TABLE OF CONTENTS

DEATAILS PAGE

1. Introduction 02

Foreign Direct Investment 03

Benefits of Foreign Direct Investment 04

2. Strategies to Attract Foreign Direct Investments 06

3. SAARC 07

4. BRIC 11

5. Conclusion 13

6. References 14

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 1. INTRODUCTION

Sri Lanka is currently on the way to an economic revival, with high optimism boosted
by the end of a 26 year civil war which created havoc in the Northern and Eastern
parts of the country. Sri Lanka’s GDP expanded by 7.1% (year-over-year) in the first
quarter which was driven largely by its agriculture & services sectors, industrial
production and soaring tourism. It is forecasted that the GDP of the country will rise
7% this year, before reaching the current government target of 8% in the year 2011.

Sri Lanka’s improved economic performance is partially attributed to the end of the
26 year civil war which has opened up the Northern and Eastern parts of the country
for production purposes. In addition, inflows of remittance payments are soaring
while banking loans are also accelerating. However most importantly the prevailing
peace in the country and expectations of rapid economic growth have attracted more
foreign investments such as the Emirates Telecommunications Corporation which is
the largest phone company in the UAE. The company recently divulged plans to
spend approximately US$ 163 million over a period of 6 months with plans to expand
its network within Sri Lanka. Minor International Thailand’s biggest hotel operator
has also acquired a controlling stake in Kani Lanka Resort & Spa to take advantage of
increased tourism to the island.

Sri Lanka is also focused on improving its infrastructure which is highlighted by the
construction of the massive Hambantota Port project. It is anticipated that the project
will create thousands of new jobs and simultaneously lift private sector investments. It
is believed that the country will provide rich dividends for foreign investors, due to its
highly educated work force, democratic traditions, an open economy, as wells as well
regulated stock market, among other positive attributes. Sri Lanka today is described
as a middle-income country with an ambitious but realistic plan to upgrade its
infrastructure.

Despite the recently ended civil war, Sri Lanka has recorded a very satisfactory rate of
growth, averaging approximately 6.4% during the last 6 years, with a GDP of US$ 42
billion and a per capita income of US$ 2,014. Notably, the countries per capita
income doubled in a period of about 5 years while the war was raging. Now with the
end of hostilities and rapid development projects already in place the countries

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government is confident and are targeting to ensure that Sri Lanka again doubles its
GDP by the year 2015.

However even though Sri Lanka is enjoying a peaceful atmosphere with the end of the
civil war and the government is making every endeavour to attract Foreign Direct
Investments (FDI's) it has been reported that the country has not attracted even 10%
of the projected investments during the last 15 months.

The following report is prepared through the Board of Investments (BOI) of Sri Lanka
which is the Investment Promotion Agency of the Government of Sri Lanka whose
main objective is to attract FDI’s as well as domestic investment. The subject of the
report is focused on FDI’s and the supporting strategies the country should adopt in
order to attract the projected investments.

FOREIGN DIRECT INVESTMENT (FDI)

FDI or Foreign Direct Investment refers to any form of investment that earns interest
in enterprises which function outside of the domestic territory of the investor.

FDI’s today play an extraordinary and growing role in global business. It provides
firms with new markets including marketing channels, cheaper production facilities,
access to new technology, skills, products and financing. For the host country which
receives the investment, it provides a source of new technologies, processes, capital,
products and management skills which has a direct impact on the economic
development of the country.

FDI’s require a business relationship between the parent company and its foreign
subsidiary which in turn gives rise to multinational corporations. It is important to
note that for an investment to be regarded as an FDI, the parent firm needs to own a
minimum of 10% of the ordinary shares of its foreign affiliate. The investing firm
may also qualify for an FDI if it owns voting power in a business enterprise operating
in a foreign country.

A carefully planned FDI can provide a huge new market for its parent company by
introducing products and services to an area where they have never been available

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before. Such an investment may be more profitable if construction costs and labour
costs are less in the host country.

The original definition of FDI meant that the investing corporation gained a
significant number of shares (10% or more) of the new venture. However in recent
years companies have been able to make Foreign Direct Investments that actually
entailed long-term management control as opposed to direct investment of buildings
and equipment.

FDI growth has been a key factor for International Business that many are familiar
with in the current century. This growth has been facilitated by changes in regulations
both in the originating country and in the host country. Corporations from countries
that lead the world’s economy have found fertile soil for FDI in nations where
commercial development has been limited, if it existed at all. The dollars invested in
such developing-country projects increased 40 times over in less than 30 years.

