Attracting Good FDI Starts with Designing Good Incentives Regimes

Attracting Good FDI Starts with Designing Good Incentives Regimes

Sri Lanka is on a renewed push to attract foreign direct investment (FDI) following a poor performance in the last decade, post-war. Fiscal incentives regimes have changed from time to time, laws and regulations have been introduced, investment promotions missions have been held in major capitals. Yet, attracting FDI remains a struggle, amidst heightened competition from regional competitor locations. In this interview, former Deloitte consultant Danindu Udalamaththa outlines some key areas for Sri Lanka to focus on and learn from. He draws from his experience advising global clients on the investor side, and argues that to attract good investment, Sri Lanka needs to design good incentives frameworks. Until early this year, Danindu worked with the Deloitte US Multistate Tax Service (Credits, Incentives & Economic Development Group) and the Global Investment and Innovation Incentives Practice. He has extensive experience working with global clients, borders, and industries. He has a MPA specializing in Economic and Financial Policy from Cornell University and has a Masters in Agribusiness and Applied Economics from North Dakota State University.

SFF: Danindu, we like to think that Sri Lanka is an attractive FDI location for a variety of reasons. But having worked on the international client side of things, you have a good sense of what investors often look for when making location decisions. In your view, what are some of the key decision factors for foreign investors?

DU: For a company, investing on a location means spending large sums on tangible assets that in many occasions will stay there for a longer horizon. So, companies carefully consider how they can optimize the utilization of these assets to reach their operational goals. [When an investor considers a location to invest there are a number of key factors considered such as supply chain management, access to labor and resources, geographical distribution, and access to markets, etc. These factors determine the operational success of the company from the potential investment. When an investor considers a location to invest there are a number of key factors considered such as how easily they can access the material for production, the availability of qualified employees and necessary resources, and ease of entering the markets that a company wants to sell their products, etc.  The ease of access can be obtained through factors such as trade agreements  like EU and NAFTA or it can simply be the distance. These factors determine how well the new addition fits into the operations of the company.

Beyond these factors, companies look into a second set of factors and ask themselves – ‘what are the added benefits of this location?’. These factors include credits and other incentive regimes relating to the investment, regulatory environment, economic stability, and the ease with which they can establish negotiations with the authorities. These factors determine what is the most beneficial location to invest among the potential candidates.

In my experience, the first set of factors determine the region which a company would invest in and the second set of factors determine the specific location or country they will invest in. As we have seen, there is increased competition among governments/state level authorities on the second set of factors. In my opinion, Sri Lanka is in a highly advantageous position when it comes to the first set of factors, but is facing extreme competition within the region when it comes to the second set of factors.

I think a primary concern with the incentives available within that country is the historic success and efficiency of similar companies in securing them. Because there is a cost for a company to even go through the process – they will conduct a cost-benefit analysis prior to the initial approach.  Additionally, a company will look into the economic stability of the country by evaluating factors such as inflation rates, unemployment rates and exchange rates. They will also be looking into labor market conditions such as cost of labor, availability of required talent and current labor laws.

SFF: Your expertise was primarily in the US, looking at federal and state incentives regimes in advising clients. So, how much of that applies more generally, to countries?

DU: I think the US is a unique case when it comes to their incentives regimes because US states compete to attract investments in the same fashion that countries compete to attract investments. Globally, countries have a holistic approach through institutions similar to BOI in Sri Lanka and each US State operates its own entity to attract investments. In my opinion, this is mostly due to the availability of large capital stocks within the country and the governing structure that allows states to compete.

I believe that the general nature of the job remains the same whether its state level operations or the global operations. Since I worked in state level through the multistate practice and in the global level through global investments practice I feel that the nature of the work is very similar in both levels except for a few key differences. Usually the state level opportunities are fixed and there are not many opportunities to negotiate. However, if you look at the structure of the benefits and requirements they are quite similar. Therefore, the essence of the work remains constant regardless of the regulatory body that we are working with. Within my client engagements, I conducted data analyses, cost-benefit analyses, scenario analyses and projections to identify the most beneficial opportunities for clients among US states and internationally. In my opinion, the nature of the work will remain the same although the application might be different depending on the engagement.

Danindu Udalamaththa, former consultant with Deloitte US Multistate Tax Service (Credits, Incentives & Economic Development Group) and Global Investment and Innovation Incentives Practice.


SFF: As economists, we like to reiterate that it’s important to identify the policy objectives you are trying to meet with FDI, and line up the incentives regime accordingly. In that spirit, how can Sri Lanka do better to think about framing the incentives framework, to achieve different policy objectives around economic development?

DU: I completely agree with what you say, it is of absolute importance for a country to have a clear picture of where they want to grow and align the necessary infrastructure and policy framework accordingly. By doing that, Sri Lanka can send a clearer message to investors. Most importantly, it is critical to think like an investor. First and foremost, Sri Lanka needs to do a deep dive into understanding the competition we face within the region, especially from India and Bangladesh. Second, Sri Lanka needs to carefully evaluate what industries or sectors that we want to be established within the country. To do this Sri Lanka needs to understand what are the key advantages we have or needs to be developed that would attract investors. Third, we need to take steps to ready the labour force to match the demands that will come as a result of the new investments. A perfect example of such alignment is the US states Arizona and Texas. These two states are currently seeing huge inflows of tech business, due to the availability of talent coupled with favorable tax conditions – compared to California where there is now a lot of outflow. Fourth, Sri Lanka will have to design an incentives framework that would meet the criterias of potential investors in the targeted sectors. And finally, we will have to convince the investors that Sri Lanka will stay on track within the long-run and that policy frameworks will not shift. In my opinion, this is one of the key challenges the country is facing and will continue to face.

