Sri Lanka debate: Sri Lanka looks to a brighter future

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EXECUTIVE SUMMARY

• Sri Lanka is aiming for a sustainable, long-term growth rate of 7% to 8%  • Private companies are flocking in, attracted by a business-friendly government and a low corporate tax rate • New cities, special economic zones and logistics zones are springing up  • Colombo is building a new financial centre that will operate under UK law • FTAs with China, India and Pakistan can turn the country into a regional logistics and manufacturing hub • Sri Lanka can be to India what Hong Kong is to China: a provider of financial services to the south Asia region • The government wants to see more consolidation in domestic banking, and deeper and broader local capital markets

Euromoney Sri Lanka’s economy is booming, benefiting from the peace dividend and its role as a gateway to Asia. Where will new growth come from? And how can the country generate a higher, sustainable pace of economic output? 

RK Sri Lanka’s economy is resilient. Even during the period of conflict, GDP growth averaged 5%. So achieving an annualized and sustainable growth rate of 7% to 8% should not be a major challenge, so long as things are done properly. Most growth is created in the private sector, so we need to create a business environment conducive to supporting private-sector investment and growth, and to ensure that the public sector works to support the needs of the private sector.

AP, Sampath Last year was one of the best in our history, with the bulk of new growth at Sampath Bank emanating not from corporate side but from retail and SME lending. And I see 2016 being a reflection of 2015: it will be a challenging year, but our aim is to secure adequate deposits to match our lending portfolios and to continue to boost retail lending. Our non-performing loan situation is one of best in the country, and we hope to cut bad loans further in 2016.

IC, CBS Two vital sectors to future growth are business-process outsourcing and ICT. Both are key future export drivers. From a short-, medium- and long-term perspective, it is vital to ensure that we move to a more sustainable growth model. For a long time, we have had a stop-go economy. Now, if you look at the budget, there is a real effort to build a truly sustainable growth model, giving Sri Lanka a GDP growth rate of 7% to 8% over the next 10 to 15 years, rather than pursuing sugar-highs through unsustainable macroeconomic policies. There is a lot of buoyancy in the domestic sector, and better incentives are now in place to attract more foreign investment. When the Soros Foundation organised a summit in January, bringing with it several stellar global economists, their view was clear: they see a world buffeted by headwinds, and within that maelstrom, a potential bright spot in the form of the Sri Lankan economy.

AW, CCC In the past, a lot of inward investment was in the form of portfolio investment, but we are now seeing a distinct move to more capital arriving in the form of foreign direct investment. At the Ceylon Chamber of Commerce, we see potential investors making genuine contact every week: enquiring how to structure projects and move forward with real inward investment.  Sri Lanka, we remind everyone, is an integral part of Asia’s dynamic economy, and more investors and corporates from Asia, Africa and Latin America are now seeing Sri Lanka as a gateway to south Asia. 

DA, BOI When an individual looks at products and brands, they see first its functional superiority and second the perception of superiority. For years we had to work heavily on both, because of the domestic civil war. Now our message is far simpler and clearer: that Sri Lanka is at an inflection point. Peace is here to stay and we can now pursue a sustainable growth model. Our earlier inward investment model was based on offering tax holidays and incentives. We need to get to the point where investors come for sustainable long-term reasons, and that can be achieved by improving our business environment, driving better connectivity between government agencies and ensuring that we offer investors a one-stop shop inside government, where they can expedite licences and approvals. We need to be able to grant approvals quickly – preferably in a day or two. Investors need to be able to trust us: when they have a question, they need to be confident that they can approach us any time and that we can find a solution to their needs. 

ADS, NSB Two sectors in particular are key to future growth. One is construction. A few years back it accounted for just 7% to 8% of GDP and currently it is at 12%. There is a big opportunity to take this forward even further. Then there is the push to build special economic zones (SEZs) across the country, targeting sectors such as tea, rubber, gems and the garment industry. This will also help increase our level of urbanization, which remains relatively low. The banking sector could play an important role in this regard, and the sky is the limit if we can get this business model right.

RS, Sampath Sri Lanka’s economy is resilient. Most growth is created in the private sector, so we need to create a business environment conducive to supporting private-sector investment and growth, and to ensure that the public sector works to support the needs of the private industry.