The financial strength of the investing corporations has sometimes meant failure for
smaller competitors in the host country. One of the many reasons is that FDI’s in
buildings and equipment still accounts for a large majority of FDI activity.
Corporations from the originating country gain a significant financial foothold in the
host country. Even with this factor, host countries may welcome FDI because of the
positive impact it has on their economy.

BENEFITS OF FOREIGN DIRECT INVESTMENT

One of the main benefits of Foreign Direct Investment is that it assists in the
economic development of the country where the investment is being made. This is
especially applicable for the economically developing countries. During the 1990’s
Foreign Direct Investment was one of the main external sources of financing used by
most of the countries that were growing from an economic perspective. It is also
observed that Foreign Direct Investments have assisted several countries during
economic hardships.

Foreign Direct Investment allows the transfer of technologies. The importance of this
lies in the fact that the transfer of technologies cannot be obtained by way of trading

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goods and services or investment of financial resources. FDI’s also assists in the
promotion of competition within the local market of the host country.

The countries that obtain Foreign Direct Investment can develop their human capital
resources by training employees on the necessary skills required for the business. The
profits that are generated by the FDI’s in the host country can be used for the purpose
of making contributions to the revenues of corporate taxes of the recipient country.

FDI’s help in the creation of new jobs as well as increasing the salaries of the workers
which in turn enables them to gain access to a better lifestyle. It has been observed
that Foreign Direct Investments allow for the development of the manufacturing
sector of the host country. Foreign Direct Investment also brings in advanced
technology and skills into the recipient country. It is also said that there is some scope
for new research activities being undertaken. FDI does also play a crucial role in the
productivity levels of the host country. However in case of countries that make the
FDI investment they also gain opportunity to explore newer markets thereby
generating more income and profits. These investments also open up export windows
that permit countries such as these the opportunity to cash in on their superior
technological resources.

BENIFTIS TO SRI LANKA:

In Sri Lanka, it has been observed that during periods of relative economic and
political instability, FDI inflows into the country have responded positively. For
instance during the periods 1979 to 1982, 1990 to 1993 and 2002, Foreign Direct
Investments increased to US$ 242 million. In 2003, the FDI inflows increased by US$
30 million. The investment flow was mainly to the power and energy sectors,
telecommunications, port related developments and the manufacturing sector.

Since the end of the 26 year old civil war Sri Lanka’s FDI inflows during the first 6
months of 2008 reached almost US$ 425 million. In 2008, the services sector attracted
US$ 362.3 million worth of investments with telecommunication leading the way
with US$ 290.7 million followed by power generation with US$ 46 million. Property
development brought in US$ 7.2 million, hotels US$ 2.07, other services US$ 7.5

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million and IT bringing in US$ 9.05 million. Sri Lanka expects its FDI’s to more than
quadruple to almost US$ 4 billion by the year 2012. (BOI)

Integration of developing countries with global economy increased drastically in the

1990’s with the changing of economic policies and lowering of trade and investment
barrier. Foreign Direct Investment is assumed to benefit a poor country like Sri
Lanka, not only because of supplementing domestic investment, but also in terms of
jobs created, transfer of new technology, increased domestic competition and many
other positive externalities. Sri Lanka offers numerous attractive investment
opportunities for foreign companies and has adopted a number of policies to attract
FDI’s into the country. The country seems offer one of the most liberal FDI regimes
in South Asia which has resulted in the FDI inflows during the last decade into the
country increasing considerably by 8.5 in 1990 to 15.0 in 2000 as a % of GDP

2. STRATEGIES TO ATTRACT FOREIGHN DIRECT INVESTMENTS

Promotional efforts to attract FDI’s have become an important point of competition

among developed and developing countries. Several trends have been adopted to
reinforce traditional impulses for FDI’s which are access to natural resources, markets
and low-cost labor. The rise of globalization technological progress permits for the
separation of production into more discrete phases across national barriers. The
expansion in Information & communication technologies, improvement in the

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logistics necessarily allow production to be close to markets while at the same time
taking advantage of the specific characteristic of the individual production locations.

Countries have adopted their own individual policies for attracting more investment.
Some countries rely on financial concessions such as cash grants, tax concessions and
even specific subsidies while some countries focus on improving their current
infrastructure and skill parameter to meet the demands and expectations of foreign
investors while others try to improve the overall general business climate of the
country by changing the administrative barriers and red tape policy. Governments of
many countries have created state agencies to help investors through the required
administrative paperwork.

