Sri Lanka is a lower middle-income country with a Gross Domestic Product (GDP) per capita of about $ 3,682 (according to the Central Banka of Sri Lanka (CBSL) and a population of approximately 22 million in 2020. The island’s strategic location off the southern coast of India along the main east-west Indian Ocean shipping lanes gives Sri Lanka a regional logistical advantage.
After 30 years of civil war, Sri Lanka is transitioning from a predominantly rural-based economy to a more urbanized economy focused on manufacturing and services. Sri Lanka’s export economy is dominated by apparel and cash-crop exports, mainly tea, but technology service exports are a significant growth sector. Prior to the April 21, 2019, Easter Sunday attacks, the tourism industry was rapidly expanding, with Lonely Planet naming Sri Lanka its top travel destination in 2019. However, the attacks led to a significant decline in tourism that continued into 2020 due to COVID-19 and the government’s related decision to close its main international airport for commercial passenger arrivals in March 2020. The airport reopened for limited commercial passengers in January 2021, but newly reimposed travel restrictions are resulting in severe contractions for both the tourism and apparel export sectors with potential follow-on impacts in related sectors including services, construction, and agriculture. Tourism revenue dropped 73 percent year-over-year (YoY) in 2020 while apparel exports dropped 15.6 percent in the same period. However, official figures for migrant labor remittances, another significant source of foreign exchange, increased to $7.1 billion in 2020 due to the collapse of informal money transfer systems during the pandemic, despite the job losses to Sri Lankan migrant workers, especially in the Middle East.
The administration of President Gotabaya Rajapaksa, who was elected in November 2019, has largely promoted pro-business positions, including announcing tax benefits for new investments to attract foreign direct investment (FDI). As outlined in its election manifesto, the Rajapaksa government’s economic goals, include positioning Sri Lanka as an export-oriented economic hub at the center of the Indian Ocean (with government control of strategic assets such as Sri Lankan Airlines), improving trade logistics, attracting export-oriented FDI, and boosting firms’ abilities to compete in global markets. However, COVID-19 and the subsequent lockdowns brought new economic challenges, forcing the government to adapt policies to the situation on the ground. In April 2020, the Ministry of Finance restricted imports of luxury and semi-luxury consumer products such as consumer durables, motor vehicles, and the import of certain agricultural products as a means of saving foreign reserves and creating employment in labor intensive agriculture. With a debt-to-GDP ratio now above 100 percent (of which 60 percent is foreign debt), Sri Lanka is facing a potential liquidity crisis, exacerbated by declining export receipts due to the pandemic. Exports of goods fell 15.6 percent to $10 billion in 2020, down from $12 billion in 2019. Exports of services fell roughly 60 percent to $3 billion in 2020 down from $7.5 billion in 2019.
FDI in Sri Lanka has largely been concentrated in tourism, real estate, mixed development projects, ports, and telecommunications in recent years. With a growing middle class, investors also see opportunities in franchising, information technology services, and light manufacturing for the domestic market. The Board of Investment (BOI) is the primary government authority responsible for investment, particularly foreign investment, aiming to provide “one-stop” services for foreign investors. The BOI is committed to facilitating FDI and can offer project incentives, arrange utility services, assist in obtaining resident visas for expatriate personnel, and facilitate import and export clearances. However, Sri Lanka’s import regime is one of the most complex and protectionist in the world. Sri Lanka ranks 99th out of 190 countries on the World Bank’s Doing Business Index and ranks very poorly in several areas, including contract enforcement (164 out of 190); paying taxes (142/190); registering property (138/190); and obtaining credit (132/190). Sri Lanka ranks well in protecting minority investors, coming in at 28/190 in 2020.
Sri Lanka’s GDP contracted 3.6 percent to approximately $81 billion in 2020 due to COVID-19, an improvement on the International Monetary Fund (IMF) projection for a 4.6 percent contraction. FDI fell to approximately $550 million in 2020, significantly less than the $1.2 billion in 2019 and $2.3 billion in 2018. The IMF projects a four percent growth in 2021.
|TI Corruption Perceptions Index||2020||94 of 180||http://www.transparency.org/research/cpi/overview|
|World Bank’s Doing Business Report||2020||99 of 190||http://www.doingbusiness.org/en/rankings|
|Global Innovation Index||2020||101 of 131||https://www.globalinnovationindex.org/analysis-indicator|
|U.S. FDI in partner country ($M USD, historical stock positions)||2019||$165 million||http://www.bea.gov/international/factsheet/|
|World Bank GNI per capita||2019||$ 4,020||http://data.worldbank.org/indicator/NY.GNP.PCAP.CD|
1. Openness To, and Restrictions Upon, Foreign Investment
Policies Towards Foreign Direct Investment
Sri Lanka is a constitutional multiparty socialist republic. In 1978, Sri Lanka began moving away from socialist, protectionist policies and opening up to foreign investment, although changes in government are often accompanied by swings in economic policy. While the incumbent government largely promoted pro-business positions, including announcing tax benefits for new investments to attract FDI, the government also made interventionist policies to arrest the ongoing economic fallout from COVID-19. This in turn has altered the field of foreign direct investment towards manufacturing intended to the domestic market.