SFF: You mentioned just now that Sri Lanka will have to design an incentives framework to meet the criteria of investors in the targeted sectors. By this do you mean structuring different fiscal and other incentives regimes for different sectors? Any examples you can share, to illustrate this?

DU: Most importantly, we have to understand that the benefits we provide investors come with a cost to the country. The incentives do not stem from an unlimited resource that we can give out indefinitely. Additionally, we must understand that we have a smaller capacity to provide incentives than a more prosperous nation. Therefore, it is beneficial to Sri Lanka to utilize the limited capacity we have to offer incentives to investors to attract investments in sectors that match well with the long-term growth strategy of the country. Each industry is different from another and has specific needs. By carefully accommodating these needs, we can be an attractive destination for investment for these sectors. Moreover, having special incentives regimes in place also shows investors that the targeted sectors have a higher chance of securing benefits; therefore, they are more likely to consider investing in Sri Lanka. Because in my experience, a topic that most often comes up in discussions on the business side is the success of securing an opportunity.

As I mentioned earlier, countries with more resources can provide both generalized and targeted incentives. A few examples for targeted regimes are life sciences R&D credits from New York state, pharmaceutical sector incentives in India, film industry opportunities in New York and California states as well as the UK, and mining sector opportunities in Australia. All the regulatory bodies that provide the above opportunities provide more generalized options as well. However, in the case of Sri Lanka, it is tough for us to do both with the limited resources, and it is relatively more beneficial for us to provide targeted incentives regimes for sectors we want to attract. To sum up and answer your question, we should structure fiscal and other incentives to cater to different industries that we want to attract, but we should also be aware that such a structure would increase the costs for monitoring, evaluation, and administrative tasks, etc.

SFF: As the Centre has a specific interest in innovation and advancing technological progress, we are keen to know how investment – and the associated incentives regime – can be structured and aligned to encourage innovation in an economy. What are your perspectives on this?

DU: In my experience, I think a  lot of the innovation happens through startups compared to larger and more established organizations. Therefore, when designing an investment regime to uplift innovation we have to cater to the two most important needs of a startup. one, being able to pay a competitive salary for top talent and two, getting access to capital. a perfect example on how to foster innovation through an incentives framework in New York State. NY established a tax credit for startups that will continue to increase their employment within NY and another tax credit that would benefit the investors who would invest in Emerging Technology Companies. With these incentives NY was able to attract many innovative startups both foriegn and local. I strongly believe that a carefully designed incentives regime can greatly foster innovation within an economy.

SFF: We would like to focus a bit more granular on the specific type of incentives, Danindu. There has been a debate in Sri Lanka – and changes over time – from blanket tax holidays and concessionary tax rates, to more investment allowances and accelerated depreciation. A Presidential Commission on Taxation in 2009-10 had also advocated for the latter over the former. But still, investment authorities argue that FDI simply doesn’t respond as well to this, than generous tax holidays. In your experience, what instruments and types of instruments work best?

DU:  In my opinion, the main reason for a company to favor blanket tax holidays and concessionary tax rates is that through these opportunities, benefits will increase with the company’s growth. Given that the managers of a company most certainly expect the operations to grow over time, they are likely to tilt a little more towards the former than the latter. However, if the investment requires a considerable amount to be spent upfront through the purchase of PPE or any other expenses, a company would favor investment allowances and accelerated depreciation as they would help the company recover costs relatively fast. I think it will come down to the nature of the project whether they expect growth over a more extensive period or require considerable upfront investment to determine which regime is preferable. A majority of the opportunities I worked with indeed belong to the first category. It may very well be due to the preference of the relevant authorities, not investors. To conclude, In my experience with both types, I have not seen much difference in likeness or have come across solid evidence to say that one is preferred over the other.

SFF: Having returned to Sri Lanka recently, you may have some early reflections on what sectors or types of economic activities have the most potential for attracting US-based investors. So as our final question – if you were speaking with a US investor today, what would you tell them?

DU: I think it would be relatively difficult for Sri Lanka to attract investors who are investing in labor intensive sectors in the region due to the competition from India and Bangladesh with their low cost and vastly available labor resources. However, I think Sri Lanka has a substantial advantage and should target small to mid-level firms especially in IT and other services sectors. Especially with the developments such as the port city, there will be more advanced infrastructure in place to meet the demands of service sector investors. Additionally, Sri Lanka will be a lucrative investment location for sectors such as food processing, and cargo transportation due to the geographic location and the nature of the operations in those sectors.

When speaking about a location for investments there’s always pros and cons. Speaking about cons, limitations placed on foriegn currency outflows and relatively high inflation will be a considerable drawback for a potential investor. Additionally, considerable low sovereign ratings by all major rating agencies will continue to lower the future expectations of economic stability for investors.

However, I firmly believe Sri Lanka can still attract investors by building on the advantages it has to offer. If I am presenting to an investor to invest in Sri Lanka, I would be speaking about the geographical location connecting East and West, access to one of the busiest ports in the region, the fact that with LKR currency value products made in Sri Lanka will be comparatively cheaper in foreign markets,  access to high-quality talent, and most importantly incentives regimes that provide benefits over a wide range of investment types and dedicated institutions such as BOI.