Travels In Sri Lanka: The Political And Investment Climate by Mark Mobius, Franklin Templeton Investments

My team and I recently traveled to Sri Lanka and saw firsthand its great appeal as a tourist draw. We crisscrossed the country by air and by automobile, visiting a few of its cultural attractions and speaking with officials there. Along the way we gained a better understanding of the people and the business climate. While my previous blog focused on our travel experiences as we visited a few historic sites, here my team and I further explore the country’s business and political climate as we seek out potential investment opportunities.

Politics in Sri Lanka: Tempest in Paradise

Mark Mobius - Travels In Sri Lanka: The Political And Investment Climate
Source: CNBC Video Screenshot

The ethnic composition of Sri Lanka has had a critical impact on its political development. The Sinhalese constitute its largest ethnic group, making up approximately 75% of the total population, while Sri Lankan Tamils—some of whom came from India to work on tea plantations during the British colonial era—are the second major ethnic group at 12%.1 In addition to introducing tea, which became a major export crop, the British introduced a new political culture based on a representative government. Initially, voting rights were limited to only a small part of the population and the ethnic divisions could be balanced, but when universal adult suffrage was introduced in 1931, the Tamil and other minority groups demanded equal representation to the majority Sinhalese. Tension between the Sinhalese and Tamils resulted in a civil war. By 1983, insurgency by the Liberation Tigers of Tamil Eelam (LTTE) based in the north of the country with support from adjacent Tamil Nadu in southern India resulted in an estimated 100,000 casualties. Finally, in 2009 the Sri Lanka Armed Forces under President Mahinda Rajapaksa defeated the LTTE and re-established control over the entire country.

In January 2015 Maithripala Sirisena was elected president, ousting Mahinda Rajapaksa with the help of the United National Party (UNP), which reached an alliance with a faction of the Sri Lanka Freedom Party (SLFP) and other smaller Muslim and Tamil parties. Sirisena appointed UNP leader Ranil Wickremesinghe as prime minister of a UNP-led minority government and encouraged the SLFP to work with the new ruling party to pass constitutional reforms. After general elections in August 2015, the UNP emerged as the largest party, and President Sirisena re-appointed Wickramasinghe. On my recent travels to Sri Lanka, I had the pleasure of meeting Wickremesinghe, who was quite generous with his time. He was very relaxed and seemed confident about his term in office under the new government, although he recognized challenges, including the ability to get legislation passed.

Chinese Influence in Sri Lanka

Driving around the city of Colombo in Sri Lanka, the signs of Chinese involvement are very clear. We spotted a tall telecommunications tower and a beautiful, flower-shaped concert hall, both built by the Chinese. Perhaps most important is a new Chinese-built container port right on the city seafront, which is capable of handling the world’s largest container ships. Throughout the country there are additional signs of Chinese-funded infrastructure, including excellent roads, one being a highway from the city center to the airport.

During his 10-year term in office, former President Rajapaksa had encouraged Chinese investment and concessionary loans, which since the end of the civil war in 2009 became the foundation of the Sri Lankan economy. Under the new government, Chinese projects have more recently come under scrutiny and have faced delays and cancellations, including a coal power plant, the south extension of the modern Chinese-built Colombo harbor, and the Colombo Port City project involving massive reclamation with plans to create a new city. In early 2015, the government cancelled a US$95 million contract to upgrade the runway at the international airport at Katunayake, alleging that the domestic company selected had insufficient experience.

Ongoing investigations of suspected corruption by the previous administration could mean extensive delays and even cancellation of important projects. Ravi Karunanayake, Sri Lanka’s new finance minister, has stated every deal, decision and transaction is being scrutinized with great detail and attention. The new administration inherited debt of more US$25 billion to offshore creditors, amounting to around a third of gross domestic product (GDP).2 Interest payments are estimated to consume about 40% of government revenue, a real problem when the Sri Lankan rupee has devaluated in recent years by as much as 20%.3 The new administration believes that eliminating corruption and the associated economic costs should bring benefits to Sri Lanka’s economy. Anticorruption efforts have already resulted in action not only against Chinese projects but also projects sponsored by Indian firms, and in some cases, past contracts are being cancelled or renegotiated. The government has also shown a tendency to favor local businesses, but foreign companies remain active in the country.

The Importance of Privatization

After our trip to Sri Lanka, its new government announced a policy statement that included efforts to revitalize underperforming state enterprises. In recent years, the government had taken over private companies or companies that had been previously privatized with the so-called “Underutilized Assets Act.” There were mixed reactions to this law; while some genuinely underutilized assets (i.e., state land leased to private businesses) were taken over, certain assets that were performing or on the path to recovery were unfortunately also taken over. Some say these actions were politically motivated.

Policy statement plans called for the formation of a State Holding Corporation Limited, structured like Singapore’s Temasek Holdings, where all state-owned enterprises would be managed by experienced executives, replacing inefficient and corrupt state employees. A Public Wealth Trust would pass on the shares of these enterprises to the people, with the treasury secretary and the central bank governor acting as custodians. Local and global investors would be invited to participate in equity in these ventures. Other non-strategic enterprises such as hotels and hospitals would be sold. In addition, a National Pension Fund would be formed combining the Employees’ Provident Fund and the Employees’ Trust Fund.

The statement also called for converting the economy from a “non-tradable” economy to a “tradable” economy, since the ratio of exports to GDP had fallen to the current level of about 12%, compared with more than 30% in 2000.4  Despite the huge market potential of India, it is the destination for only about 6% of Sri Lanka’s exports, with just over 1% to China and more than 50% to the United States and European Union.5 

The International Monetary Fund (IMF) estimates GDP growth at 6% in 2015,6  although Sri Lanka’s finance minister has a higher forecast. Foreign direct investment flows have been solid, climbing from US$516 million in 2010 to US$1.685 billion in 2014.7  It remains to be seen if foreign investment will continue to rise in view of the more aggressive tax regime and a generally unfriendly attitude toward businesses with some retrospective and ad-hoc tax proposals in recent times.

Market capitalization of Sri Lanka’s stock exchange is low and represents only 32% of GDP.8  In order to expand capital markets, in our view it will be necessary to carry out more privatizations of state enterprises and encourage the

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