The BOI (www.investsrilanka.com), an autonomous statutory agency, is the primary government authority responsible for investment, particularly foreign investment, with BOI aiming to provide “one-stop” services for foreign investors. BOI’s Single Window Investment Facilitation Taskforce (SWIFT) helps facilitate the investment approvals process and works with other agencies in order to expedite the process. BOI can grant project incentives, arrange utility services, assist in obtaining resident visas for expatriate personnel, and facilitate import and export clearances.
Importers to Sri Lanka face high barriers. According to a World Bank study, Sri Lanka’s import regime is one of the most complex and protectionist in the world. U.S. stakeholders have raised concerns the government does not adequately consult with the private sector prior to implementing new taxes or regulations – citing the severe import restrictions imposed as a reaction to COVID-19 as an example. These restrictions, quickly imposed without consulting the private sector, further complicated Sri Lanka’s import regime. Similarly, stakeholders have raised concerns that the government does not allow adequate time to implement new regulations. Additionally, the Sri Lankan government has banned the importation of several “non-essential” items since April 2020 in an attempt to curtail foreign exchange outflow as the Sri Lankan rupee (LKR) depreciated around five percent year-to-date in 2021 and is expected to come under further pressure.
Sri Lanka is a challenging place to do business, with high transaction costs aggravated by an unpredictable economic policy environment, inefficient delivery of government services, and opaque government procurement practices. Investors noted concerns over the potential for contract repudiation, cronyism, and de facto or de jure expropriation. Public sector corruption is a significant challenge for U.S. firms operating in Sri Lanka and a constraint on foreign investment. While the country generally has adequate laws and regulations to combat corruption, enforcement is weak, inconsistent, and selective. U.S. stakeholders and potential investors expressed particular concern about corruption in large infrastructure projects and in government procurement. The government pledged to address these issues, but the COVID-19 response remains its primary concern. Historically, the main political parties do not pursue corruption cases against each other after gaining or losing political positions.
While Sri Lanka is a challenging place for businesses to operate, investors report that starting a business in Sri Lanka is relatively simple and quick, especially when compared to other lower middle-income markets. However, scalability is a problem due to the lack of skilled labor, a relatively small talent pool and constraints on land ownership and use. Investors note that employee retention is generally good in Sri Lanka, but numerous public holidays, a reluctance of employees to work at night, a lack of labor mobility, and difficulty recruiting women decrease efficiency and increase start-up times. A leading international consulting firm claims the primary issue affecting investment is lack of policy consistency.
Limits on Foreign Control and Private Ownership
Foreign ownership is allowed in most sectors, although foreigners are prohibited from owning land with a few limited exceptions. Foreigners can invest in company shares, debt securities, government securities, and unit trusts. Many investors point to land acquisition as the biggest challenge for starting a new business. Generally, Sri Lanka prohibits the sale of public and private land to foreigners and to enterprises with foreign equity exceeding 50 percent. However, on July 30, 2018, Sri Lanka amended the Land (Restriction of Alienation) Act of 2014 to allow foreign companies listed on the Colombo Stock Exchange (CSE) to acquire land. Foreign companies not listed on the CSE—but engaged in banking, financial, insurance, maritime, aviation, advanced technology, or infrastructure development projects identified and approved as strategic development projects—may also be exempted from restrictions imposed by the Land Act of 2014 on a case-by-case basis.
The government owns approximately 80 percent of the land in Sri Lanka, including the land housing most tea, rubber, and coconut plantations, which are leased out, typically on 50-year terms. Private land ownership is limited to fifty acres per person. Although state land for industrial use is usually allotted on a 50-year lease, the government may approve 99-year leases on a case-by-case basis depending on the project. Many land title records were lost or destroyed during the civil war, and significant disputes remain over land ownership, particularly in the North and East. The government has started a program to return property taken by the government during the war to residents in the North and East.
