Columns - The Sunday Times Economic Analysis

Investor confidence vital for attracting FDIs

By Nimal Sanderatne

The slow and inadequate foreign investment inflows into the country are a concern as FDI is vital to sustain a high trajectory of economic growth. Much foreign investment was expected after the end of the war in May 2009. Why have there not been substantial inflows of foreign investment in the post-conflict period? The answer is not difficult to find.

The uncertain policy environment, the law and order situation, lack of reforms in labour legislation, macro-economic instability and corruption are among the reasons attributed for the slow inflow of foreign direct investment, especially the type of desired investments in export industry and services.

ADB assessment

The recent Asian Development Report Outlook for Asia makes some pertinent observations that: "Investor confidence is a key factor in attracting investment and this requires a predictable policy environment as articulated and reinforced through the legal, regulatory, and institutional framework."
It points out that "the lack of such an environment for the private sector is a major obstacle to private sector development."

Further, the report says that although the government was keen to obtain foreign investment "the government has taken only a few steps to reduce red tape and improve the business climate, needed to create the conditions for ramping up private investment." One of the specific deterrents to investment cited was that "the government expropriated businesses last year and thereby violated property rights of both citizens and non- citizens that had a negative effect in investment."

The need for foreign investment

The high trajectory of growth that is planned cannot be realised unless the amount of foreign investment increases substantially. This is particularly so as domestic savings are declining and the investment-savings gap is widening. The recent high-powered mission to South Korea is an indication of the government's interest in securing foreign direct investment. However, such missions are not likely to achieve much unless the ground situation is made more conducive for foreign investment.

Foreign investment is a significant driver of economic development. It fills the savings-investment gap by supplementing domestic savings with foreign savings and enhances the capacity for economic growth. While the quantum of foreign investment is important in determining economic growth, the nature and type of such foreign investment determines the long-term development of the country. Foreign investment in export industry is especially valuable in strengthening the external finances of the country. FDI contributes to improving work ethics, discipline, skills and knowledge of workers and productivity. It is an important means of technology transfer, transmission of management best practices and accessing new international markets.

International experiences

It is the realisation of these economic benefits that has made many countries both developing and developed to aggressively seek for investment. Former communist countries like China and Vietnam, and the formerly inward looking Indian economy, have sought and obtained large amounts of foreign investment. China is the world's second largest recipient of foreign investment.

It may surprise most readers that the United States is the world's largest recipient of FDI. In 2010, the U.S. received $194 billion of foreign investment, 84 percent of which came from or through eight countries: Switzerland, Britain, Japan, France, Germany, Luxembourg, the Netherlands, and Canada. FDI has resulted in 30 per cent of jobs for Americans in the manufacturing sector. In China foreign investment has increased considerably in the last decade reaching $185 billion in 2010. Foreign direct investment in India estimated at $44.8 billion in 2010 increased by 25 percent to $50.8 billion in 2011.

Factors Deterring Foreign Investment

Foreign investment is influenced by political and economic stability and an overall assessment of political and economic conditions. Tax and other incentives, labour regulations, work ethics, social and economic infrastructure, costs of production, potential domestic market have an important role in foreign investor decision making. Some investments are deterred by perceptions of corruption; others accept such costs as worthwhile incurring for favours granted. For one or more of these reasons, the international investment community does not appear to consider Sri Lanka a favourable destination for investment.

The political situation in Sri Lanka is stable only in the sense that the President and government are secure to rule for another five year period. However, international assessments consider other features in the polity as destabilising. The continuous protests and violence; religious intolerance and violence such as witnessed recently in Anuradhapura and Dambulla; issues in press freedom and disappearances of people regularly that are highlighted around the world; and murders of tourists are deterrents to foreign investors coming to the country. Investors are concerned about these security concerns as much as the safety of, and return to, investment. Perception of corruption could also deter prospective investors. It is therefore crucial that any such perception is wiped out.

Economic stability and macro-economic fundamentals are also investor considerations. The instability of the exchange rate, the large deficit in the balance of payments, large foreign borrowing, the net reserve position, fiscal deficit and rate of inflation are among important economic criteria that investors look at when determining the countries they invest in. Although the country has achieved high growth rates these other considerations matter much to investors.

Government policies

There is still a degree of uncertainty regarding government policies on foreign private investment. The experience of privatised ventures being re-nationalised such as Shell and Sri Lankan Airlines are not conducive to developing confidence among foreign investors. While inflation has been kept at single digit levels, there are fears that it may rise again owing to weaknesses in economic fundamentals.
Costs of production play an important role in determination of investment locations. Several production costs too are high. This is especially so with respect to high energy costs. Sri Lanka is no longer a cheap labour country: labour is cheaper in Vietnam and Bangladesh. Labour regulations in the country also affect investment. Investors find the lack of freedom to hire and fire in Sri Lanka a disincentive as labour regulations that do not permit labour discontinuance increases investor risks.


The inflow of foreign investment to Sri Lanka is low when compared to other countries. The current level of FDI is quite inadequate to raise the country's economic growth to a higher trajectory. The uncertain policy environment, the law and order situation, lack of reforms in labour legislation, macroeconomic stability and corruption are among the reasons attributed for inadequate foreign investment inflows. Investor confidence that is a key factor in attracting investment requires a predictable policy environment to attract much larger amounts of foreign investments in the types that would boost long term economic growth.

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