A sound investment climate is crucial for the economic growth of a country.

Microeconomic reforms focused at simplifying the business regulation, improving
labor market flexibility, strengthening property rights and increasing a firm’s access
to finance are essential for raising the living standards and reducing the level of
poverty in a country. The world is stepping forward to change the climate for
attracting more investment. The openings up of doors by nations have compelled most
countries in adopting reforms.

FDI’s are most likely to occur in countries with a good physical infrastructure such as
ports, highways, bridges, etc. For countries with poor infrastructure it is important to
invest in the improvements of these infrastructures as they are a deciding factor in
attracting FDI’s into the country as the positive impact of infrastructure on FDI has
been found to be quite robust in recent years.

3. SAARC

SAARC (The South Asian Association for Regional Cooperation) was created to
promote economic integrity & cooperation among 7 South Asian countries namely
Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka. SAARC was
formed in 1985 with the focus to ensure social & economic development of the

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member countries. However with time it has been seen that SAARC primarily worked
towards the development of economic relationship within the SAARC nations.
Attempts have also been made to further trade relations with member nations of
ASEAN as well as the European Union.

Economic integration within South Asia gathered momentum through the

implementation of SAPTA (The South Asian Preferential Trade Agreement) in 1995.
SAPTA today is looked at as an interim platform in the move towards economic
integration within South Asia. In 1996 the South Asian governments committed
themselves to the creation of a SAFTA (The South Asian Free Trade Area). It has
been forecasted through theory and evidence that the reduce trade costs among partner
countries will provide an important stimulus not only for trade, but also to FDI’s.
Specific regional integration initiatives would also influence the level and pattern of
FDI flows between the SAARC member countries, as well as, between non-member
countries. The SAARC integration initiatives have taken place in the context of a
significant liberalization process within all member countries. This has involved both
trade & investment liberalization including the adoption of a pro FDI stance. Even
though significant trade and investment barriers still remain in place in many
countries, the regional economies are today much more open than they were until the
late 1980s. Today there is a general acceptance for expanded trade, as well as FDI’s.
Even after considerable liberalization, intra-SAARC trade remains only a tiny fraction
of total trade within the region, which is being constrained not only by political
factors, but also by economies that limits comparative advantage driven trade.
However it must be noted that for some smaller economies, bilateral trade with a
SAARC partner such as India, constitutes a large and important component of overall
trade. In current times, the liberalization process within the region has infused
dynamism to the region’s economies in numerous ways. Today economies are
becoming more open and receptive to foreign investment and trade and are more
outward oriented while at the same time, many business firms are expanding their
horizons by entering into joint ventures and other partnerships with foreign firms.

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Even with lying in the vicinity of one another the trading activities amongst the
SAARC nations were restricted. Over the years, there has been a significant
improvement in the trade relations among the seven SAARC member countries with
their focus shifting to gain access to markets of the other members. Methods have also
been formulated to attract FDI’s to strengthen the economic infrastructures of the
SAARC countries. All these initiatives point towards an improvement in the
economic relationship among the seven countries.

HOW SRI LANKA CAN GROW WITH INDIA:

Today India is recognised as one of the world’s most dynamic economies and
attractive markets with which Sri Lanka has strong relations by reason of proximity as
well as history. India’s relations with Sri Lanka for the most part have been friendly
and are probably the best that it enjoys with its non-micro-state neighbours. India’s
first bilateral Free Trade Agreement was with Sri Lanka which resulted in
considerable growth in trade as well as investment. The Indian economy grew at 5.3%
during the 4th quarter of 2008 when Sri Lanka’s other export destinations were
experiencing negative growth and is only expected to grow at approximately 7% in
2009. It was forecasted that India was most likely to be among the least affected
countries by the global economic crisis.

This relationship implies significant benefits to both countries from building on

existing foundations of bilateral disciplinary framework to trade in goods. Sri Lanka
could benefit from a larger market that would permit the realization of economies of
scale, the ability to integrate into a sustainable and low-cost value chain and greater
investment while India could benefit through demonstrating a model of a productive
partnership with one of its neighbours that if emulated has potential to generate robust
regional growth and ameliorate political friction.

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Sri Lanka today has become an attractive destination for Indian FDI’s. As seen
through the table above India is one of the top-five countries investing in Sri Lanka
by, accounting for 6.5% of the total FDI stock which amounts to LKR 331.2 billion
(Figure 3).