Euromoney How important is the peace dividend, in terms of giving investors confidence to grow and invest here? Can we quantify it? 

RK The peace dividend is integral to our growth story, though to be sure, the message remains under-reported. The world sees Sri Lanka’s five-star rating when it comes to human rights. We are walking the talk. During the conflict period, we were less able to sell our investment story. Now we can – and we are selling that story very well. 

AW, CCC We are living in a period of time that I would define as ‘Peace dividend 2.0’. When we first emerged from our period of conflict, the world economy was unsettled, so we couldn’t take full advantage of our new lease of life. Peace dividend 2.0 began in January 2015, when a new era of government dawned, and we are trying to rebalance the economy and chart a fresh course. One of the reasons we lost so many foreign investors in the 1980s, particularly Japanese corporates pulling back, was because of the domestic civil war. Now, those investors are returning. And they are coming back not because of tax incentives, but because they see the clear and huge potential of investing and building new facilities here.

IC, CBS The war weighed on us for decades, at a time when everyone around the world was chasing FDI investment. Now Sri Lanka is competing on a much more even keel. We used to give all kinds of financial concessions to get into the game because of the high war-related risk premium attached to the economy, but those concessions are no longer necessary. If you don’t have peace and stability, it’s hard to push sectors like tourism and logistics. But we are changing that perception at home and abroad. Now, the challenge is to prove that our mind set is no longer closed and inward looking; rather, that the government, citizens and the corporate sector are open and outward looking. And it’s working: thanks to round tables and summits here in Colombo and in places like Davos, Switzerland at the World Economic Forum, people are looking at Sri Lanka in a more positive light. 

DA, BOI The government has moved swiftly to send out the message that Sri Lanka is open to foreign investment. We are piggybacking on that goodwill. We have to create a business environment where there is a competition in Sri Lanka for the best projects. 

AW, CCC A recent Japanese delegation included a vice-president of Panasonic and senior delegates from Matsushita and Marubeni. It has been 25 years since such a high-level delegation from Japan visited, and it shows how seriously we are being taken.

IC, CBS It’s notable that Bank of Tokyo-Mitsubishi UFJ became the first Japanese bank to establish a representative office in Sri Lanka in January. It underlines the confidence major Japanese companies have in our future. Other foreign banks have also expressed an interest in building a presence here. 

AP, Sampath We also need to encourage our own entrepreneurs to venture out and take on the world. Several Sri Lankan firms are investing in countries and areas like Africa and Bangladesh, in sectors like hydropower.

ADS, NSB One of the sectors with a great future is the garment industry. The big players have integrated themselves horizontally and vertically with key investments in technology. Now, the middle tier and smaller companies need to follow suit, adding value and become more internationally competitive. Entities like the Board of Investment have a role to play here.

AW, CCC Sri Lanka is often seen as a hidden story in terms of its global impact: as an exporter of raw commodities like tea and rubber. But that is misleading. We have companies that make advanced components like airbags for Japanese carmakers. And we have apparel firms that are investing heavily in technology, designing and creating the clothing of the future. Finally, software. India had a head start on us. But we are catching up fast. Sri Lankan firms build the software that drives some of the world’s largest telcos and stock exchanges. These are lucrative niches to be in. 

AP, Sampath Two of our big export customers are expanding overseas, buying peers in the UK and elsewhere. We are expanding overseas too: we have an office in Myanmar for instance, and while it’s only a representative office, we are there to help Sri Lankan firms find local business partners and to help them grow their business in the country.

IC, CBS The consistency of our national business model is something that we have long struggled with. The current government believes we should have a private sector-driven growth model, and that is the right path to choose. Business development and growth has to come from the private sector. It’s the only viable way forward. There is no fiscal space for a statist model. 

DA, BOI What gives me hope is that we have such a high quality of workers, as well as budding young companies. We have firms operating at the cutting edge of robotics and artificial intelligence. Top global hotel chains are busy expanding here: Shangri-la Hotels and Resort recently decided to build their third hotel in the country. For the first time, I see our government building a merit-driven society. In order to evolve from a third-level to a first-tier economy, it is essential that we make use of the talent we have. We are building a platform to let help people shine at the highest level.

