Columns - The Sunday Times Economic Analysis

Shortfalls in foreign investment and aid for reconstruction

By the Economist

Foreign investments and aid to reconstruct the North and East and resettle displaced persons are important for the country’s economic development. The expectations of large inflows of foreign investment after the ending of the war do not appear to have materialized to the extent that was expected. There has also been a disappointing flow of foreign assistance for resettlement. Both these factors are slowing down the economic development of the country.

Perhaps the high expectations of foreign investment were unrealistic due to both global economic conditions and the local environment. The Budget for 2011 was expected to improve investment conditions by changes in taxation and other measures that were conducive to private investment. This too does not appear to have come about so far. The sluggishness of the Colombo Share Market is an indication that the business community is not upbeat about the budget proposals. There are perhaps other reasons why the incentives provided by the budget may not have had the desired effect to spur investment.

The visible areas of increased private investment have been in the hospitality industry. The revival of tourism has been seen as a grand opportunity for local investors to increase hotel capacity and improve hospitality services. Foreign investors too are building hotels in various parts of the country that are attractive to tourists. There is likelihood that foreign and local investments in hotels would be substantial. The intention of large international hotel chains to build hotels in Sri Lanka is indeed good news, as these chains by their very presence here would generate an increase in tourists to the country.

Besides the hotel industry, investments in other areas of economic activity have not been impressive. The recessionary condition in the west is no doubt one of the important factors that account for this. There are two ways in which such conditions affect foreign investment. One is that investment funds are limited and second, the export markets for industrial exports from Sri Lanka are not propitious, as the country’s industrial export statistics show.

There are other reasons too that deter investment here. The economic fundamentals are not strong. Large fiscal deficits, massive foreign debt and high debt servicing costs, large trade deficit and stringent labour regulations, among other weaknesses are deterrents to investment. Energy costs are high, labour regulations are rigid and the effective exchange rate may be too high for competition with other countries. Perceived corruption to obtain investment approvals is yet another reason. An unfavourable image of the country on human rights and democratic freedoms make the country rather unattractive for investment to western countries. In any event the expectation of a quadrupling of foreign investment is an optimistic expectation rather than a realistic goal.

Foreign aid for resettlement has been disappointing. The promises by governments and aid agencies for reconstruction and settlement of displaced persons in the North and East have been very inadequate. Despite numerous pledges to help resettlement of displaced persons in the North and East, the actual funds received have been a fraction of the promised amounts. This includes the disappointing amount of assistance from India.

The Indian government offered an 800 million U.S. dollar loan for the redevelopment of northern Sri Lanka. It also promised to rebuild 150,000 houses destroyed by the fighting. Only a part of these offers appear to have been realized. Several factors account for this shortfall.

The United Nations’ agencies are having funding difficulties. They are short of funds to implement planned programmes. Only half of the required funds or 170 million dollars have been received or committed. Funding difficulties this year have seriously restricted the capacity to deliver life saving services to internally displaced people. According to U.N. estimates, Sri Lanka’s health sector has fallen short of targeted funding requirements by 30 per cent, followed by agriculture (25 per cent), economic recovery and infrastructure (11 per cent), water and sanitisation (10 per cent) and protection, human rights and rule of law (7 per cent).

The World Food Programme (WFP) has halved the wheat flour and sugar in the dry rations it delivers to those displaced due to funding difficulties and estimates that it needs about 27 million US dollars to provide assistance to an estimated 371,000 people in the North. WFP’s reduction of wheat distribution is the result of skyrocketing prices of the commodity worldwide. Regrettably, it will cease assistance to those in advanced stages of recovery. A U.N. report warns that "WFP foresees a full pipeline break in early 2011 if donor funding is not received”.

Although the funding challenges are due to the global financial crisis, some of the cutbacks are due to unsatisfactory relations of the Sri Lankan government with western countries and international agencies. Some humanitarian aid agencies have pulled out of war-torn areas while others are phasing out their assistance. The Sri Lankan government has requested some humanitarian aid agencies to scale down operations. In 2009, the United Nations’ Office for the Coordination of Humanitarian Affairs (UNOCHA) ceased operations in the East. The United Nations’ High Commission for Refugees (UNHCR) followed suit in July 2010. In 2009, the Sri Lanka Red Cross Society downsized its operations, including the closure of its offices in the East following government requests. It is also likely that two offices in Jaffna and Vavuniya would be closed soon. The ICRC voluntarily closed its office in Mannar in November. This is a serious setback to resettlement of people and economic production.

Increased foreign investment flows are needed to help bridge the savings investment gap that exists and spur economic development to achieve the higher trajectory of growth anticipated by the government. This is especially so if foreign direct investments are in high value added industry whose products have a good international market. The reconstruction and resettlement programme too is a vital component of the country’s development needs. The massive amounts needed for resettlement and reconstruction cannot be generated from within the country alone. It is therefore vital that foreign governments assist the country at least to the extent they promised.

A fresh effort is needed to replenish resources of international agencies to carry on their work and the government should encourage their resettlement activities. The Sri Lankan government must recognize the need for such assistance and make diplomatic moves that would assist in obtaining more foreign help for reconstruction and resettlement. Foreign investment and foreign aid are vital for achieving high economic development.

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