UDA seals deals worth US$ 1b” was the headline of a story in the Sunday Times last week. After going through the news, one of my friends called me for a clarification on its economic implications. “Does it solve our foreign exchange problem? Or does it worsen it further?” he asked me. I knew his [...]

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Knife with a double edge


"The sustainability of these foreign funded projects (like the Port city in the picture) depends on how much they can support export growth"

UDA seals deals worth US$ 1b” was the headline of a story in the Sunday Times last week. After going through the news, one of my friends called me for a clarification on its economic implications.

“Does it solve our foreign exchange problem? Or does it worsen it further?” he asked me. I knew his in-depth knowledge in the subject area with his postgraduate qualifications and working experience; therefore, his question made sense.

I thought of taking this up for our discussion today, because of its grave importance for the national economy in general, and the country’s current foreign exchange crisis in particular.

As last week’s Sunday Times revealed, the two deals that were sealed by the Urban Development Authority with foreign investors, were to lease out state lands in Colombo. One of them was with a private Indian hospital to transfer on lease a 5-acre land in Dematagoda bringing about US$200 million foreign investment. The second was under a China-Dubai joint collaboration to transfer the Summit Flat land in Colombo-7 for a new apartment complex bringing about $755 million foreign investment.

In addition to the above deals which are nearing finalisation, there are many other similar land deals currently under negotiation. They all are expected to bring in millions or billions of dollars relieving the country’s foreign exchange crisis. If it is the case, the question that my friend raised is bizarre – how does it worsen the foreign exchange crisis?

Foreign exchange crisis

The questions that many representatives of media asked me during the past couple of weeks were of one particular issue – the foreign exchange crisis. It is because the official foreign reserves of the Central Bank of Sri Lanka have dropped to around $1.5 billion. In 2009 too – that is 12 years ago, for some genuine reasons Sri Lanka’s foreign exchange reserves had declined to $1.2 billion as we discussed in this column last week.

The IMF supported us twice in 2009 and again in 2016, while one of the important objectives of the support was to build our foreign reserve position. However on both occasions we ignored the conditions and did our own way. And “our own way” brought us to the present status of the crisis! This time we don’t want to hear even what the IMF has to say.

Apart from the foreign exchange crisis, the country has to honour the maturing foreign debt about $ 4 – 5 billion every year; the economy is already being placed under an unsustainable policy regime with import controls and exchange controls. In this context, our attention is naturally caught up by the foreign exchange crisis and, not the other issues such as supply shortages, black markets, and living costs which have also becoming mounting issues.

No other way

One of the important questions that I had to deal with was how to get out of this crisis: I would say “foreign direct investment (FDI) and exports” and, there is no other way. FDI and exports are the two major sources of foreign exchange earnings which can guarantee long-term stable foreign exchange inflows. Therefore, if we seek a “genuine answer” to the foreign exchange crisis, we must look for answers to the following two questions:

1. Why did Sri Lanka fail in ensuring FDI inflows to the country, whereas many other Asian countries succeeded? Firstly, we must make corrections there.

2. Why did Sri Lanka fail in ensuring export promotion as many other Asian countries in our neighbourhood did? Secondly, we must make corrections there.

The heart of the foreign exchange crisis lies in the answers to these two questions. Obviously, my explanation leads to more questions: FDI and exports are the long-term answers to the problem, but what are the short-term answers? Well, our problem is not a short-term one and neither was it caused by the COVID pandemic. If the problem is a long-term one, solutions must come as long-term ones.

We are continuing with bilateral borrowings, credit lines and swap arrangements too. True, but they don’t solve the problem, but rather aggravate it. We are only postponing the problem by borrowing and paying for previous borrowings so that we will have a bigger problem later. Even the worker remittances and the expected tourism earnings do not solve the problem, but they can cover up the problem for the moment and, help postponing it.

Land deals for dollars

I must reiterate the point that, if there is no export expansion, there is no sustainable solution to the foreign exchange crisis. In this case, FDI is important not because these investors bring foreign exchange, but because they provide a boost to export promotion, directly or indirectly. There is no country in Asia which succeeded in a rapid export drive without FDI inflows to the country.

The export drive of fast-growing economies such as those of China, India, Vietnam, Cambodia, Thailand as well as the countries which succeeded in the past such as South Korea, Singapore, Hong Kong, and Malaysia, were supported by FDI inflows. As a developing country, Sri Lanka too cannot ignore the importance of FDI for export growth. This means that whatever the policy and regulatory bottlenecks as well as corruption and bribery and, the lack of law and order, all these issues must be sorted out if we are genuinely aimed at attracting FDI.

This brings us to the opening question that my friend raised: Do the land deals that the government intends to lease aimed at solving the foreign exchange crisis? Here is the answer: Any FDI project as long as it is not connected with the export drive, would not solve the foreign exchange crisis; it could be even counterproductive; it can worsen the foreign exchange crisis if such investment projects generate “returns to investment in domestic currency” which may be required to convert into foreign currency in the future.

Re-investment and repatriation

Let me explain the problem with an example: If we succeed in bringing a FDI project in order to construct an apartment complex, the amount of foreign exchange that the investor brings in would be added to our FDI inflows, and apparently help relieving the current foreign exchange crisis as well. With the completion of the project, its value addition will also be counted as part of the county’s GDP adding something to the growth rate: this addition of GDP contribution will come to an end, once the construction is over.

However, if all the apartments are bought by the “local residents”, then they would pay in local currency. Whether the investor’s decision to either re-invest or repatriate the profit of this project is entirely up to his choice. An investor who is looking for an opportunity to earn “quick bucks” and get out, can decide to repatriate profits, while another might be interested in re-investing and expanding his businesses in the same country. It all depends on “how much the investors can trust the business climate, working conditions and living environment” of that country.

If the investor decides to repatriate his profit, alas, then we have to convert his returns to investment into foreign exchange outflows. Obviously, it would worsen the foreign exchange problem in the long-run although we had a foreign exchange inflow in the short-run.

Tradable and non-tradable sectors

The underlying problem in the above example is related to the distinction between investment in, what economists’ call, tradable and non-tradable sectors, which cannot exist and expand in isolation. We remember how we borrowed and financed (not even with FDI) most of our post-war construction and reconstruction activities, including all mega-infrastructure projects in Hambantota and other areas. Our GDP went up too in 2010-2012, but then started to slow down. Now it’s time to pay for the borrowings, apparently with more borrowings! It’s because most of the investment projects were “non-tradable” in nature, which were not connected with the expansion of exports in goods or services, or in other words, the “tradable sector.

(The writer is a Professor of Economics at the University of Colombo and can be reached at sirimal@econ.cmb.ac.lk and follow on Twitter @SirimalAshoka).


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