Euromoney In its latest budget, the government decided to cut corporate tax rates in order to encourage more inward investment. Which sectors are you most interested in promoting?

RK When the current government came to power last year, we had to introduce some tough structural adjustments, which was not easy in a society accustomed to having subsidies from womb-to-tomb. But we had to do it, no matter how much it hurt. We focused on three specific reforms, starting with improving the investment climate, then making rules more consistent, and finally improving our economic image around the world. 

We focused on improving the services sector with a particular focus on financial services, building out the newly planned international financial centre in Colombo and showcasing the fact that we have one of the lowest corporate tax regimes in world. We cut the cost of inputs, bringing down the price of electricity, and focused on ensuring that investors wanted to enter the country on merit and for the right reasons, rather than because they were being offered, say, a tax holiday. 

Another important step was to cut spending on pensions, so we ring-fenced it – in future we are running a contributory pension system that is more affordable and flexible. It wasn’t easy but we showed Sri Lankans that there was no other choice. It was a painful process but it showed the people and the world that we were capable of making necessary structural changes. Now it’s up to the private sector to meet the challenge of being the best they can be. 

IC, CBS For millennia, we have been traders located in the middle of the Indian Ocean, and we still are, so it makes great good sense to focus on becoming a regional logistics player. We are equidistant between east Asia and Europe, just 20 miles from India, and with easy access to the Middle East and Africa. Sri Lanka is extremely well positioned to southeast Asia. 

We have already made a start redeveloping Colombo Port, which is extremely efficient and an area that offers considerable growth. ICT and BPO companies are dynamic and innovative, and the government plans to build more than 40 SEZs, with firms from China, Singapore, South Korea and Japan all interested in developing them. They will all be privately owned and managed. 

Sri Lanka needs to attract firms that are strongly tied to the global value chain. We have a negligible impact on global value chains, and that has to change as we attract more investment and technology. 

There are some major urban development plans in the pipeline, from a new SEZ in Trincomalee to the Western Megalopolis programme, which will include 11 SEZs, new commercial and residential real estate, and the international financial centre in Colombo, operating under UK financial law. 

A big effort is under way to upgrade training and schools, as human resources could be the biggest long-term binding constraint to our economic development.

RS, Sampath There are around 12 well-established domestic banks operating here, but only one Sri Lankan lender has made its presence felt in the outside world. That needs to change if Sri Lanka wants to become a financial hub, and the biggest obstacles are capital-account liberalization and high levels of capital requirements in the region. It’s unaffordable for most Sri Lankan banks to expand outside the country, so we need to find a solution to that.

DA, BOI We need to inject impetus and momentum into the private sector. Many domestic private firms are innately conservative; they live in their own comfort zone. They make a tidy amount of profit and don’t expand or reinvest. Take the spices sector, which has been profitable for centuries, but there is precious little current growth or innovation. The gems trade is the same. We export raw gems, but we need to follow the likes of Dubai and Thailand and venture into the higher-valued-added sector, and begin to export processed gems. 

ADS, NSB For that to happen, the public and private sectors need to work together. The government sets the rules but the private sector needs to provide the impetus and know-how to provide incremental value for our products. We can only succeed if we continually to penetrate other markets. Several east Asian countries have done this successfully, as has India, and we need to follow their lead.

RK Strong and healthy cooperation between the public and private sectors is something we definitely want to encourage. 

ADS, NSB A key focus will be encouraging entities to be listed on the Colombo Stock Exchange. This will create a sort of inclusive economic growth that we need both in terms of raising capital and participation.

IC, CBS If you ask the private sector, they will say their expansion plans are restricted by a lack of labour. In fact, there is no shortage of skilled workers. The government wants to introduce a national contributory pension scheme that would create a level playing field between the public- and private-sector labour markets. That is vital for creating a private sector-led development drive. 

Once the economy starts to generate productive employment, many of the 2 million Sri Lankans currently working overseas as economic migrants, can return home. Agriculture accounts for 28% of the workforce but contributes only 12% of GDP. This is a result of distortionary subsidies, which trap people in low-income brackets. 

Euromoney Sri Lanka is working on a number of free-trade agreements with countries such as China, while deepening existing FTAs with the likes of India. How vital are these deals to the country’s future?