Over 50% of Indian investments in the SAARC region is located in Sri Lanka. With
the turn of the century investment from India grew by approximately US$ 33 million
per annually, accounting for 16% of total FDI flows during the period 2001 to 2007.
(BOI)

Policy reforms, in Sri Lanka since 1978 and in India since 1991, have created
conditions conducive to bilateral trade as well as investment flows. The increase seen
in the Indian FDI may be partially attributed to the FTA which increased the scope for
the expansion of trade in goods between the two countries, and thereby broadened the
scope for investment expansion.

Compare to the 1990s, when there were only 12 Indian projects with a total
investment of LKR 177 million, Indian FDI’s today have increased to over LKR 20
billion with over 90 Indian projects currently under way (Figure 4).

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06. BRIC

This thesis claims that China and India will be the world's dominant suppliers of
manufactured goods/services while Brazil and Russia will be dominant suppliers of
raw materials. It is important to note that these countries do not have a political
alliance or even a formal trade association. However they have the potential to form a
powerful economic block. Due to low labour and production costs BRIC today is
recognised as a source of foreign expansion opportunity.

When compared to its Asian counterparts Sri Lanka is said to attract foreign investors
as there is huge potential to build on the country's rich natural resource base to
develop higher-value-added agricultural and manufacturing products and tourism
related services. More than anything else, Sri Lanka offers its investors an abundant
supply of a trainable work force. The adult literacy rate of the country is calculated at
92% which is the highest in South Asia. The biggest drawback Sri Lanka faces in
attracting FDI’s is its infrastructure as it fares very badly when compared to other
Asian economies. Therefore the country needs a significant boost in order to attract
private investments into its infrastructure areas.

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The following factors are important for attracting FDI:

• An educated and skilled labour force

• An efficient and fair legal system
• An adequate transportation system and other infrastructure facilities
• A strong anti-monopoly policy
• A sound macroeconomic policy
• Government policies

The table shows the FDI inflows into Sri Lanka from the year 1992 to 2002

Year FDI Inflows (US$ Millions)

1992 122.6
1993 194.5
1994 166.4
1995 56.0
1996 119.9
1997 430.1
1998 193.4
1999 176.4
2000 173.0
2001 171.1
2002 241.5

Source: adb.org

Governments generally use some strategies to attract FDI’s into the country. The most
commonly used incentives today by many nations are as follows:

• Direct cash grants or capital grants

• Land & building purchase subsidies
• Interest subsidies
• Tariff protection
• Exemption with regards to imports and export duties
• Exemption or if possible lower rates of income taxes, capital gain taxes and
dividends
• Guarantee of profit

07. CONCLUSION

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As presented in this report Sri Lanka is an attractive market for FDI’s. However the
country has not achieved the forecasted FDI investment due to numerous reasons
including the world recession. However if incentives are rationalised by the Sri
Lankan government as anticipated there is a danger of FDI flows falling to past
annual average and a low of US$ 300 million. The estimated FDI base in Sri Lanka is
slightly over US$ 5 billion with an annual average of US$ 200 million with over 40%
of the investment been attracted since 2006 and the highest figure of near $ 900
million been invested in 2008. However, the estimated decline of FDI investments to
nearly $ 400 million this year is despite the country enjoying a full year of peace,
which clearly implies that despite no war or terrorism, the country has yet failed to
attract foreign investor interest. The impending rationalisation of incentives has sent
wrong signals to prospective future investors. Therefore Sri Lanka needs to improve
its incentive regime as a further attraction on top of the peace dividend to ensure that
the FDI flows would not take a further fall in 2011 as well.

References:

Hill, C.W.L., 2007. International Business: Competing in the Global Market Place.
6th Edition. The MacGraw-Hill.

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Daniels, J.D., Radebaugh, L.H., Sullivan, D.P., 1997. International Business:
Environment & Operations. 10th Edition. Pierson Education.

Meier, G.M., 1998. The International Environment of Business: Competition and

Governance in the Global Economy. Oxford University Press.

Bennett, R., 1999. International Business. 2nd Edition. Pierson Education.

Bitzenis, A., 2003. Universal Model of Theories Determining FDI’s. European

Business Review.

Central Bank of Sri Lanka,. 2009. Annual Report.

Hejzi, W., 2007. International Trade Theories.

http://www.economywatch.com/foreign-direct-investment [accessed on 4th December

2010].

http://www.nationsencyclopedia.com/Asia-and-Oceania/Sri-Lanka-FOREIGN-
INVESTMENT.html [accessed on 4th December 2010].

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