FDI

Kick-Starting FDI - Industrial Zones with a Twist

Originally appeared on Echelon

By Ravi Ratnasabapathy

Liberalising Sri Lanka’s economy is a controversial topic. Different groups have different views on what this means or how far it should go, but most people will agree that attracting FDI and boosting exports is a good thing. One way to reconcile differing interests is to revisit the old concept of industrial zones – but with a twist; privately-run zones that are managed by international zone developers. The success of Japanese and Thai industrial zone developers in Vietnam and Thailand offer a model that may be replicated in Sri Lanka. Japanese zone developers offer investors a complete solution – not just the physical infrastructure but all the soft services: from company incorporation, tax registration and advice on visas for expats to introducing accounting and law firms.

COMPREHENSIVE ‘HARD’ INFRASTRUCTURE
The ‘hard’ infrastructure goes beyond just the land, power, water and waste disposal that Sri Lanka’s zones currently offer. Japanese developers offer housing (flats for expats), clinics, schools, banks, shops and even a Japanese restaurant (or canteen offering Japanese food) – sometimes even a golf course. With regard to power, the developers either have special arrangements with the utility to guarantee continuous power (with engineers dedicated 24×7 to deal with issues) or have a private power producer as a tenant in the zone. For example, in the Amata Nakorn Industrial Estate in Thailand, the developer has group companies that provide power, water, natural gas, logistics and transportation services to clients within the zone.

What developers provide is a complete infrastructure and services model in which client companies can start operations almost on a plug-and-play basis

SUPPORT SERVICES
The developer also offers services: continuous support during factory construction, as well as ongoing operational support—logistics, customs, recruiting, banking, courier service, security guards and fire brigade. To deal with problems, they provide a 24-hour, 365-day helpdesk. They also disseminate information on changes in laws, wage levels, etc., and hold a monthly meeting with tenant firms to discuss any common issues. Critically, soft services are provided by Japanese staff (or fluent Japanese speakers who understand their business mindset). Japanese investors tend to be more risk-averse than others, and Japanese SMEs even more so. The advantage is that, if a zone is developed with the Japanese, the standards of service would be to such exacting levels that any other investor would find it a breeze.

Thus, what developers provide is a complete infrastructure and services model in which client companies can start operations almost on a plug-and-play basis.

GETTING LAND AND DEALING WITH RED TAPE
A recent paper on industrial zones and their link to economic growth notes that access to suitable land is one of the biggest problems faced by investors. Some 80% of the land is owned by the government, and difficulties in obtaining land combined with uncertainty over land policy (constantly changing tax rates, ownership restrictions) act as a deterrent.

Interviews with investors revealed that it was relatively common for FDI projects to be stalled or cancelled due to land disputes with the government; as a result, many investors report using middlemen to obtain approvals.

Likewise, smaller firms reported operating without a licence due to issues securing formal land approvals. Industrial zones offer easy access to land, which solves this problem. It is worth noting that Sri Lanka has not built any new zones since 2000 (although some are now underway), and all the existing 12 zones are full. The lack of land may as well account for low FDI flows. The other problem is red tape when obtaining approvals, unclear or contradictory rules, multiple agencies and delays. The current zones offer some blanket approvals: environmental and land clearance, electricity, water and telecoms. However, site, building plan, environmental protection license and certificate of conformity all need separate approval, though the EPZs do offer an expedited process.

Nevertheless, a further gamut of paperwork must go through the normal approval processes: preliminary investment clearance, work permit/visa, tax registration, import and export registration, import and export licence, rules of origin certificate, chemical materials approvals, and company registration.

There is room for further simplification or speeding of approvals, which the developer will need to work with the BOI to achieve. Even if the red tape is minimised, it will still be a problem. From an investor perspective, having the developer to guide them through an unfamiliar bureaucracy in a foreign language in a strange country is a huge plus.

The Japanese philosophy is to create the environment where the investor can focus on his business, leaving all the hassle to be sorted by the developer.

COMPETITIVE FISCAL INCENTIVES AND A STABLE POLICY ENVIRONMENT
Policies in Sri Lanka are driven by short-term political considerations. Ad-hoc changes in rules and tariffs cause uncertainty, deterring investors. An export zone can be better insulated from domestic policy upheavals as it has minimal local market impact.