The government allows up to 100 percent foreign investment in any commercial, trading, or industrial activity except for the following heavily regulated sectors: banking, air transportation; coastal shipping; large scale mechanized mining of gems; lotteries; manufacture of military hardware, military vehicles, and aircraft; alcohol; toxic, hazardous, or carcinogenic materials; currency; and security documents. However, select strategic sectors, such as railway freight transportation and electricity transmission and distribution, are closed to any foreign capital participation. Foreign investment is also not permitted in the following businesses: pawn brokering; retail trade with a capital investment of less than $5 million; and coastal fishing.
Foreign investments in the following areas are restricted to 40 percent ownership: a) production for export of goods subject to international quotas; b) growing and primary processing of tea, rubber, and coconut, c) cocoa, rice, sugar, and spices; d) mining and primary processing of non-renewable national resources, e) timber based industries using local timber, f) deep-sea fishing, g) mass communications, h) education, i) freight forwarding, j) travel services, k) businesses providing shipping services.
In areas where foreign investments are permitted, Sri Lanka treats foreign investors the same as domestic investors. However, corruption reportedly may make it difficult for U.S. firms to compete against foreign bidders not subject to the U.S. Foreign Corrupt Practices Act when competing for public tenders.
The Department of Registrar of Companies (www.drc.gov.lk) is responsible for business registration. Online registration (http://eroc.drc.gov.lk/) was recently introduced and registration averages four to five days. In addition to the Registrar of Companies, businesses must register with the Inland Revenue Department to obtain a taxpayer identification number (TIN) for payment of taxes and with the Department of Labor for social security payments.
The government supports outward investment, and the Export Development Board offers subsidies for companies seeking to establish overseas operations, including branch offices related to exports. New outward investment regulations came into effect November 20, 2017. Sri Lankan companies, partnerships, and individuals are permitted to invest in shares, units, debt securities, and sovereign bonds overseas subject to limits specified by the new Foreign Exchange Regulations. Sri Lankan companies are also permitted to establish overseas companies. Investments over the specified limit require the Central Bank Monetary Board’s approval. All investments must be made through outward investment accounts (OIA). All income from investments overseas must be routed through the same OIA within three months of payment. (Note: In the wake of the COVID-19 pandemic, the Sri Lankan government introduced a series of measures attempting to ease pressure on the Sri Lankan rupee. These measures included a temporary suspension on OIA transactions and additional foreign exchange controls.)
3. Legal Regime
Transparency of the Regulatory System
Many foreign and domestic investors view the regulatory system as unpredictable with outdated regulations, rigid administrative procedures, and excessive leeway for bureaucratic discretion. BOI is responsible for informing potential investors about laws and regulations affecting operations in Sri Lanka, including new regulations and policies that are frequently developed to protect specific sectors or stakeholders. Effective enforcement mechanisms are sometimes lacking, and investors cite coordination problems between BOI and relevant line agencies. Lack of sufficient technical capacity within the government to review financial proposals for private infrastructure projects also creates problems during the tender process.
Corporate financial reporting requirements in Sri Lanka are covered in a number of laws, and the Institute of Chartered Accountants of Sri Lanka (ICASL) is responsible for setting and updating accounting standards to comply with current accounting and audit standards adopted by the International Accounting Standards Board (IASB) and the International Auditing and Assurance Standards Board (IAASB). Sri Lanka follows International Financial Reporting Standards (IFRS) for financial reporting purposes set by the IASB. Sri Lankan accounting standards are applicable for all banks, companies listed on the stock exchange, and all other large and medium-sized companies in Sri Lanka. Accounts must be audited by professionally qualified auditors holding ICASL membership. ICASL also has published accounting standards for small companies. The Accounting Standards Monitoring Board (ASMB) is responsible for monitoring compliance with Sri Lankan accounting and auditing standards.
Overall legislative authority lies with Parliament. Line ministries draft bills and, together with regulatory authorities, are responsible for crafting draft regulations, which may require approval from the National Economic Council, the Cabinet, and/or Parliament. Bills are published in the government gazette http://documents.gov.lk/en/home.php at least seven days before being placed on the Order Paper of the Parliament (the first occasion the public is officially informed of proposed laws) with drafts being treated as confidential prior to this. Any member of the public can challenge a bill in the Supreme Court if they do so within one week of its placement on the Order Paper of the Parliament. If the Supreme Court orders amendments to a bill, such amendments must be incorporated before the bill can be debated and passed. Regulations are made by administrative agencies and are published in a government gazette, similar to a U.S. Federal Notice. In addition to regulations, some rules are made through internal circulars, which may be difficult to locate.
