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Big Idea – Openness – Sri Lanka as the next regional Investment Centre… is it time to take off?
We never thought we could win the war, but we did. We never thought we could build a freeway, but now Sri Lankan companies are building them. We don’t think we could ever compete with Singapore and Dubai for investments, but maybe we should. The opportunity proposed is not of becoming the “financial centre” of South Asia. It’s far more modest. It’s to position Sri Lanka as the “investment centre” for South Asia. Sri Lanka now has the opportunity to platform a regional economy of over .6 trillion GDP. If we reach just 1% of Singapore’s assets under management (AUM), we could see billion channeled through our banking system and earn fees on that. First, it’s important to point out that capital account and currency convertibility restrictions need not be relaxed to exploit this opportunity. The structures and solutions can be leveraged through the foreign investment promoting BOI and the Colombo Stock Exchange (CSE). A set of global circumstances holds this lucrative opportunity wide open. Sri Lanka is also primed to take on this challenge, far more than any other country in the region.
Global and regional dynamics
The Reserve Bank of India, fondly referred to by Indian investors as the ‘Reverse Bank of India’, controls foreign investor access to its stock markets. Foreign retail investors and smaller corporations are denied access.
Meanwhile, Singapore and Mauritius compete evenly for FDI into India. The largest private equity investment destination from Singapore in 2014 was India. However, only those companies that spend at least 0,000 annually in Singapore can avail themselves of its double tax treaty with India. Mauritius is also costly and geographically inconvenient. These restrictions in India and Singapore give rise to a large but homeless second tier foreign retail and corporate investor base that Sri Lanka is well placed to welcome.
It’s been done before. Hong Kong took advantage of restrictions in China. US restrictions on the use of dollars for Euro Bonds led to a market in dollar-denominated euro bonds in London. By 1968 an estimated 60% of Euro-Bond trading took place in London. Similarly strict Japanese government regulations in regulating the Nikkei futures market in Osaka in 1992 handed Singapore’s SIMEX an advantage to attract US traders.
In fact, the opportunity stretches beyond our immediate vicinity. US and European tax regimes monitoring capital flows to thwart terrorist funding have given rise to myriad and onerous ‘know your customer’ rules hindering capital flows. Taxation and information sharing agreements (TIEAs) have gained traction globally and exposed previously sheltered funds in tax havens. As a result, global capital is more fluid and ripe for redistribution. If Sri Lanka positions itself credibly, these funds will start to notice the opportunity here soon.
The service triangle and Singapore
The service triangle, from shipping through tourism onto finance, has worked for hubs like Singapore, Hong Kong and Dubai. Sri Lanka’s market share of Indian shipping cargo tops 20%. We have also begun the journey in regional tourism. Our recently strengthened relationship with India now gives us the chance to complete our own service triangle. Take a moment to reflect on the scale of the possibility. Singapore creamed this opportunity last year. In 2014, AUM in Singapore grew 30% to
Singapore’s achievement goes beyond its strategic location. It didn’t cut tax rates or relax compliance standards to attract capital, but upped its game to win global investor confidence. Singapore’s tax rates are competitive, and it offers western standards in creditor legal rights and investor protection. It offers a stable political structure with parliamentary democracy, a well-established judicial system, a strong regulatory environment and good corporate governance practices. It has an open-door policy to international talent, so its labour force is highly skilled. Although Singapore’s phenomenal success as a Triple-A credit rated economy has attracted global capital, it has become too expensive for South Asians. Its capital commitments are too large and its compliance regimes onerous for second tier investors. Furthermore, the interest rate on Singaporean US dollar bank deposits is below 0.5% per annum.
Sri Lanka’s competitive advantage
The lack of trust between India, Pakistan and Bangladesh leaves South Asia politically divided. Sri Lanka is the only politically neutral regime with strong relationships with India, Pakistan and other neighbours. Sri Lanka also has a well-established 150-year-old banking industry. Our corporate structure gained credibility with the Companies Act of 2007, and we have signed double taxation agreements with India and other South Asian countries. Unlike in India, the CSE provides ready access to foreign retail investors. Reforms such as Counter Party Protection (CPP), exchange traded funds (ETF’s and REITs) and dollar-denominated listings are in the pipeline. Once implemented, these reforms will raise the CSE’s global standing. Furthermore, the capital market regulating the SEC’s new leadership has pledged to uphold a robust regulatory environment.
The lack of trust between India, Pakistan and Bangladesh leaves South Asia politically divided. Sri Lanka is the only politically neutral regime with strong relationships with India, Pakistan and other neighbours.
Our abundance of CIMA and Chartered Accounting qualified professionals, CFA’s and many investment bankers with global experience, either resident here or currently overseas, lend the financial skill base necessary to develop the financial sector. Our legal services are also of an international standard. The common thread of an English-speaking post-colonial administration, SL’s ethnic diversity, the availability of “Sharia” investments, and Tamil being spoken widely support the unique needs of South Asians. However, the greatest competitive advantage over Singapore and Dubai, besides location, remains the price of services.
How can we exploit this opportunity?
