Chinese free zone unlikely to save Sri Lanka’s economy
Sri Lanka’s economic and political crisis is overshadowing grand plans to build a new international city on a 269-hectare sandy plot of reclaimed land off the coast of its commercial capital, Colombo.
“It is difficult to convince investors and establish a financial centre in a country effectively in default,” says Aritha Wickramasinghe, a Colombo-based financial lawyer who has advised on the development of Port City Colombo’s financial centre.
The city is a long-term project with most of its benefits expected to be realised at later operational stages. Launched in 2014, during a visit by Chinese president Xi Jinping, the city has already attracted $1.4bn of investment from China Harbour Engineering Company (CHEC), which oversaw the land reclamation.
Port City Colombo was granted special economic zone (SEZ) status through an act passed by Sri Lanka’s parliament in May 2021. This law permits tax holidays to be granted to companies of up to 40 years.
Consultancy PricewaterhouseCoopers expects the city to contribute around $13bn (16% of 2020 gross domestic product) in direct and indirect value addition to Sri Lanka’s economy per annum after it becomes fully operational in 2041. Its contribution in the near-term will be mostly limited to construction jobs.
Despite high hopes, the project has struggled to gain momentum among prospective investors. The country’s current dire macroeconomic picture, which includes record-high inflation and dwindling foreign exchange reserves, is further undermining Port City Colombo’s appeal.
“The current situation in Sri Lanka is the mother of all crises,” says Murtaza Jafferjee, the chair of the Advocata Institute, a Colombo-based think tank. Nationwide protests across the island nation of 22 million people against the government began in early April 2022.
Sri Lanka is in talks for loan assistance from the IMF, which has urged the government to tighten monetary policy, raise taxes and adopt flexible exchange rates. The Sri Lankan rupee has lost over 70% of its value against the US dollar, year to date.
The IMF took aim at the project itself in its latest country IV assessment, writing that while the project provides “a good opportunity for attracting foreign investment and for experimenting with growth enhancing reforms that are otherwise more difficult to undertake in the onshore economy … tax incentives are often not a critical determinant for attracting investment and the revenue forgone could be better spent on human capital and infrastructure, while improving the doing business environment.”
It adds that “an investment promotion regime resting on discretionary incentives is also not conducive for attracting new investors, as it lacks transparency and clarity”.
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Seizing the opportunity
Senior officials from the Colombo Port City Economic Commission (CPCEC), the public body authorised to screen investments and shape regulations in the SEZ, note that Port City Colombo’s unique regulatory environment provides some shelter against the headwinds the country as a whole is facing.
Thulci Aluwihare, the assistant managing director of CHEC Port City Colombo, a wholly owned subsidiary of state-owned China Communications Construction Company that is developing the city project, echoes this sentiment. He notes that foreign investors will be “somewhat insulated” from Sri Lanka’s macroeconomy because the SEZ law states that all business and investment must be designated in foreign currency.
Mr Aluwihare says the development of the city “does not have significant dependence” on local Sri Lankan demand either. “We want to really give an international flavour to the port city and understand that is what will make it successful,” he says. Officials hope that Sri Lanka’s quality of life, which is relatively cheap compared to other destinations, will be a draw for foreign investors.
Saliya Wickramasuriya, the director general of the CPCEC, says that while the current climate is “limiting the number of conversations”, there has been some notable interest in the project.
“The port city has a separate law that is quite protective of investment,” he says. “We are looking for investors who see opportunity on the other side of the coin and that stress and challenge [of the current crisis].”
The city hopes to lure real estate developers and multinational companies from the Middle East, India, Southeast Asia and China. CHEC Port City Colombo has been allocated 116 of the 269 hectares of reclaimed land, on a 99-year leasehold basis.
Regional hub
Mr Wickramasuriya stresses that Port City Colombo’s goal is to serve the South Asia region and model itself on the successes of other prominent free zones, such as those in Singapore, Dubai and Mauritius.
“We are not creating our own sets of rules and policy frameworks,” he says. “We are picking what we think suits Sri Lanka best from those that are very good at it.”
The master plan for the city, which includes a marina and designated plots for residential, retail, financial and commercial activities, has already garnered some interest.
Mr Wickramasuriya says the CPCEC has been in discussions with several Hong Kong-based companies looking to relocate their regional headquarters, including in areas such as banking, financial services and trading houses.
These inquiries come amid increased multinational wariness over China’s rising political influence over Hong Kong, particularly since Beijing imposed a national security law on the special administrative region in June 2020.
The CPCEC has also received interest from hospital chains based in the US and India and hopes to attract a British international school.
Financial centre lags
Despite some interest from foreign professional services and IT firms, there remains a way to go for the planned offshore financial centre, which is expected to take about four years to be completed.
“Most global banks say it is still a bit premature until they get familiar with the banking regulations with the port city,” says Mr Aluwihare. More clarity on the ring-fenced banking regulations are expected to come online in June 2022.
Another key hurdle to Port City Colombo’s success is the extent to which fiscal incentives can be offered. Mr Aluwihare stresses the importance of ensuring regulations do not cause tax leakage from within Sri Lanka, but adds that the city “needs to be competitive” on tax.
