Speech at the Breakfast with German Chamber of Commerce

Speech by ADB Sri Lanka Resident Mission Country Director Rita O'Sullivan on 25 January 2012

Economic overview

The Mahinda Chintana – the  Government’s Development Policy framework for 2010 to 2016 aims to increase GDP growth to above 8% in the medium term and double per capita income from $2,400 to $4,200.  The Government has embarked upon an ambitious plan to remove infrastructure bottlenecks in the country and to reduce the infrastructure gap between Sri Lanka and the other countries in the region.

In the current economic environment, these results are more easy to express than accomplish. To increase and sustain growth at above 8%, investments have to be increased to 33-35% of GDP. Since the Government is planning to maintain public investment at 6-7% of GDP, increase in investment by domestic private sector and inflow of FDI is key to achieve the projected rate of economic growth. However, despite the improved political and economic environment after the end of the civil conflict in May 2009, growth in domestic and foreign private investments thus far, stands below the expected levels.

Reviewing the 2012 budget assumptions we see:

  • The economy is expected to grow at around 8.0% in 2012. (On Track so far)
  • Public investment is estimated to be around 6.0%-7.0% in the next 6 years (On Track). Private investments will be incentivized to reach 28.0% of GDP. (Challenging)
  • Inflation in 2012 is expected to remain subdued at around 5.5%. (On Track)
  • Doubling of Foreign Direct Investments: $2.0 billion during current decade. (Challenging)
  • Debt-to-GDP expected to decrease to 75.0% in 2012 from 78.0% in 2011. (On Track)
  • One area that is performing well is the tourism sector. Earnings from tourism to be reach $1 billion in 2012. (On Track)

Tourist arrivals have increased by well over 50% during the last two years, reaching 850,000 in 2011, increasing revenues by 44% TO $830m.  By 2016 tourist arrivals are targeted to reach 2.5 million. The current infrastructure cannot cope with the increasing number of tourist arrivals. The Government is encouraging development of high-end tourism infrastructure by the private sector. We are seeing Government development of ‘domestic’ market infrastructure, which arguably would not be readily acceptable to the private sector.

Private sector potential

Need to move quickly - Government has undertaken a significant amount of investments in many infrastructure activities ranging from transport, energy, water, sanitation and irrigation.—for example, Sri Lanka has only just opened its first expressway in November 2011.  The Southern Expressway linking Colombo and Galle was financed by ADB and JICA.    However infrastructure development is however not sufficient.

Road and water supply, two sectors which have traditionally been under the Government, are now being opened up for private sector participation. With the recent legislative amendments it is possible to have fee levying roads in Sri Lanka. The proposed expressways are expected to be fee levying roads. To increase access to clean and safe water PPP projects in the area of water production are to be implemented.  ADB’s cities cluster RETA is developing concepts for PPP waste water treatment plants in the rubber industry.

The Colombo South Port Development Project is one of the recent examples of a PPP model in Sri Lanka which ADB has involved. The major elements of the projects are construction of a breakwater and dredging the approach channel of the inner harbor basin sufficient to accommodate three new terminals.  The terminals are to be constructed by operators chosen through open competitive bidding under Build-Operate-Transfer (BOT) concession agreements. The project cost is estimated at $1.4 billion including the construction of three terminals. ADB finances $300 million of the public component, which had stipulated that the project be carried out as PPP.

The first terminal was awarded in 2010 to an investor consortium consisting of Aitken Spence PLC and Hong Kong-based China Merchant Holdings.  China Merchants Holdings will own a 55 percent stake of the terminal, while Aitken Spence1 and Sri Lanka Ports Authority will own 30 percent and 15 percent stake respectively.

With the opening of the Colombo South container terminal, Colombo port will have capacity to handle another 2.4 million Twenty-foot Equivalent Units (TEUs) on top of over 4 million TEUs at present. Two other terminals proposed are Colombo East and the West container terminals, and with the completion of all three terminals by 2020, the Authority expects to handle 10 million TEUs. Other port development projects include those for Hambantota International Port and the second international airport at Mattala.

In power sector, the private sector participation in future electricity generation will largely be in the arena of renewable and green energy. To meet the Government target of generating 10% of electricity through renewable sources by 2015 requires substantial private sector investments in renewable energy, especially in wind power generation, which we are seeing in the Mannar region.  Transmission lines need to be upgraded to cope with additional supply.

ADB recently undertook a rapid assessment of Urban development on the island.  Growth centers were identified at Trincomalie, Batticaloa, Hambantota, Matara, Galle, vavaouniya and Mannar.  At present, 35% of the population lives in urban areas and this is expected to increase to 60% by 2020 creating an urgent need to develop the urban infrastructure to accommodate this transformation. The Government plans to develop several metro cities and metro regions and provide housing for the under-served settlements, improve transport, water and sanitation facilities in the urban areas and introduce improved solid waste management systems. Therefore a greater role is to be expected from the private sector in urban development. We see the opportunities for PPPs with Government providing the land.

