Destination Sri Lanka

Even after the end of Sri Lanka’s civil war in 2009, the island nation remained an international outsider, with the then-President Mahinda Rajapaksa not enjoying the best of relations with the West and India. Under Rajapaksa’s regime, India-Sri Lanka relations were strained due to issues such as Sri Lanka’s inaction to accord equal rights to the Tamil minority and the country’s growing proximity to China.

With the recent election of Maithripala Sirisena as Sri Lanka’s new president, the question arises whether Lanka will politically realign itself, and how that will impact the potential for Indian investments into the country.

The absence of major violent events during or after the presidential election and the smooth transition of power from Rajapaksa to the new president demonstrate that Sri Lanka has matured into a functioning and inclusive democracy, notwithstanding the wars of the past. The fact that that a long-standing, dominant politician could not take victory for granted and was voted out in a democratic process — and in fact, conceded defeat ahead of a full tally of votes — reflects the country’s political maturity.

It is widely believed that the new government is unlikely to overturn the major economic policy decisions of the previous government because it supports foreign and domestic investment that the country requires to accelerate growth.

While the previous government had a definite tilt towards China in terms of awarding government contracts, the new government is expected to be more open to do business with India and other western countries in order to balance Sri Lanka’s external relations. India stands to benefit significantly with the change, primarily due to the proximity and existence of important trade agreements between the two countries.

That said, the government still needs to pass important legislations such as free trade agreements, and policies on key sectors such as mining and tourism to accelerate the investment cycle. The parliamentary polls due later this year will determine the strength of the Sirisena government to pass these Bills in parliament. Sri Lanka will need a majority government to deliver on the expectations that have been set.

In its report on trade between India and Sri Lanka, published in 2014, the Asian Development Bank identifies three main waves of Indian investment into Sri Lanka. The first wave was in 1977 when Sri Lanka opened up its economy and Indian companies such as Ashok Leyland established manufacturing facilities in the country for domestic consumption.

The second wave was in the mid-1990s when Indian investments in steel, cement and paint flowed into Sri Lanka. The third wave was after the implementation of a free trade agreement between the two countries in 2000, which attracted large Indian corporations such as Bharat Petroleum, ICICI Bank, Bharti Airtel and Apollo Hospitals into the island nation.

The investment momentum slowed down after 2008, mainly a result of deteriorating Indian relations with Sri Lanka over the war and large strategic Chinese investments into Sri Lankan government projects.

This year may very well be the fourth wave of investment from Indian companies, with the new governments in both countries hoping for a fresh start. The countries signed key agreements during Prime Minister Modi’s visit to Sri Lanka early this year. India extended $318 million of line of credit to Sri Lanka to upgrade its existing railway network. The 400-km railway line linking Colombo and Jaffna was completed in October 2014, with Indian financial assistance, and the project was executed by Indian Railways arms.

The central banks of India and Sri Lanka agreed to enter a currency swap agreement of $1.5 billion, to provide stability to the Lankan currency and promote trade between the two countries. As a result, Sri Lanka’s foreign exchange reserves increased by $400 million in April 2015.

Traditionally, trade between India and Sri Lanka has been an unequal one, with imports from India outnumbering the exports into India. However, this trend has been slowly changing, with increased exports of high value products from Sri Lanka to India, such as insulated wires.

Despite its complexities, Sri Lanka presents several opportunities for investors — with its stable democracy, improving infrastructure and a peaceful environment. One of the best indicators of Sri Lanka’s potential is the rapid growth achieved in the infrastructure sector, where large investments have spurred consistent growth in the past three to four years.

Indian engineering and infrastructure firms can expect to get more work given the ambitious construction plans for the countrywide railway and road network. The post-war investment drive is likely to continue as it was welcomed across provinces, but the government’s client base could shift from China to include countries such as Japan and India.

Sirisena’s political history seems largely free of allegations of corruption, which undoubtedly lent credibility to his campaign.

It was recently reported in the media that Sirisena would review the $1.5-billion Colombo Port project by China Communications Construction Company and has blocked the $400-million casino project of Australia’s Crown Resorts Limited, both projects which were signed during Rajapaksa’s administration.

According to local sources, corruption in Lanka may be less rampant in the lower levels of government compared to the higher levels. This view seems to be supported by the 2010 and 2013 Corruption Perception Index reports of Transparency International, which noted public sector corruption in Sri Lanka is somewhat less compared to other South Asian countries in the region.

Still, conducting business in Lanka can be complex with overlapping issues such as lack of transparency, opaque disclosure norms, unstable regulations and a strong nexus between politicians and businesses that impacts business dynamics at every stage.

Expect business friendly policies, but the local environment will continue to influence the way business is actually conducted on the ground. For example, investors still need to protect themselves against the opaque nature of corporate disclosures and evolving standards of corporate governance.

They need to be careful about whom they are partnering with and must understand the various consequences of their relationships, especially with respect to any potential political witch-hunting, which is a peculiar feature in Sri Lanka.

It also remains to be seen what the new government will do with respect to investor unfriendly laws such as a 2011 Underperforming Enterprises and Underutilized Assets Act (UEUAA), which gives complete powers to the government to take over any business deemed to be underperforming. This was used by the previous government to expropriate many private businesses.

The writer is the managing director of risk solutions firm Kroll India