.

The investors’ side

Sri Lanka has to go far beyond setting targets for FDI if we are to attract it in the numbers that we need. We need to understand what investors are looking for, and then ensure that Sri Lanka has met that criteria. The World Bank’s Global Investment Competitiveness Survey is a tool that can help governments design policy and prioritise reform that investors will recognise and value. The survey captures 754 interviews with executives of multinational corporations (MNCs) that have invested in developing countries, and identifies the determinants to attracting FDI.

When speaking about FDI in Sri Lanka, focus is often solely on attracting FDI, with great effort being expended to answer the question of how to get investors to see Sri Lanka as a lucrative destination for investment. This is of course important, but we need to go beyond this if we are to retain FDI, and see the investment grow. One of the top five findings from the survey was that more than a third of investors reinvest all of their profits into the host country. This means that investors will be looking for policies in the host country that will help them grow their business, and not just policies to facilitate their initial setup.

Another key finding from the survey was the importance of having economic stability and a transparent, predictable policy regime. Three-quarters of investors have experienced disruptions in their operations as a result of political turmoil. A quarter of these investors then either cancelled or withdrew their investment.

Next steps

Achieving long-term policy stability is not an easy task; it will require considerable political will and commitment to long-term growth over a quick short-term win. Focus has to move beyond quick-fix investment incentives. The report highlights that incentives are not the most important determinant for a potential investor, according to the survey. They rank fourth in importance, below transparent governance, investment protection guarantees, and ease of establishing a business. Of course, this is not to say that incentives should be removed wholesale. They are a criterion, but possibly not the most important one.