Issues

Despite the positives, there are impediments that would continue to deter private sector investments; Lack of policy direction as well as weak and inconsistent policy implementation has hindered growth in private investments. The Government has had limited communication on its policy on PPPs with its institutes both at Central and provincial level, leading to poor implementation of the policy by respective agencies.

There is also a sense of urgency within the Government to implement infrastructure projects emanating from a opinion that Sri Lanka has already lost three decades due to war and has much ground to cover to catch up with the rest of the world. Hence, there is an increasing tendency to use unsolicited bids which arguably sacrifice transparency for the speed of implementation. This approach is viewed as undermining governance and accountability, leaving room for increasing legal risks and costs and possible corruption.  It also is a disincentive for private sector investors who feel locked out of any development proposals.

In November 2011, Sri Lanka introduced an Act on reacquiring underperforming enterprises and underutilized assets. The Act provides for the appointment of a Competent Authority which will control, administer and manage the enterprise or asset so as to ensure the revival of the named enterprise or asset, through means such as restructuring or entering into a management contract.  The purpose of the Act is to revive loss making entities into profit making ones, and the government has earmarked 37 businesses to be taken over under the proposed Act.  While the government has given the assurance to the business community in the country that the proposed bill is a one-off bill and maintains that foreign investments would not be deterred by the legislation, concerns have been raised by some private sector on the enabling business environment.  It is difficult to assess the real impact as it’s a ‘negative’ action.

The current legal and regulatory framework has limited impact to provide the necessary impetus for private sector participation. For example, the independence and autonomy of the regulatory institutes has been questioned. The Guidelines on Government Tender Procedure which is to provide a transparent, competitive, open bidding process for private sector infrastructure, in practice is perceived to have become an exception than the rule.

In addition, the under-developed financial sector is a constraint to secure long term domestic funding for private sector infrastructure projects. Loans of 5 year tenors are too short for capital improvements.  There is difficulty to borrow offshore – and the volatile rupee also adds to the potential costs. Poor stakeholder consultation and public awareness on the benefits of private sector participation in the provision of infrastructure also acts as a constraint. Difficulties in obtaining land for investment projects, stringent and rigid labour regulations, procedural delays associated in obtaining approval for construction projects are yet other factors that inhibit private sector investments.

Strategy and approach

ADB’s thrust to support private sector development focusing on three areas; (i) creating an enabling environment for business, (ii) generating business opportunities in ADB financed public sector projects and (iii) catalyzing private investments through direct financing, credit enhancements and risk mitigation instruments. ADB through its Private Sector Development Program has worked towards elimination of impediments to, and developing opportunities for, greater private sector involvement in Sri Lanka.

The results of the PSDP implemented by ADB in Sri Lanka have been mixed. The performance of projects has been uneven mainly due to changes in government, variation in policies, and political economy contexts. In the area of PPP, ADB made much headway on development of ports—for example, ADB policy dialogue with the Government has led to government accepting to adopt the PPP approach for the Colombo Port Expansion Project. The Government signed a 30-year concession agreement with South Asia Gateway Terminal (SAGT) for the development of country’s first modern private container terminal—but achieved limited success in other sectors such as agriculture, power and education.

The lessons we learnt from ADB’s private sector development operation involves (i) the need to understand and evaluate multifaceted dimensions of projects, (ii) make provisions to increase public awareness in sectors with substantial public and political resistance, (iii) provide sufficient time and resources for stakeholder consultation, (iv) strengthen the absorptive capacity of key institutes and (v) remain involved in policy dialogue even when the political environment is difficult.

ADB is working with the Ministry of Finance and Planning to identify, plan and design PPP arrangements in particular from the beginning. Ultimately it is this Ministry that will determine the overall feasibility and acceptability of the provision and contributions of public finance to the PPP modes of investments and operations which include considerations of the costs and terms of financing from both public and private sources.

To push forward ADB’s private sector development operation, it is necessary to strengthen the legal and regulatory framework by introducing necessary legal and regulatory amendments, strengthen institutional framework by creating a central agency to facilitate private sector investments and by enhancing institutional capacity to design, implement and manage PPP projects. As part of ADB’s strategy, assistance will be extended to improve efficiency, effectiveness and financial independence of SOEs.

To attract private sector investments into infrastructure, ADB will also assist national and sectoral government institutions to develop a pipeline of bankable projects accessible to the private sector and assist the government to develop relevant PPP guidelines. Further, ADB can generate business opportunities for the private sector through its public funding arm by providing complementary support infrastructure to enhance commercial feasibility of renewable energy projects.

Given the difficulties experienced in raising long term project finance, ADB assistance to enhance availability and access to long term financing at a reasonable cost through refinancing, financial market reforms, long term bonds, introducing innovative financial instruments and by creating a private sector infrastructure development fund as a transitory funding mechanism will also help increase private sector participation in infrastructure development.

Concluding remarks

I have no doubt that the Sri Lankan Government, with its forward looking policies and programs, is poised to play a leading role towards addressing the aforesaid challenges in private sector development. We look forward to working with you and for your continued support and suggestions for the development of Sri Lanka and for ADB operations.

Thank you very much.

 


[1] There is a news article stating that Aitken Spence has decided to sell its stake (Daily FT, 24 Jan 2012).