RK When you don’t have critical mass, you have to look at market access. Greater access to the likes of China or Singapore allows us to tap into a greater pool of foreign investment and investors. And our financial services sector key will be vital. We can be to India what Hong Kong is to China: a major provider of financial services to India, as well as to Pakistan and the entire region. The IFC Colombo was designed with this regionalism in mind: a classic and innovative way to showcase our country and our financial centre. One third of the world’s population is within striking distance – three, four hours’ flight from here. That will be our focus into the future. 

RS, Sampath Sri Lanka is located in the Indian Ocean close to international shipping lanes. Yet despite this we handle a very small portion of trade compared with Singapore. We can take some of that business. We could and should be handling a great quantity of maritime trade. That would give our economy and our employment numbers a boost.

AW, CCC For a long time, Sri Lanka’s export sector was heavily focused on the west, particularly the UK and Europe, and the US. During the last 10 to 15 years, when a lot of the action switched to Asia, we lost out, lacking significant access to those markets. So FTAs with China and nations in southeast Asia are key: they will open up new markets to Sri Lankan products. FTAs provide a rules-based structure that allows Company A to connect and trade with Company B, with all the right legal and dispute resolutions in place. Some of our FTAs, such as the one with India, have been controversial: some consider them unbalanced. But they do grant Sri Lankan firms tariff-free access to one of the world’s fastest-growing economies. FTAs also show foreign investors that we are serious about development, reform and trade. They improve our competitiveness and our business climate at home, and boost our skills base. We need to give companies reasons to relocate operations here, and FTAs and service agreements do that. 

IC, CBS By the end of 2016, Sri Lanka could have preferential access to a market of nearly 3 billion people. That will happen if we can expand our existing FTA with India to become an economic and technology cooperation agreement; by invigorating our FTA with Pakistan; and by signing a new trade pact with China. Preferential access to these three huge markets will constitute a unique selling proposition. A primary objective of these arrangements is to increase market access for Sri Lankan exporters. Sri Lanka can operate as a trade bridge connecting India and Pakistan, and India and China. That would be a huge incentive to foreign corporates looking to put their capital to work here. Potential FTAs with other countries, including Thailand, Turkey and Singapore, are also in the pipeline. Our plan is to plug ourselves directly into global value chains.

Euromoney What can be done to broaden and deepen the local bond and equity markets?

RK We are instilling a sense of confidence in the economy that had been eroded. Our stock exchange offers strong fundamentals, but valuations are under threat. People need to become comfortable with investing in and being involved with the stock exchange. I am sure bankers will help to ensure that we reach that objective. 

ADS, NSB There is a big opportunity for the banking sector to support capital market activity. Hitherto, when state entities required infrastructure funding, they would carry out syndicated deals. Why not use other debt instruments such as asset-backed debentures, leaning on the heavy participation of retail investors? Banks once again have a role to play in this regard. But we also need to create the platform such as exchange houses for these debt instruments to be traded in primary and secondary markets. 

AP, Sampath When it comes to the domestic stock market there is a confidence issue, and the government can help with that. Stocks are heavily under-priced, but as confidence in the economy increases, stock prices will rise. Our funding used to come primarily from deposits, but we need to find new ways to raise funds from the international capital markets. We have been overseas many times this year already, to Saudi Arabia and to China. We have taken a team of leading domestic banks and from the central bank itself, and we have been well received. Funding will not be an issue for banks. The industry is well capitalised, but we can leverage our balance sheet much more.

RS, Sampath There are local factors at work that limit the scope and scale of the stock market. There are just 270 corporates listed on the Colombo Stock Exchange, and the total float is relatively small. Most of the big companies listed here have small floats; their holding groups are owned by a small number of families. In other countries, the debt markets are far larger than the equity markets, but here that is not the case. A major problem is that we do not have a secondary market for debt securities.

IC, CBS Another key challenge is in getting the budget in order. The government has a target of a 3.5% budget deficit. A start has been made on developing our capital markets and long-term debt market. We don’t have a mortgage market but we are moving toward one. We have an embryonic private equity and venture capital market, and foreign investors can take that slice of the financial sector to the next level. If economic activity picks up, and if the government divests some of its assets through the stock market, that would also create greater depth to the market. 

