FROM THE SECOND DECADE
A selection from LMD’s Cover Stories

JANUARY 2010

DAWN OF A NEW ERA

Mohan Pandithage sketches a road map for postwar development and pinpoints the main stumbling blocks that could undermine Sri Lanka’s advancement – Larry Enas reports

Last year marked one of the most dramatic moments in this nation’s long history. The end of the war in May will undoubtedly be etched in our memories for several years to come. And while this time will be remembered with much relief, 2009 also marked one of the darkest periods for business since the Great Depression.

DOMINO EFFECT The global economic and financial crises saw a domino effect ripple across the globe, resulting in a meltdown that the world economy has yet to recover from.

Like so many developing economies, Sri Lanka wasn’t spared the onslaught – but the fallout here at home was perhaps less damaging due in part to some measures taken by the powers that be.

Despite this apparent economic security, many experts have argued that risk mitigation and crisis preparedness continue to be far from ideal. And while there is now some interest from potential investors in our island-nation, many sensitivities need to be addressed if we are to capitalise on the opportunities that lie before us in the year ahead… and beyond.

This may well be the litmus test for our economy and indeed the nation as a whole.

Indeed, the climate for development and growth have improved significantly, and while the apparel industry does face some challenges because it risks losing the crucial GSP-Plus concession (for no fault of its own, mind you), other corporates engaged in export activities may be in for better times despite the sluggish demand in target markets.

ROLE MODELS Sri Lanka is blessed with many conglomerates with long and model histories, connected as they have been for well over a century with the island’s agriculture and export industries. And Hayleys is undoubtedly one of this group’s torchbearers.

The highly diversified blue-chip’s newly appointed Chairman and Chief Executive Mohan Pandithage agrees that 2009 was a watershed year for many businesses.

“The country witnessed a historical milestone when the 26-year conflict ended on 18 May 2009. The areas affected by the conflict are now linked with the rest of the country, and we are hopeful of seeing a freer flow of goods and services, perhaps when infrastructure is fine-tuned. The private sector can play a pivotal role in accelerating such development,” he believes.

Having taken the reins of Hayleys soon after the historic victory by the armed forces, Pandithage is highly optimistic about his group’s ability to contribute towards the betterment of the economy, specifically in agriculture.

Hayleys is a leading contributor to the country’s exports, with a 2.3 percent share of the national total, and a strong presence in both agriculture and logistics.

“The overall business sentiment is positive, albeit that we are yet to see a dramatic turnaround in external trade. Our sovereign rating outlook has improved, contributing to a level of optimism for business expansion that was not possible previously. The fact that the US$ 500 million sovereign bonds offered by Sri Lanka last October to international capital markets were 13 times oversubscribed is testimony that this nation is back in favour as a destination for investment,” he declares.

Pandithage remains highly positive about prospects for 2010 against the backdrop of Sri Lanka’s transformation into a unified nation and increasing investor interest – many showing an eagerness to be front-runners and establishing themselves in the newly liberated areas.

“I believe that the year 2010 would be the ‘Year of Takeoff.’ One-third of the country’s land and two-thirds of its oceanfront were not available for economic activity until recently. With the opening up of the north and east, Sri Lanka is now on the radar screen of international investors – and I see a resurgence of investment interest in private equity as well as in listed securities,” he states.

NORTHEAST BOOST Drawing attention to the opening up of the north and east, the Hayleys boss observes that “the opening up of the north and east has given us a boost, extending the areas where we have mobilised the farming community, incorporating them into our outgrower network to supply fruits and vegetables. We have about 8,500 farmers mobilised in the country and since the cessation of hostilities, we have been able to mobilise 1,500 from the Eastern Province too.”

He adds: “Labour mobility needs to be encouraged from the northeast provinces to the Western Province, which will facilitate lower unemployment levels and increase income generation.”

Elaborating on possible avenues that are ripe for investment, Pandithage draws attention to three in particular that in his view have tremendous scope.

“We see new opportunities to extend the scope and reach of our businesses in the north and the east, mainly in agriculture, logistics and leisure. We have already expanded our vegetable outgrower network in the Eastern Province and plan to open a World of Hayleys outlet in Jaffna soon, to showcase our products and services,” he reveals.

At a macro level, the newly installed corporate leader notes that the cost of borrowing has declined together with the rate of inflation, which is indeed good news for the corporate sector.

STUMBLING BLOCKS Among the concerns though, Pandithage alludes to the appreciating value of the rupee (which impacts exports) as well as rising labour costs (this undermines export competitiveness).