A structure designed to attract long-term investors is already within our arsenal in a little known BOI category named “Commercial Hub” [formerly “Regional Operating Headquarters” (ROHQ)]. It provides foreign investors exemption from the restrictions of the Exchange Control Act to operate an FCBU (foreign currency banking unit) account in order to freely bring and freely repatriate capital and profits. It also grants tax concessions and, along with our low incorporation costs, acts as an incentive for long-term foreign investors to set up in Sri Lanka.
Further refining this Commercial Hub/ROHQ structure will enable foreign investors to set-up their regional investment companies in Sri Lanka; park their foreign currency capital here; enjoy high dollar interest rates of around 4%; benefit from a competitive tax structure on dividends, interest and royalty income; and benefit from our double tax treaties in the region. This is an attractive prospect for second tier regional investors who cannot afford the 0,000 annually Singapore demands to allow them to operate from there.
Once this structure is refined, and its value propositions promoted and marketed to regional investors, Private Equity, real estate and other fund management investors can be attracted to Sri Lanka as a low-cost alternative to Singapore, Dubai or Mauritius.
Next, the CSE can introduce regional dollar ETF products through already established Unit Trusts that provide direct access to all foreign investors via Trustee and Custodian banks. Dollar denominated ETFs listed on the CSE will provide foreign investors freedom over capital repatriation. They will not need any rupee convertibility or SIA accounts necessary for trading rupee-denominated securities. Foreign retail investors can then access South Asian funds that invest in the Indian NSE, BSE Indices, Karachi 100 Index and the Bangladesh DSE index through a CSE platform. The CSE can also promote regional dollar debt issues and other securities to be listed on the CSE at competitive costs relative to Singapore.
A structure designed to attract longterm investors is already within our arsenal in a little known BOI category named “Commercial Hub” (formerly “Regional Operating Headquarters” (ROHQ)).
Once the structure is ready, a marketing drive must position Sri Lanka in the minds of investors as a viable lower-cost option. This visibility can be achieved through the internet and in partnerships with regional tourism drives. We must learn from the services offered by Singapore and Dubai to offer a financial sector-focused division at the BOI to cater to this specific investor category. Once dollar ETFs and REITs are available, we can expect our well-established stockbrokers to take these opportunities to foreign investors.
The challenges to overcome
The biggest challenge will be for Sri Lanka to win the confidence of regional investors with regard to investor protection. The highest standards will obviously be expected of our regulatory framework. Colombo being promoted as a regional arbitration centre will improve investor protection and boost confidence. The next challenge is for our financial service sector to be regionally competitive. Our banking and financial sector is mature, but we need to offer sophisticated products and superior standards foreign capital usually seeks. These standards will improve naturally if international or regional banks, stockbrokers, fund managers and rating agencies can be attracted to set up in Sri Lanka.
The risks and benefits
The risk is real that weak regulation or poor controls will attract illegal terrorism related or laundered money into our system. However, the exposure of this industry to the local economy is limited due to the “closed capital account” that can be expected to continue. The opportunity is vast. We can platform a regional economy of ,600 billion, representing 23% of the world’s population. India is forecast to represent 10% of global GDP by 2030.
The benefits of this will accrue directly to the investment, banking, accounting and legal sectors. As Colombo emerges as a destination for high net worth foreign businessmen and women, benefits will flow into the real estate sector. Colombo has no hang-ups about alcohol and gambling unlike many other South Asian cities. As Sri Lanka gains the confidence of investors and progresses to becoming an “investment grade” (BBB+) economy, we will qualify for substantial foreign institutional capital. Sri Lanka’s current BB- international dollar rating is below investment grade.
Sri Lanka has world-class leadership in shipping, tea, tourism, apparel export and even cricket. Whether we have the leadership and institutional sophistication to position ourselves to exploit this vast financial opportunity, to achieve what small nation hubs like Singapore, Hong Kong and Dubai have done for their citizens, remains to be seen. Private financial sector institutions, local, regional and global, have to be provided the right conditions to make it viable for Sri Lanka to evolve as an investment hub. Although Singapore was behind Sri Lanka in the 1960’s, it reinvented itself under PM Lee Kuan Yu to emerge as the financial capital of Asia. Sri Lanka was submerged in a closed economy for two decades, and in civil war for another two and a half, while Singapore and Dubai went after the opportunity and won their share of the global capital markets. The former President ended the war and mobilised an infrastructure development drive to deliver faster growth. In the current President, we have a leader of great vision and stature. The new Prime Minister, together with the Foreign Minister, has engaged the international human rights charges with remarkable tact and first-class diplomacy.
The free market-oriented PM, who has the confidence of India, the West, Sri Lankan minorities and the diaspora, presents the best chance we have had since independence to do something special in the financial sector. Critics will be many and we should listen. But are we going to be limited to attracting foreign investments for projects in Sri Lanka? Or are we able to attract large-scale foreign investments to the region via Sri Lanka? We need to reach out before it is too late. Although talent is abundant and conditions are perfect, whether we score the six to win the match from this opportunity the size of a football remains the billion dollar question.