Sri Lanka's road to economic liftoff

Sri Lanka re-embraces China as it re-starts stalled infrastructure projects.

George Soros declared in January that the world is witnessing “only the beginning of the decline of financial markets and only the beginning of Sri Lanka being the exception”. 

The billionaire investor made the bold claim at a conference in Colombo one year after the country’s strongman president, Mahinda Rajapaksa, was unexpectedly ousted by a broad coalition of former colleagues from his Sri Lanka Freedom Party and the main opposition United National Party. 

Under the stewardship of the country’s new president, the SLFP’s Maithripala Sirisena, and Prime Minister Ranil Wickremesinghe of the UNP, the coalition consolidated power following parliamentary elections last summer. 

As Jim McCabe, Standard Chartered’s chief executive officer in Sri Lanka told FinanceAsia, “2015 was a year of great constitutional change for the country. The people voted to move in a new direction and have given the new government a broad mandate.”

FinanceAsia readers can learn more about opportunities in the country at our Sri Lanka Investment Summit on March 15.

Besides shifting the political system from an executive presidency towards a parliamentary democracy, the coalition is busy drafting a new constitution. By devolving power away from the centre it hopes to prevent a potential resurgence of ethnic conflict between the Sinhalese majority and the Tamil minority in the island’s north. 

The government has also embarked on what it terms a non-partisan foreign policy, re-embracing Western nations critical of the Rajapaksa regime and particularly the way it handled the end of a three-decade civil war. The main loser initially was China, which had warm relations with the previous government. 

During his election campaign Sirisena lambasted huge bribes allegedly paid to his predecessor and a coterie of brothers in ministerial office. He also criticised the non-transparent way contracts were awarded to Chinese companies and the cost of servicing their country’s loans. 

Hambantota port: new tenants? 

By the spring of 2015, 35 infrastructure contracts (28 awarded to Chinese firms) had been put on hold as the government investigated potential irregularities. The biggest deferral was the $1.4 billion Port City project in Colombo.

This was to form part of a megalopolis covering most of Western Province, which accounts for 45% of Sri Lankan GDP. China’s President Xi Jinping had laid its foundation stone only six months earlier.

China threatened to sue. “If one side suspends the project, they will have to face the legal consequences. China has come to assist you and yet you pour dirty water over China’s face,” Ren Faqiang, deputy head of the Chinese embassy in Sri Lanka, told one local newspaper.

Law firm DL&F De Saram worked on one the concessionaire agreements for the Port City.  “All the infrastructure contracts awarded to Chinese companies were valid legal contracts,” partner Savantha De Saram said. “The government would have been financially liable had it tried to cancel them. What it’s done is re-negotiate them where it can and tried to bring some of the costs down.”

Dr Harsha de Silva, deputy minister of foreign affairs, agrees. During his time in opposition, the former economist was a well-known and highly vocal critic of the Rajapaksa regime.

“The past year has given us space to re-evaluate these contracts and by and large many of the issues have been resolved,” he commented. “For instance, the government ordered an environmental impact assessment for the Port City project and after a number of revisions, there’s every indication it will go ahead.”

Old allies

Citigroup’s local chief executive officer, Ravin Basnayake, believes the megalopolis is the correct way forward. “Sri Lanka’s urbanisation ratio is still pretty low but there’s not much room to expand in Colombo itself,” he noted. “It makes a lot of sense to retain the old-world charm of the historic centre and push new development out onto reclaimed land through projects like the Port City.”

One of the new government’s other ambitions is to turn Sri Lanka into a logistics hub. This is also deemed sensible given the country’s strategic position on both China’s Maritime Silk Road and India’s competing Project Mausam - named after the monsoon winds that propelled ships across the Indian Ocean. 

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The government wants Sri Lanka to become a reprocessing centre and has removed restrictions on foreign companies owning local logistics companies. However, as Citi’s Basanayake highlighted: “The current legislation still requires local companies to own 10%. This isn’t going to bring in much revenue and it’s an irritant to foreign operators.”

Over the past few months a stream of projects initiated by the former government have resumed. The coalition is even starting to revive projects in the former president's hometown of Hambantota in the far south. 

At the beginning of January it announced that four Chinese state-owned contractors would complete the final section of a highway linking Colombo to Hambantota with financing from an Export-Import Bank of China loan.

De Silva says it has not been easy. "We spent $1.3 billion building a port in Hambantota and $220 million on an airport that no-one uses, he noted. "They are very expensive white elephants."

However, he added that the "ports minister is now sending out fresh proposals to try and find tenants for the port at the least." 

Loan pressure

In the meantime, Sri Lanka is saddled with paying off loans taken out by the previous government to finance them. Global economic conditions are unlikely to help. Any outflow of funds from emerging markets is likely to push up the cost of the country’s debt, while the rupee’s continuing decline is increasing debt-servicing costs. 

But the government’s biggest fiscal challenge lies at home where it needs to get to grips with revenue collection. “Tax collection only amounts to about 12% of GDP,” de Silva said. “It’s one of the lowest ratios in the world and it needs to change.”

A learning curve

Over the past year, the new government has won many plaudits for its openness, its willingness to source multiple opinions, and a flowering of press freedom. But 2016 will test its ability to pull these many different strands of thinking together and form a coherent economic strategy it can execute.

One of Rajapaksa’s strongest calling cards was his perceived ability to get things done. “If the government can stick to its stated policies and use the democratic process to execute them in a transparent manner then it will keep the people behind it,” Standard Chartered’s McCabe said.

“The international community will also swing right behind it,” he added. “The FDI will really start to flow.”

De Silva thinks the government has already demonstrated the leadership required. “No-one ever thought the two main parties could work together, but they have done and continue to do so,” he said. 

Lawyer De Saram agrees. “I feel so positive about what’s happening in my country,” he concluded. “There’s so much potential here and it’s finally being unleashed.”

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