Transparency And Foreign Direct Investment (FDI)
By Dr. Arujuna Sivananthan
A skilled cheap work force is an important determinant of FDI flows and in Sri Lanka’s under employed labour market there exists an excess supply of this. Also, favourable tax regimes along with enterprise zones in which foreign investors are granted large incentives have the propensity to increase FDI. Sri Lanka has all of these including, on the face of it, peace which eluded it for over thirty years.
Sri Lanka should be a beacon for FDI. Yet over the past two years FDI has consistently undershot expectations; and the rating agency Fitch in its latest country report raises doubts over the likelihood of the Central Bank’s 2012 forecast of “USD 2bn (3% of GDP) in FDI inflows in 2012… which is nearly four standard deviations above historical norms”. The net FDI forecast of 1.5bn US dollars (USD) is an optimistic fifty percent higher than the reported 2011 figure, which was only achieved by changing accounting rules.
In a New York University, Wilf Department of Politics 2011 discussion paper B. Peter Rosendorff and Kongjoo Shin argue that it is not just economic metrics but the supporting institutional framework which promote FDI inflows. They demonstrate that state institutions which protect foreign investors’ assets from outright nationalisation and rent seeking taxation are necessary conditions for economic growth. Furthermore, those institutions must not merely exist “but they must be seen to exist and to be functioning properly”. But, also, suggest that “… many states find it difficult, if not impossible, to build and maintain institutions that that are both functional and transparent, and to entrench these crucial institutions in the fabric of the polity and the economy”. Unfortunately for Sri Lanka, its institutions fall into this category.
The World Bank’s Ease of Doing Business report for 2012 ranks Sri Lanka 89th out of a 183 countries. It is firmly entrenched in the bottom quartile for registering property and enforcing contracts at 161 and 136 respectively. The recently passed Revival of Under-Performing Enterprises and Under-Utilised Assets Act has been has been highlighted by all rating agencies as a negative drag on FDI. However, its debilitating influence is further augmented according to the Economist Intelligence Unit (EIU) by “… rather than a general set of principles to be applied, appears to conflate the roles of the executive and the judiciary with that of the legislature”.
The EIU asserts that such legislation will increase the likelihood heightening concerns among foreign inventors despite repeated assurances by Sri Lankan authorities that it was a ‘one-off’ measure which will not be repeated. In a stark warning concludes that such action “… undermines the predictability of policymaking and increases uncertainty for foreign investors. It also raises uncomfortable echoes of the actions of populist Latin American governments, notably Venezuela, which has repeatedly used similar excuses to nationalise foreign-owned land and companies”.
Of course, Sri Lanka’s policy makers have several tools they can use to overcome negative perceptions including Bilateral Investment Treaties (BITs). These are used by countries with weak institutions to bind governments from indulging in volatile policy shifts and expropriation FDI. BITs are enforced in investor-state disputes through international arbitration agencies such as the World Bank Group’s International Centre for the Settlement of International Disputes, or, the International Chamber of Commerce and others. However, Rosendorff and Shin point also suggest that countries “… for whom the international property rights enforcement regime is too politically costly, do not bother to sign”.
Sri Lanka confronts other headwinds in attracting FDI including being ranked 86th on Transparency International’s corruption perception index; and, the developing trend in 2012 of capital which was parked in emerging economies, following the economic crisis in the United States and Europe, being repatriated back to developed markets.
Sri Lanka’s needs FDI not merely to provide the capital necessary to foster economic growth, create new jobs and help develop its export sector, but also to pay for its burgeoning current account deficit. Sri Lanka and India are unique among rated Asian economies which still suffer a deficit in their ‘basic balance’; that is the inability to fund imports through exports and FDI. However, to achieve this it must undertake the necessary structural reforms of its institutions which it has thus far been reluctant to embrace. Until it does so, it must sit and watch while waning FDI inflows into emerging markets seek more credible regulatory environments.