Economist Intelligence Unit says Expropriation law raises investor concerns

The influential Economist Intelligence Unit (EIU) has claimed that the expropriation law has raised investor concerns. Here are excerpts from EIU’s observations.

Sri Lanka’s Parliament has passed a controversial law to expropriate the assets of certain private enterprises deemed “underperforming” or “underutilised”. Apart from concerns over the way in which the law was fast-tracked through the legislature, it is bound to worry foreign investors.                   

This will be particularly counter-productive at a time when Sri Lanka is keenly seeking foreign investment for development following the end of the civil war.

On 9 November Sri Lanka’s Parliament passed the Revival of Underperforming Enterprises and Underutilised Assets Act. The act identifies 37 targets for State expropriation, including one holding company and 36 assets held by private companies. All 37 private enterprises have previously received land or aid from the Government.

According to the Government, these assets are either underutilised or being used for purposes other than those originally envisaged. The list includes properties owned by a sugar company, Pelwatte Sugar Industries, which is a listed subsidiary of Sri Lanka’s largest liquor producer, as well as the assets of Hotel Developers Lanka, which owns the Hilton Colombo hotel. The law also lists several foreign-invested assets, including a Singaporean-owned conference centre in Colombo and Suchir NEB Projects, which is owned by an Indian company.

Sri Lanka has a history of nationalisation of private enterprises: The local subsidiaries of several international oil companies were nationalised in 1961, and tea and rubber plantations were nationalised under the aegis of the Land Reform Act in 1972. When a new Constitution was adopted in 1978, the Government sought to allay the fears of foreign investors by including specific provisions precluding expropriation when bilateral investment agreements have been signed, as had been done in the case of Singapore.

However, before the Expropriation Bill was brought in front of Parliament, the Government referred it to the Supreme Court as an “urgent bill,” and the Supreme Court indicated that it was not inconsistent with the country’s Constitution. Parliament then passed the bill by a margin of 122 to 46.

A US-based rating agency, Moody’s, questioned the need for the fast-tracking of the law, which limits public scrutiny: In Sri Lanka once a law has been passed in Parliament, it cannot then be referred to the Supreme Court for review. Various business associations also protested against the move, arguing that it is likely to hurt the investment climate. Shortly after the passage of the law, Sri Lanka’s stock market hit a 14-month low on 15 November, falling by 2.4% despite the Government’s apparent efforts to boost market confidence by buying shares.

The legislative process itself raises two key concerns. Firstly, the passage of a law which specifically lists assets to be expropriated, rather than a general set of principles to be applied, appears to conflate the roles of the executive and the judiciary with that of the legislature. Secondly, the speed with which the legislation was pushed through will add to the political opposition’s concerns that the Government is using its two-thirds majority (it enjoys the support of 160 MPs in the 225-member house) to consolidate its grip on power.

Sri Lanka’s main opposition United National Party and the Marxist Janatha Vimukthi Peramuna party have alleged that the Government is targeting businesses linked to opposition parties, a charge the Government denies.

The law is likely to raise significant concerns amongst foreign investors. The Sri Lankan authorities have repeatedly tried to assure investors that this is a “one-off” measure which will not be repeated. Unavoidably, however, the move undermines the predictability of policymaking and increases uncertainty for foreign investors. It also raises uncomfortable echoes of the actions of populist Latin American governments, notably Venezuela, which has repeatedly used similar excuses to nationalise foreign-owned land and companies.

As this comparison suggests, Sri Lanka’s expropriation law is likely to be economically counter-productive. Following the end of a 26-year civil war in mid-2009, there is an urgent need for large-scale investment in the country. However, owing in part to the global economic crisis of 2008-09, Foreign Direct Investment fell from a high of US$ 752 m in 2008 to US$ 404 m in 2009. Last year it recovered only slightly, reaching US$ 478 m, according to IMF figures.

Ironically, the Government has also recently implemented several reforms to improve the local business environment for entrepreneurs. In the World Bank’s Doing Business 2012 index, Sri Lanka rose to 89th in the global ranking (out of 183 countries), up from 105th in the previous year. The strengthening of investor protections and reduced taxes on business were partly responsible for the improvement. However, the passage of an expropriation law with scarcely any public scrutiny or debate is likely to undo at least some of this progress in the eyes of foreign firms.