“As exporters, we are naturally concerned by the appreciating rupee. Further, with rising GDP per capita income, labour costs are bound to escalate. So as exporters, we would have to move up the value chain if we are to compete effectively in the global marketplace,” he asserts.

Like many captains of industry, the Chairman of Hayleys emphasises the need for critical marketing as well as streamlined systems that would make Sri Lanka an attractive investment option for FDI – if we are to capitalise on the peace dividend that now lies before us.

“For the peace dividend to materialise, measures need to be taken to improve the attractiveness of Sri Lanka for business. Project approvals from statutory bodies must be granted within a reasonable time frame, as lengthy delays would dampen investor confidence. It is important that public sector entities too monitor their performance in terms of the quality and timeliness of their services,” he says.

Nevertheless, many sectors and industries engaged in exports have suffered setbacks that have indirectly had a knock on effect on the job market and income generation. But some, like Hayleys, have weathered the storm and posted decent bottom line growth – as the results and analyses of THE LMD 50 special edition, which was released last month, suggest.

Describing his group’s resilience, Pandithage notes: “Despite the effect of the global recession, our Global Markets and Manufacturing Sector continued its robust performance due to greater efficiencies and lower input costs in some units, and a strong focus on value added products in others.”

But some areas of the business were affected, he concedes – notably, the Industrial Gloves Division, which has of late shown signs of improvement. He adds a reflective note that “this situation has compelled us to look more carefully at our cost structures and introduce lean manufacturing practices, alternative energy sources and so on.”

LEAN AND MEAN Certainly, many businesses have taken steps to become leaner and more efficient as a direct result of having to go into survival mode. But the landscape hasn’t been rosy for all. The recent plantations wage hike for instance, has impacted the tea industry to some extent.

Addressing some of the concerns, Pandithage suggests measures that would, if implemented, be a formula on the way forward.

Two key steps, he says, would be “a panel of reputed professionals with judicial or arbitration powers to evaluate submissions by all interested parties and fix wage rates.” He also moots “a predetermined agreed formula to provide wage increases with the engagement of all stakeholders.”

Heading a group of companies that has taken The Ceylon Chamber of Commerce award for the Best Corporate Citizen for three consecutive years, its Chairman is mindful of his group’s responsibility towards its employees and to society at large. And he says he firmly believes in “the sustainability of our businesses rather than in short-term earnings.”

INFRASTRUCTURE NEEDS One of the many benefits accruing from the end of the war is a renewed focus on infrastructure, and developing much needed road networks and support structures that are essential for business and economic growth.

Elaborating on the immediate and long-term infrastructure needs of the country, and in particular the newly liberated areas, Pandithage also notes that financial services are the need of the hour in terms of accelerating growth.

“The infrastructural needs of these areas are many – roads, telecommunications, electricity, housing, water and sanitation, financial services particularly focussed on microfinance and access to markets needs to be developed in the near to medium term. These are critical in providing employment opportunities for the youth and a brighter life for residents in these areas. Education is a vital need as is health services, if we are to elevate the living standards in those areas,” Pandithage asserts.

Commenting on the infrastructure needs in metropolitan areas and the city of Colombo, he highlights roads and transportation as being the key concerns.

“The city of Colombo requires a metro for easy access to and from the suburbs. Peak time traffic results in wasted time and an unnecessary burning of fuel, and of course pollution. Construction needs to be expedited on the Katunayake Expressway and the Colombo-Matara Highway. We have long overlooked the area of city planning. For example, the frequent inundation and sinking of roads are problems we should avoid in a city that intends to become a hub for the South Asian region. It is imperative that any future development is based on professional urban planning,” he urges.

ENERGY IMPERATIVES Another area that has been in the limelight, so to speak – partly due to media coverage of a work to rule campaign – is the energy sector. To this end, there is a feeling that China’s investment in a coal power plant will address much of the future energy needs of this country. A recent official communiqué set a completion date of 2012 for this and other power projects.

“It is likely that Sri Lanka will have sufficient power to meet the increasing demand for electricity and ensure uninterrupted supply. Work is already under way on mega power projects such as the 900 MW coal power plant in Puttalam, the 500 MW coal power plant in Trincomalee and so on. The rehabilitation of New Laxapana, Wimalasurendra and Ukuwela hydropower plants is also envisaged to add 215 MW to the national grid,” Pandithage notes.

“However, it is imperative that these projects be commissioned as planned. Any major delays may result in a shortage of power,” he cautions.