Industrial zones in Thailand and Vietnam offer a complete waiver of all import tariffs and VAT, as well as time-bound income tax holidays. Currently, exporters in Sri Lanka are offered similar terms for raw materials but not for capital goods, placing Sri Lanka at a disadvantage.

While Vietnam and Thailand allow the import of all construction material in zones free of tax, Sri Lanka charges PAL, NBT and duty on capital goods. Worse, key construction materials are subject to high protective tariffs and are on a ‘negative’ list, meaning that they must be sourced from the local market, at a higher cost. This raises construction costs significantly, resulting in lower returns to investors.

Sri Lanka is only one among many destinations for FDI. To succeed, we have to make a competitive offering. A comparative analysis of the tax/tariff regime is needed with competing destinations to offer an attractive overall package to investors.

The zone developer not only develops but also markets the zone. The developer’s return is earned through rents and fees for ancillary services, so they have the incentive to ensure the zone is filled.

ATTRACTING INVESTORS
The zone developer not only develops but also markets the zone. The developer’s return is earned through rents and fees for ancillary services, so they have the incentive to ensure the zone is filled.

One of the problems faced by Sri Lanka is the lack of diversification in exports. Exports grow not only because of volumes, but also because of new products being added to the basket. Between 2000 and 2015, Sri Lanka added just 7 new products (worth $0.1 billion) to its export basket. In contrast, Thailand added 70 new products (worth $21.8 billion) and Vietnam 48 (worth $50.4 billion). The possibility of exporting related products within Sri Lanka’s existing export basket seems exhausted, so completely new sectors must be attracted. Attracting investment into a sector in which the country has little experience is difficult. Firms tend to cluster in close geographic proximity to each other to benefit from reduced transport costs, shared inputs and productivity spillovers due to learning and technology transfers. Getting a good anchor tenant who attracts a critical mass of related firms to move is important.

A well-connected zone manager already has relationships with potential investors and can encourage their clients from other countries to extend their production networks to Sri Lanka.

For example, the Thang Long Industrial Park (Vietnam) attracted Canon, which was followed by several dozen satellite Japanese businesses. Today, the park hosts 98 businesses, 78 of which are Japanese.

OWNERSHIP MODEL
There are many ownership options for industrial zones, public, private or JV, but the model best suited at the initial stage is a public/foreign joint venture. The government, represented by the BOI, provides the land and the private developer invests in the infrastructure. As the BOI has a stake in the venture, it has an incentive to make it work. The BOI works with the developer to secure all approvals and streamline the processes. The developer manages the zone, renting the properties and providing services, and the government takes a share of this.

The good news is that Sri Lanka is taking steps in the right direction. Currently, a logistics and industrial zone is being developed in Hambantota with Chinese investment, while Rojana Corporation of Thailand, a joint venture with Nippon Steel and Sumikin Bussan Corporation of Japan, is setting up an industrial zone in Kalutara. More must be done. As at September 2016, Vietnam had 220 zones in operation with a further 105 under construction. In Thailand, the central agency operates 9 estates, plus 39 more in conjunction with the private sector, while 50 more zones are entirely private owned and operated.

To work best, they should follow the full service model described above and offer a competitive fiscal package.

 

Razeen Sally : Open up shipping and Tea to competition

If the outlined measures are implemented, two prominent sectors will be opened up to international competition: shipping and tea

If the outlined measures are implemented, two prominent sectors will be opened up to international competition: shipping and tea

Read the full article originally appeared on Financial Times

 

Sri Lanka desperately needs a new global economic strategy as part of a broader strategy for national renewal. It needs a decisive shift to markets and globalisation. A prospering, globalised market economy is the sturdiest foundation for a genuinely open society – for constitutional liberalism, the rule of law, ethnic peace and balanced international relations. Without it, all else fails. It has to be among the Government’s top priorities. The good news is that Sri Lanka has its most golden opportunity to achieve its long-advertised potential since the victory of the UNP in June 1977. 

But no economic reforms have materialised since the change of government last year. As I argued in my last Daily FT column, there should be four economic priorities for the remainder of this Government’s term: 1) “first do no harm” – no more senseless public sector salary hikes, price controls and ad hoc taxes; 2) fiscal stability, especially through tax and expenditure reforms; 3) improving the domestic business climate; and 4) trade and FDI liberalisation. They are all connected. Together they would greatly strengthen Sri Lanka’s competitiveness for higher productivity, growth and prosperity. Here I focus on the last component – a new trade policy.

 

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.