Sri Lanka can boost economic recovery by embracing regional investment and connectivity

By Sanjay Kathuria, Ravindra A. Yatawara and Xiao’ou Zhu

After enjoying people and places encountered during holidays in Sri Lanka, Nepalese entrepreneur Binod Chaudhary decided to venture into Sri Lanka’s hospitality industry. Chaudhary, then known as “Noodle King” from his success with Wai Wai dried noodles, invested in Sri Lankan hotels through the Taj Group in 2001. The investment led to the development of CG Hospitality, which later made further investments in Sri Lanka, Maldives, India, Rwanda, China, the United States, and its home country of Nepal. 

Chaudhary’s experience highlights the win-win nature of regional investments. New jobs and incomes emerged for Sri Lankans as CG Hospitality partnered with local firms such as Jetwing, Ceylon Hotels Corporation and Sunshine Holdings. At the same time, CG Hospitality converted its learning experiences to a profitable new line of business and contributed to Chaudhary’s status as a Forbes-listed billionaire. 

The investments also facilitated new investments and employment in Chaudhary’s native Nepal and in South Asia as the company developed its own hotel brand. 

Our new World Bank report, ‘Regional Investment Pioneers in South Asia – The Payoff of Knowing Your Neighbors’, incorporates broader notions of emerging market companies’ international engagement and bilateral connectivity across nations and firms. Two issues became clear. First, emerging market firms and governments need to understand that international engagement involves exports, imports, inward foreign direct investment (FDI), as well as outward FDI. 

Second, bilateral connectivity must explicitly include knowledge connectivity in addition to traditional transport and trade costs. Knowledge connectivity is part of every-day business in most global regions – it is the extent to which firms know the economic and investment environment in another country. Knowledge connectivity reduces the entry costs of cross-border business. 

Cross-border economic engagement is increasingly important for South Asia’s economic recovery as trade costs rise dramatically and global value chains adjust to these costs. The greater resilience of services sector in the global recovery, and strong services sectors in South Asia enhance the case for regional engagement in South Asia. A global push to diversify sourcing also presents an opportunity for South Asian firms to develop regional value chains and get more involved in global value chains. 

CG Hospitality’s venture in Sri Lanka shows the interplay of cross-border investments, knowledge connectivity, and regional engagement. Knowledge connectivity – acquired through travel and interacting with locals – was important for the company’s investment decision. Knowledge connectivity also helped CG Hospitality build bilateral trust and deepen regional engagement. 

Sri Lanka and Bangladesh are biggest recipients of intraregional investment

South Asia has long had low intraregional trade that makes up just 5-6% of total trade. Our report found that while there is some increase in intraregional investment flows, it remains very small and accounts for only 2.7% of outward FDI and just 0.6% of inward FDI. About half of the South Asia region’s outward FDI goes to Singapore, United Arab Emirates, and Mauritius. Sri Lanka and Bangladesh are the largest recipients of intraregional investment.

Our report shows that bilateral knowledge connectivity is, on average, only 1.9 in South Asia (score of 4 means being well-informed). This increases the costs of searching for trustworthy partners. 

Outward FDI is low in South Asia compared to other regions. Outward FDI policies that are restrictive (Bangladesh, Bhutan, and Nepal) and non-transparent (Afghanistan, Maldives, and Pakistan) curtail investments. Low knowledge connectivity, small countries’ fears of being dominated by the region’s largest nations, and an approval process in India for countries sharing land borders with it, dampen intraregional investment, relative to other regions. 

Restrictions on outward FDI restrain dynamic companies, discourage regional value chains, and are an anomaly in an era of globalisation. For small economies like Sri Lanka, outward FDI compensates for its size – be it for better catering to consumer markets abroad (through retail and trade supporting investments) or expanding production abroad to meet scale and scope demands of global buyers. Innovative Sri Lankan firms like MAS Brands and Timex Garments have used outward FDI to develop brands and capture higher profit margins in the apparel value chain. Brandix and MAS have used outward FDI to provide scale and a wider variety of products. 

Sri Lankan firms outside the apparel industry have also invested abroad to secure raw materials and acquire technology when capacity is limited at home, and to cater to consumers abroad. Such investments have been undertaken in tourism, logistics, IT, food products and activated carbon.

Implications for private sector, government policy

Our research illustrates many opportunities available in the region and a wider pool of potential investors beyond large, established firms. Companies execute a range of cross-border engagement strategies with varying entry and start-up costs. Many start with low-cost approaches such as trade-supporting investments, or using the knowledge gathered from exporting to reduce the costs of later investment. 

The availability of networks and inherent knowledge of destination markets reduces entry costs for the investing firm. Given the importance of knowledge connectivity in South Asia, there is scope for Sri Lanka and neighbouring countries to develop an industry of “knowledge brokers” – consulting firms that can reduce entry costs through information, partner matchmaking and manoeuvring the regulatory environment abroad. 

The policy implications are relevant both for the short-term, as countries tackle strategies for economic recovery, and for the longer-term, as policy makers help domestic firms become more competitive. From the perspective of fiscal and foreign exchange restrictions, it is important to devise interventions that would least disrupt the return to optimal policies in the medium term. It is also important to support building new cross-border relationships. We recommend the following actions in Sri Lanka, which are also applicable to most other countries in the region:

Enhance knowledge connectivity and networks: Such interventions by the Board of Investment, overseas trade representatives of the Department of Commerce, and the Export Development Bureau can help expand international engagement beyond large firms with established networks. 

Maintain a liberal outward FDI regime: Sri Lanka has a transparent and somewhat liberal outward investment regime compared to most countries in the region, except India. The country should maintain this positive approach, amply justified by the performance of its cross-border champions. This approach will also benefit the next generation of firms that seek to use cross-border engagement to enhance competitiveness and become more resilient.

Strategies for inward investment promotion and facilitation: Our report suggests various targeted strategies that would promote inward foreign direct investment. Sri Lanka could target foreign firms that already have invested in other countries in the region and approach companies owned by a conglomerate that has invested in the country. Policy makers can also focus on firms that export to Sri Lanka or firms with small investments already in the country, given the documented gradual approach to investing in South Asia. 

Digital and overall connectivity: Investments in digital connectivity that reduce communication costs and provide a platform for doing business are also important, as they will continue to be important in a post-pandemic context. These will reinforce the traditional investments in transport connectivity. 

Most of the suggested interventions do not entail large fiscal outlays but could have a significant positive impact on FDI inflows and help Sri Lankan-based firms to enhance competitiveness and resilience. 

Sanjay Kathuria, a former lead economist with the World Bank, is a senior visiting fellow at the Centre for Policy Research in India, a fellow at the Wilson Center in Washington, D.C., and a non-resident senior fellow at the Institute of South Asian Studies in Singapore. Twitter: Sanjay_1818.

Ravindra A. Yatawara is a senior economic consultant in South Asian regional integration in the World Bank’s Macroeconomics, Trade, and Investment Global Practice. He has held faculty positions at Columbia University and the University of Delaware, and also worked for the Government of Sri Lanka.

Xiao’ou Zhu is a consultant in South Asian regional integration in the World Bank’s Macroeconomics, Trade, and Investment Global Practice. Earlier, she worked in impact investing.