ASIAN HUB In its favour, the incumbent government has stepped up efforts to construct new ports and highways. The Hambantota Port project and the newly commissioned international airport (also in Hambantota) are just two such initiatives in the pipeline.

Mooted as a possible Asian hub, Sri Lanka’s shipping industry will receive a well-deserved shot in the arm when these projects are completed.

The industry suffered severe setbacks as a result of the global crises and has been slow to recover. In addition, our emergence as a solutions provider, especially in the field of BPO, has added further impetus to Sri Lanka’s efforts to promote itself as a viable investment destination.

“The shipping industry is facing a downturn due to the global downturn; both freight rates and trade volumes have only recently showed signs of recovery. Trading volumes within the Asian region could improve. The development of ports in Colombo, Galle and Hambantota – which are strategically placed on the east-west shipping route – is welcome news for the industry. Sri Lanka has a natural advantage with its location and it needs to be promoted as a transhipment hub,” Pandithage maintains.

Highlighting the possibilities, he adds: “With appropriate government policies, Sri Lanka can become a transport and logistics hub for the region, and the island’s ideal location could be leveraged to make it an international gateway that is similar to Singapore. Also, the country has the potential to become a hub for high-end BPO services.”

In our favour, the recent acquisition by the London Stock Exchange of a leading technology solutions provider (MIT) has not only given the BPO industry much needed exposure but also raised the bar in terms of the importance of quality and service.

Importantly, the industry contributes well over 250 million dollars in foreign exchange earnings to the country. In addition, a highly literate and easily trainable workforce are other pluses that augur well for entrepreneurs and established corporates to leverage on, in both the medium and long terms.

“With regard to BPOs, our youth are talented and literate. We have the highest number of British qualified accountants outside the UK. Hence, BPOs on finance and accounting (F and A) could leverage on our talent pool. In addition to F and A, Sri Lankan BPOs could also be developed to target niche markets such as mobile telephony, stock exchange software solutions and so on. We have seen several companies operating successfully in Sri Lanka in the F and A field,” Pandithage points out.

ENGINE OF GROWTH Alluding to a framework that fosters public private partnerships (PPPs), the Hayleys chief believes that the government could and must engage the private sector more significantly to address key issues.

“The private sector could be engaged more in addressing key issues affecting Sri Lanka’s economy. I believe PPPs are vital for the country’s economic development,” he stresses.

The Colombo Stock Exchange (CSE) too has been at the centre of much attention in recent months – for both pluses and at least one shock. Ranked as the best performing bourse in the world not long ago, it saw a flurry of activity and indeed the highest trading in its history.

On the other side of the ledger, the arrest (on alleged insider trading charges) of leading hedge fund manager and investor in many Sri Lankan corporates Raj Rajaratnam saw trading plunge to lows as panic hit the market.

Many have suggested that the authorities should focus their attention on attracting further FDI into the system and create a climate in which this is possible. Maintaining that we do have the potential to become a top player, Pandithage remains optimistic while drawing attention to the sensitivities that must be addressed.

The Chairman of Hayleys observes: “The market capitalisation of stocks listed on the CSE is notably less than Sri Lanka’s GDP, an indication of the potential for growth of our capital market. There are many undervalued companies that could be of interest to the discerning investor. Currently, the growth in FDIs is around US$ 750 million annually. Several international investment companies and funds see Sri Lanka as a potential investment opportunity. I’m quite optimistic with regard to the country’s investment climate in the medium term.”

Insisting that “we should pay sufficient attention to increasing the ease of doing business in Sri Lanka,” he cites a recent report compiled and released by the World Bank.

“In the Doing Business 2010 Survey, Sri Lanka is ranked 105, down eight places from 2008 and behind Pakistan and the Maldives. The World Bank report points out that ‘there are 22 procedures to go through when seeking construction permits and it takes about 214 days.’ The government should take urgent measures to change such negative perceptions, which are a deterrent to investor interest,” he urges.

Agreeing with the recent assessment of the head of RAM Ratings, Pandithage feels that the corporate bond market requires urgent attention, which if corrected would provide the private sector with the necessary funding mechanisms to fuel growth.

He clarifies his position as follows: “Although interest rates have been brought down, there is a dearth of long-term funds at reasonably low fixed interest rates. A vibrant corporate bond market is a necessity for the corporate sector to borrow funds at lower or more competitive interest rates than bank loans in the long term.”