The Central Bank and the Finance Ministry published information on Central Government debt including contingent liabilities and government finance. Central Bank publishes information on debt of major SOE’s. Debt obligations are available online in the Central Bank Annual Report; Fiscal Management Report of the Finance Ministry; Annual Report of the Ministry of Finance. Information on contingent liabilities is available in the Annual Report of the Ministry of Finance. Since 2018, the Central Bank published guaranteed debt and central government debt annually.
International Regulatory Considerations
Sri Lanka is a member of the World Trade Organization (WTO) and has made WTO notifications on customs valuation, agriculture, import licensing, sanitary and phytosanitary measures, the Agreement on Technical Barriers to Trade, the Agreement on Trade-Related Investment Measures, and the Agreement on Trade-Related Aspects of Intellectual Property Rights. Sri Lanka ratified the WTO Trade Facilitation Agreement (TFA) in 2016 and a National Trade Facilitation Committee was tasked with undertaking reforms needed to operationalize the TFA. The WTO conducted a review of the TFA in June 2019 in which Sri Lankan officials noted challenges related to accessing technical assistance and capacity building support for implementation of TFA recommendations.
Legal System and Judicial Independence
Sri Lanka’s legal system reflects diverse cultural influences. Criminal law is fundamentally British-based while civil law is Roman-Dutch. Laws on marriage, divorce, inheritance, and other issues can also vary based on religious affiliation. Sri Lankan commercial law is almost entirely statutory, reflecting British colonial law, although amendments have largely kept pace with subsequent legal changes in the United Kingdom. Several important legislative enactments regulate commercial issues: the BOI Law; the Intellectual Property Act; the Companies Act; the Securities and Exchange Commission Act; the Banking Act; the Inland Revenue Act; the Industrial Promotion Act; and the Consumer Affairs Authority Act.
Sri Lanka’s court system consists of the Supreme Court, the Court of Appeal, provincial High Courts, and the Courts of First Instance (district courts with general civil jurisdiction) and Magistrate Courts (with criminal jurisdiction). Provincial High Courts have original, appellate, and reversionary criminal jurisdiction. The Court of Appeal is an intermediate appellate court with a limited right of appeal to the Supreme Court. The Supreme Court exercises final appellate jurisdiction for all criminal and civil cases. Citizens may apply directly to the Supreme Court for protection if they believe any government or administrative action has violated their fundamental human rights.
Laws and Regulations on Foreign Direct Investment
The principal law governing foreign investment is Law No. 4 (known as the BOI Act), created in 1978 and amended in 1980, 1983, 1992, 2002, 2009 and 2012. The BOI Act and implementing regulations provide for two types of investment approvals, one for concessions and one without concessions. Under Section 17 of the Act, the BOI is empowered to approve companies satisfying minimum investment criteria with such companies eligible for duty-free import concessions. The BOI acts as the “one-stop-shop” to facilitate all the requirements of the foreign investors to Sri Lanka. Investment approval under Section 16 of the BOI Act permits companies to operate under the “normal” laws and applies to investments that do not satisfy eligibility incentive criteria. From April 1, 2017, Inland Revenue Act No. 24 of 2017 created an investment incentive regime granting a concessionary tax rate (for specific sectors) and capital allowances (depreciation) based on capital investments. Commercial Hub Regulation No 1 of 2013 applies to transshipment trade, offshore businesses, and logistic services. The Strategic Development Project Act of 2008 (SDPA) provides tax incentives for large projects that the Cabinet identifies as “strategic development projects.”
Competition and Anti-Trust Laws
Sri Lanka does not have a specific competition law. Instead, the BOI or respective regulatory authorities may review transactions for competition-related concerns. In March of 2017, Parliament approved the “Anti-Dumping and Countervailing” and “Safeguard Measures” Acts. These laws provide a framework against unfair trade practices and import surges and allow government trade agencies to initiate investigations relating to unfair business practices to impose additional and/or countervailing duties.
Expropriation and Compensation
Since economic liberalization policies began in 1978, the government has not expropriated a foreign investment, with the last expropriation dispute resolved in 1998. The land acquisition law (Land Acquisition Act of 1950) empowers the government to take private land for public purposes with compensation based on a government valuation. Still, there have been reported cases of the military taking over businesses in the North and East part of the country, by claiming they were on government land, with little or no compensation.
ICSID Convention and New York Convention
Sri Lanka is a member state to the International Centre for the Settlement of Investment Disputes (ICSID convention) and a signatory to the convention on the Recognition and Enforcement of Foreign Arbitral Awards (1958 New York Convention) without reservations.
