Attracting FDI: Sorting out contradictions in policy

By Ravi Ratnasabapathy

The article originally appeared on the Daily News on 15 May 2015

The BOI is reportedly developing a new investment policy for Sri Lanka with the help of a panel of experts.

This is a welcome move, but the investment policy needs take a broad view in order to remove some of the impediments to investment that stem from different sources. Two in particular, the policy on land ownership by foreigners and the visas for foreigners have become a source of confusion and a barrier to investment.

Foreign Direct Investment (FDI) is widely used by developing countries as a tool to solve their economic problems. FDI can create employment and result in the transfer of technology which contributes to long term growth.

In countries where unemployment or underemployment is a prevalent the creation of new jobs is a priority and a good enough reason to attract FDI.

Even more important is technology transfer, a broad term that encompasses not only equipment but technical know-how, organisational, managerial, marketing practices and other skills that the employees of a firm learn while working with a foreign partner. When employees move to other firms they take these skills with them, which results in the skills being diffused into the local labour market, improving its productivity.

The transfer of knowledge is not limited to direct employees; foreign affiliates can also diffuse technology and skills to domestic suppliers, customers and entities with which they have direct and indirect dealings.

To ensure that local inputs meet their stringent technical requirements, foreign affiliates often provide the local suppliers not just with specifications but sometimes also with assistance in raising their technological capabilities.

Naturally, as countries have become more aware of the benefits of FDI an intense 'global race' for foreign investment has developed and Sri Lanka should ensure that it is not left behind.

In order for a country to be more attractive to investors (both local and foreign), there is a need to put in place measures to ensure an enabling environment by reducing so-called hassle costs, which is why the BOI was set up as a central point for all paperwork.

Access to land is necessary for investment but recent shifts in policy on land have caused concern.

The purchase of land by foreigners was prohibited in 1963, under the Finance Act. In 1992, the Exchange Control Act repealed the Finance Act allowing the purchase of land by non-residents on payment of a 100% tax.

The growth of tourism in Galle and the southern coast since the mid 1990's, particularly the development of a new concept of 'boutique hotels' may be traced to this event. Prior to this Sri Lanka focused mainly on mass tourism, the change in land ownership policy attracted a different type of investor, who brought with them a new concept of selling to niche markets. The 100% transfer tax on land was repealed in 2002. This, together with the tax amnesty of 2003 created a boom in property.

Up to that point the policy on land followed a clear trajectory towards greater liberalisation. Then followed a series of policy flip flops. First the 100% land tax was re-imposed in 2004. The tax was initially applied only to foreign nationals but was later extended to local companies owned by foreigners.

Then an announcement was made in November 2012, during the budget speech, that the sale of land would be banned. No legislation was enacted but the land registry simply refused to register any transfers due to the uncertainty causing much annoyance and confusion amongst investors.

Parliament finally enacted the Land (Restrictions on Alienation) Act No. 38 of 2014 in October 2014. This banned the sale of land to foreigners and companies where 50% or more of the shares were held by foreigners. Foreigners were allowed to lease land but a 15% tax was to be imposed on the lease rental for the entire term of the lease.

If a firm entered into a 99 year lease, it would be required to pay 15% of the total lease rental payable over the 99 years immediately as tax. In effect the firm would be asked to pay 15 years rent, up front as tax. Moreover, the tax was applied retrospectively, from January 2013.

On a short term lease of a year or two, a 15% tax may be tolerable but for any investor who is here for the long term, the type of investor that the country needs, the tax is prohibitive. Should investment slow there may be knock-on effects on areas such as tourism. Boutique hotels, being small, sell through word of mouth, to friends and associates of the owners. If foreigners are made to feel unwelcome they, along with their friends and family, are likely to start looking elsewhere for their annual holidays and winter escapes.

The spirit of the new Act appears aimed at restricting the access to land for foreigners, first by outright prohibition on sale and second by imposing an extortionate tax on leases, creating an effective barrier to investment.

Inconsistent with such a restrictive law is provision for the Minister with the approval of cabinet to grant exemptions to the Act. Therefore in practice foreigners can buy whatever they want, provided they have the blessings of the appropriate politicians and government officials. Analysts say that such wide discretion is designed to encourage what economists call 'rent-seeking' behaviour or in common parlance, corruption. Similarly confusing are the visa rules. On one hand the country wants to attract talent from overseas, initiatives such as Work In Sri Lanka have been launched to encourage skilled people from overseas to relocate but the country still denies work visas to foreign spouses of citizens. These are foreigners already resident in the country, many have skills that can be utilised productively, yet they are denied the right to work.

Although the sale of land is restricted, the Government still seems interested in promoting the sale of flats in high rises to foreigners-flats situated on or above the fourth floor of a building are specifically exempt from the restriction on the sale of land to foreigners. It does not seem to have struck anyone in authority that foreigners may not be interested in buying flats if residency visas and dual citizenship are hard to get. If the foreign spouse of a Sri Lankan has to give up a career in order to relocate the attractiveness of the country will diminish.

Some countries do restrict ownership of land and work permits are required almost everywhere but the rules need to be sensible investment is not to be deterred. Coherence, consistency and simplicity in policy will promote investment. 

Ravi Ratnasabapathy trained as a management accountant and has broad industry experience in finance. He is interested in economic policy and governance issues.