MS, CBS The government prioritized deepening the stock market and extending the yield curve. Sri Lanka has been tapping the international financial market via sovereign bond issuances since 2007, and we now have $6.65 billion outstanding in sovereign bonds. Global institutional reaction to our debt has been generally good, and we will continue to tap international markets in the period ahead. We are also working with rating agencies to improve our rating and performance.

IC, CBS I read in the press that we are considering more consolidation in the banking sector, is that correct? 

RK Yes. 

IC, CBS That is important. We have too much bricks and mortar in an industry burdened by high costs. There is a long tail in the non-bank financial sector that would benefit from consolidation. We also need to improve the performance of state enterprises: reducing their accumulated losses and inefficiencies will strengthen banks’ balance sheets. 

Euromoney There are other ways to stimulate global institutional investor interest. How about allowing the IFC and others to issue a rupee-denominated offshore bond? 

RK The IFC has said they want to participate more in Sri Lanka, but we have a slight difference of opinion about the best time to launch a debut rupee-denominated print. They want to be more involved in Sri Lanka and to help us create a better and more sophisticated financial marketplace. The fact that we are on the IFC’s radar shows the progress that we are making. That is a striking difference between the past and the future. Today, our banks are occupying themselves doing ancillary activities such as leasing rather than the real banking stuff. We want them to get back to doing what they do well. And we can accelerate the process of becoming a major global financial sovereign player by fast-tracking the development of the IFC and adopting a financial system consistent with UK and Hong Kong financial laws and norms. We are working with international lawyers and I am working to bring legislation to parliament in the months ahead. 

Euromoney What other ways can be used to add depth to the local capital markets and to boost financial inclusivity?

AP, Sampath Unwinding the dominance of a few families and companies is important. 

IC, CBS We need to boost competition. Telecoms and technology firms have pushed into banking in other markets: there’s no need why that cannot happen here. 

AP, Sampath We have a strong branch network here that permeates every part of the country, even the northern and eastern regions that were once part of war zones. But there is still a major discrepancy between the number of branches in rural areas and the availability of finance. A few other factors are key: bringing more people into the formal economy, increasing the ease of doing business and digitalizing government services to make it easier to disburse welfare payments digitally.

Euromoney Sri Lanka ranked 107th in the latest World Bank Doing Business survey, rising sharply in terms of companies’ ability to access electricity and secure construction permits. What can be done to boost that ranking further?

RK Structurally speaking there is much more to be done. At the finance ministry we have a monthly meeting that works to solve and to ease problems in the business sector, focusing on declogging the system and making decision-making easier. We see positive change taking place, and we need to ensure that the message is being handed down to and understood by our people and by incoming investors. 

IC, CBS The World Bank’s Doing Business survey constitutes 10 metrics, and the government has set up task forces vested with improving our position in every one. Each team is tasked with coming up with and implementing a roadmap, cutting out red tape and reducing commercial roadblocks. There is a tremendous amount of deregulation that can be done. We are also looking to boost our standing in the various regional and global logistical and competitiveness surveys. None of this will yield results overnight, but there are processes in train that will hopefully get us to a better place soon.

AW, CCC Interaction between the public and private sectors has certainly ramped up. At the chamber of commerce, we want to make companies accustomed to operating without special government privileges or assistance, which opens up the threat of rent seeking. When countries seek to boost their global ranking, a first instinct is to game the system. Our focus is to ensure that we move consistently and steadily up the rankings by boosting reform and by deepening integration between the public and private sectors.

DA, BOI We have a very large number of graduates who are not job-ready, and we need to ensure they are in a position to enter the workplace immediately after leaving college. We need to look at countries like Rwanda, which has scaled the World Bank business rankings very fast, or Singapore, which learns from others when it encounters a challenge. One way is to update our legal system: there are many rules that hark back to colonial days. 

IC, CBS In the past, the state has been good at planning but not at implementation. The government is setting up an agency for development and an agency for international trade, composed of many of the country’s best business leaders. They will have a dual responsibility of strengthening policy-making and prioritising a drive toward creating a more efficient and results-driven economy.