Sunday, April 20, 2014

Looking behind Sri Lanka's declining FDI


Despite the generally rosy economic numbers that are frequently in the news I don't think the economy is in good shape. Some of these weaknesses are evident in the recent Central Bank report.

Crucially, FDI in 2013 was down 2.7%, (to US$ 916m) and youth unemployment rose to 19.2%, (in 2012 it was 16.8%). Looking behind the FDI numbers reveals and even worse state of affairs.

To start with some basics, what is FDI and why is it important?

The IMF defines FDI as investment as that made

with the objective of establishing a lasting interest in an enterprise resident in an economy other than that of the investor (direct investment enterprise). ”Lasting interest” implies the existence of a long-term relationship between the direct investor and the enterprise and a significant degree of influence by the direct investor on the management of the direct investment enterprise.”

Simply put, FDI is investment in actual businesses: in factories, services (eg software development) or other trades. It is important to distinguish FDI from portfolio investment, which is what happens when an investor buys shares or lends money to an existing business.

Portfolio investment is useful in the long term in helping develop a market for capital that businesses could potentially tap for future expansion, but it does not lead to immediate job creation.

FDI generally implies new investment, which in turn implies that this creates new jobs. The first step towards improving the livelihood of people is to be able to offer them jobs. Direct investment is what generally creates jobs. It does not matter whether the direct investment is foreign or local, what matters is whether it creates jobs, preferably well paying ones.

Investment depends on savings, which is scarce in poor countries. Poor countries with low incomes have low savings, which in turn means low investment and few jobs. This is a vicious circle that can be broken if there is sufficient investment from abroad to make up the local shortfall, hence the importance of FDI.

High youth unemployment maybe be expected if investment is low, something that the statistics seem to bear out. Unemployment in the entire labour market is much lower (4.4% according to the Central Bank, up from 4% in 2012) which could be explained by migration for jobs overseas. The unemployed youth of the country find employment overseas, which brings down the overall unemployment statistics.

Examining the composition of Sri Lankan FDI reveals still further weaknesses. The biggest source of FDI is from Malaysia, the bulk of which comes from Dialog Axiata, the mobile phone operator. Having spent some years working for the telecoms industry I can testify that telco investments in this country (not just those of Dialog, but of the industry as a whole) are singularly unproductive and create little or no employment.

Why is this? The problem lies with the regulator, which does not ensure that a proper infrastructure sharing regime is in place. Each telco operator view its infrastructure with a jealous and proprietary eye, a source of competitive advantage. In simplistic terms the argument is thus: putting up a new tower opens up a new market. Why share it with other operators? The bigger operators try to squeeze out the smaller ones by refusing to share their infrastructure. Nothing illustrates this better than Airtel's experience when they entered Sri Lanka in 2008.

The telco market was fairly well developed by 2008 so there was little need to invest in the major towns. The large operators however refused to share their infrastructure with Airtel, hoping to frustrate them in to quitting the industry. After languishing for a while Airtel decided that they would stay but were forced to start building their own network from scratch, an expensive and wasteful process.

Building a bridge across a river is very useful and allows communities on either side to trade. Building multiple bridges in the same area serves no purpose. It is the same with duplicated telco infrastructure. 

Naturally this new investment would have been reflected in a favourable boost in the FDI statistics but it would have created little in the way of increased productivity or employment since the country had no need for an entire new network, built from scratch. This is the sorry tale that is played out on a larger scale in the industry as a whole.

It is not that there is no sharing at all, there is some sharing, but almost always on a limited reciprocal basis. An operator usually needs to give access on one of their own towers before they can hope to get anything anywhere else. Certain critical parts, such as SLT's fibre backbone are pretty much closed off. If this where shared properly a lot of radio towers would be redundant.

Not only is the lack of sharing wasteful, it is also ugly, as towers not strictly necessary scar the landscape, destroying the view of the countryside, not to mention creating a huge unnecessary drain on power (the towers consume a lot of electricity). The carbon footprint alone should be enough incentive for the regulator to ensure proper sharing, never mind the strain on the electricity system, which itself is in crisis. 

The financial losses are evident in the low return on investments seen in the telco sector which should be of concern to their shareholders and bankers (see note below). Unfortunately, the much larger social price for these white elephants is paid by society at large.

The regulator exists to ensure that these social costs are minimised. Instead of doing its job, the TRC is building a massive tower of its own on the Beira lake, doubtless to the great satisfaction of the building contractor and the people involved in doling out the juicy contracts. Why bother to regulate, when there are more interesting opportnities for personal enrichment through doling out construction contracts?

Another contributor to FDI are the Chinese infrastructure projects – which again create few jobs or opportunities since they are built with Chinese labour and use a high volume of imported material. The FDI comes in but a lot of it simply then goes out, leaving the economy itself little benefited.

Thus not only is the FDI number declining, a fair chunk of what comes in creates little economic impact, which means things are even worse than they seem.


Note:
SLT reported an ROI of 6.8% in 2013 and 6.35% in 2012, while Dialog reported an ROI of 9.42% and 14.07%. Return was calculated using profit and adding back net interest cost. This was divided by equity and total borrowings. As the telco sector is highly geared it is necessary to include debt as part of the investment.

Update:

Another significant source of FDI is the United Arab Emirates - the bulk of which probably represents investments by Etisalat, another mobile operator.

2 comments:

Anush said...

Very good summary assessment. I think it's also a case of FDI not knowing what sectors to come into here and the 'good' FDI not wanting to dabble in a country with a dodgy regime. They have far more secure and lucrative options in other middle-income countries. Those with better governance and rule of law, wider skill pool, greater openness to trade, more efficient product markets, and better regulatory environment.

Jack Point said...

Thank you!