“The corporate bond market needs to be supported by a neutral tax environment for trading (withholding tax is a disincentive to investment in the corporate bond market) with minimum transaction costs, if it is to become an attractive investment vehicle for institutional as well as retail investors. Government controlled institutional investors who have long-term funds available for investment, namely pension and insurance funds, should be encouraged to invest a reasonable proportion of their funds in corporate debt instruments,” he adds.

REFORMS AND THE BUDGET Concerns were raised by the business community following the announcement in October last year of the postponement of the budget in favour of a Vote on Account.

Deferred until after elections early this year, many hope the next fiscal budget will address the vexed issue of taxation, which continues to affect a handful of taxpayers.

Commenting on his expectations of Budget 2010, Pandithage elaborates: “We expect Budget 2010 to be a progressive one, which would encourage investment and capital formation to drive economic growth and reduce unemployment. A rationalisation of the tax structure is important for the private sector to do justice to its role as the engine of growth. It is encouraging to note that special tax concessions have been introduced for investments in the north and the east.”

Indeed, a reduction in the tax rate from its present 35 percent would facilitate higher revenue collection through greater tax compliance – which has been recommended by many consultants and captains of industry.

Pandithage agrees: “Yes, the Sri Lankan tax system is complex. There are too many taxes and it would be beneficial if the system is simplified with fewer taxes.” Indeed, the inability of corporates to offset taxable income against tax losses pushes the effective tax rate up, as does the tax on dividends.

“It would be beneficial if conglomerates are allowed group tax relief for their businesses. As of now, conglomerates such as Hayleys cannot offset their taxable income against tax losses, thereby increasing the effective tax rate. In addition, an exemption for debit tax for fund transfers among group companies and a waiver of stamp duties for share transfers within the group would also be welcome. The deemed dividend tax is a deterrent to a company’s progress as it discourages reinvestment,” Pandithage argues.

Following the revelation of tax fraud last year, the issue of VAT refunds has also been raised and is yet to be addressed by the Central Bank – although reports in the press in recent weeks suggest that some action is now being taken. This however, may be a case of too little, too late.

Stressing the importance of these refunds, Pandithage says that “VAT refund procedures must be streamlined. The corporate sector has valuable financial resources tied up in [VAT] refunds, which could otherwise be used for more productive purposes such as new investments, creating employment opportunities and so on.”

ENCOURAGING EXPORTERS Exports account for nearly 25 percent of Sri Lanka’s GDP. While it is heartening to note the buildup of foreign currency reserves in the last few months, it is essential that the government assists exporters in developing overseas marketing and distribution channels, new product development and branding activities in international markets, so that a sustainable stream of forex earnings is assured.

“Exporters need to be provided with incentives such as low-cost financing, tax relief, expedited VAT refunds, schemes like export development reward programmes, investment relief and so on to ensure sustainability and growth,” Pandithage insists.

Elaborating on his expectations for the forex market in the short to medium term, the Chairman of Hayleys states: “I feel that the rupee would appreciate over the next six to 12 months, given the sustained inflows of foreign currency to the country. Globally, the US Dollar is weakening and it is expected that this trend will continue into 2010 too. Much would depend on how strongly key economies, notably those of the US and China, recover – as rising input prices will have a big impact on our exchange rate.”

In particular, Sri Lanka’s apparel industry is under pressure. The GSP Plus issue continues to loom large, with those on both sides of the equation pushing their respective agendas.

“The GSP Plus issue is an area of concern. Sri Lanka needs this preferential benefit, as the EU is an important export market for us… not only for apparel but for value added agricultural products such as processed fruits and vegetables as well,” Pandithage points out.

In that respect, Sri Lanka’s image abroad has taken a beating following media coverage of alleged human rights abuses in particular. Sentiment within the international community remains a crucial precursor to investment plans by many Western investment entities.

TOURISM INITIATIVES Commenting on one industry that can and should now be managed effectively, Pandithage urges that tourism is accorded priority status.

“I feel it is high time Sri Lanka’s potential for high-end tourism is realised. This would require a significant investment in marketing this country and raising awareness of the many features Sri Lanka has as an attractive tourist destination,” he says.

Ecotourism continues to receive focus, with top hospitality brands investing in ventures to cater to what many expect to be an increase in demand. The commissioning of a report on Kalpitiya by a globally renowned leisure brand adds further impetus to the importance of developing sustainable tourism initiatives.

“Surely, as with our exports making a concerted effort to move downstream, tourism marketing must also target the more discerning and sophisticated traveller,” Pandithage says, adding that an open skies aviation policy would be an ideal fillip for the tourism industry.