Investor-State Dispute Settlement
Sri Lanka signed a Bilateral Investment Treaty (BIT) with the United States in 1991. Over the past ten years, according to the United Nations, two investment disputes in Sri Lanka have involved foreign investors: 1) a dispute between a major European bank and the national Ceylon Petroleum Corporation regarding an oil hedging agreement, concluded with the proceeding being decided in favor of the foreign bank; and 2) an arbitration involving British and local investors (with the Attorney General as respondent) regarding a tourism development project that concluded in 2020 with the ICSID tribunal dismissing the $20 million claim for failure to prove the claim.
International Commercial Arbitration and Foreign Courts
Sri Lanka ranks very poorly on contract enforcement (164 out of 190) on the World Bank’s Doing Business Indicators. As a result, many investors prefer arbitration over litigation. Sri Lanka has a community mediation system, which primarily handles non-commercial mediations and commercial disputes where the amount in controversy is less than $3,333.00. There is no-mediation system for commercial disputes over that threshold amount. The Institute for the Development of Commercial Law and Practice (ICLP) (www.iclparbitrationcentre.com) and the Sri Lanka National Arbitration Centre (www.slnarbcentre.com) also help settle private commercial disputes through arbitration.
The Companies Act and the Insolvency Ordinance provide for dissolution of insolvent companies, but there is no mechanism to facilitate the reorganization of financially troubled companies. Other laws make it difficult to keep a struggling company solvent. The Termination of Employment of Workmen Special Provisions Act (TEWA), for example, makes it difficult to fire or lay off workers who have been employed for more than six months for any reason other than serious, well-documented disciplinary problems. In the absence of comprehensive bankruptcy laws, extra-judicial powers granted by law to financial institutions protect the rights of creditors. A creditor may petition the court to dissolve the company if the company cannot make payments on debts in excess of LKR 50,000 ($320.00). Lenders are also empowered to foreclose on collateral without court intervention. However, loans below LKR 5 million ($32,000) are exempt, and lenders cannot foreclose on collateral provided by guarantors to a loan.
Sri Lanka ranked 94 out of 190 countries in the resolving insolvency index in the World Bank’s Doing Business Report 2020. Resolving insolvency takes, on average, 1.7 years at a cost equivalent to 10 percent of the estate’s value.
While Sri Lanka has generally adequate laws and regulations to combat corruption, enforcement is often weak and inconsistent. U.S. firms identify corruption as a major constraint on foreign investment, but generally not a major threat to operating in Sri Lanka once contracts have been established. The business community claims that corruption has the greatest effect on investors in large projects and on those pursuing government procurement contracts. Projects geared toward exports face fewer problems. A Right to Information Act came into effect in February of 2017 which increased government transparency.
The Commission to Investigate Allegations of Bribery or Corruption (CIABOC or Bribery Commission) is the main body responsible for investigating bribery allegations, but it is widely considered ineffective and has reportedly made little progress pursuing cases of national significance. The law states that a public official’s offer or acceptance of a bribe constitutes a criminal offense and carries a maximum sentence of seven years imprisonment and fine. Bribery laws extend to family members of public officials, but political parties are not covered. A bribe by a local company to a foreign official is also not covered by the Bribery Act and the government does not require private companies to establish internal codes of conduct that prohibit bribery of public officials. Thus far, the Bribery Commission has focused on minor cases such as bribes taken by traffic police, wildlife officers, and school principals. These cases reportedly follow a pattern of targeting low-level offenses with prosecutions years after the offense followed by the imposition of sentences not always proportionate to the conduct (i.e., sometimes overly strict, other times overly lenient).
Government procurement regulations contain provisions on conflicts-of-interest in awarding contracts or government procurement. While financial crime investigators have developed a number of cases involving the misappropriation of government funds, these cases have often not moved forward due to lack of political will, political interference, and lack of investigative capacity. Sri Lanka signed and ratified the UN Convention against Corruption in March of 2004 and the UN Convention against Transnational Organized Crime in 2006. Sri Lanka is a signatory to the OECD-ADB Anti-Corruption Regional Plan but has not joined the OECD Anti-Bribery Convention.
Resources to Report Corruption
Contact at government agency responsible for combating corruption:
Commission to Investigate Allegations of Bribery or Corruption
No 36, Malalasekara Mawatha, Colombo 7
T+94 112 596360 / 2595039 M+94 767011954
Email: firstname.lastname@example.org or email@example.com
Contact at “watchdog” organization:
Transparency International, Sri Lanka
5/1 Elibank Road Colombo 5
Phone: 94-11- 4369783