VII. INVESTMENT CLIMATE Openness to Foreign Investment The Government of Sri Lanka actively encourages foreign investment and has a bilateral investment treaty with the U.S. Non-nationals can purchase up to 100 percent of equity in Sri Lankan companies in most sectors. The Board of Investment (BOI) is the primary government authority responsible for foreign investment. BOI, a member of the World Export Processing Zones Association, is moving close to providing 'one-stop' service for foreign investors, including approval of projects, licenses, establishing tax incentives and assistance in procurement. To qualify for BOI incentives, a project must produce mainly for export. Tourism and infrastructure projects such as telecommunications, transport, housing and hospital projects also enjoy preferential treatment. In certain sectors (see below) foreign investors are permitted to invest up to 40 percent of the issued capital. However, the BOI can grant permission for a higher percentage of foreign investment in any company. The restricted sectors include: shipping and travel agencies; freight forwarding; professional services; education; mass communication; telecommunications; radio, TV and cinema; supply of water; mining; deep sea fishing; timber-based industries; tea, rubber, and coconut industries. Branch or liaison offices of companies (in sectors listed below) which are incorporated outside Sri Lanka, also have various restrictions on foreign equity that are determined by their respective regulatory authorities. These sectors are: banking; finance; insurance; air transport; coastal shipping; military hardware and munitions manufacturing; production of poisons, narcotics, drugs, or hazardous or carcinogenic materials; production and distribution of energy and power; large-scale mechanized mining; and lotteries. Foreign investment is not permitted in the following businesses: non-bank money lending; pawnbroking; retail trade with a capital of less than $1 million; personal services other than for the export or tourism sectors; and coastal fishing. The BOI gives automatic approval for most foreign investments. Investment in restricted sectors (listed above), where foreign equity is to exceed 40 percent, is subject to screening. Foreign investments in a few other sectors, such as banking and finance, will also be screened by their respective regulatory agencies. The screening mechanism for the most part is routine and non-discriminatory. Conversion and Transfer Policies Sri Lanka eliminated exchange controls on all current account transactions early this year. There are no barriers, legal or otherwise, to the expeditious remitting of corporate profits and dividends for foreign enterprises doing business in Sri Lanka. Remittances of business fees (management fees, royalties, licensing fees) are also freely permitted as well as funds for debt service, capital gains, etc. In addition, all stock market investments can be remitted without prior approval of the controller. Investment returns can be remitted in any convertible currency at the legal market rate. The only controls that do exist are on capital account (investment) transactions. Around $6 million is used annually by Embassy and other U.S. government institutions in Sri Lanka which can be used to pay an inconvertibility claim by OPIC. Embassy purchases local currency at the Financial rate. The currency is expected to depreciate by no more than 10 percent over the next year. Expropriation and Compensation Since economic liberalization policies began in 1978, the Sri Lankan government has not expropriated a foreign investment. Investors in the EPZs have the right to arbitrate under the international Center for the Settlement of Investment Disputes. Dispute Settlement Foreign investments are guaranteed protection by the constitution of Sri Lanka. The government has entered into 18 investment protection agreements with foreign governments (including with USG) and is a founding member of the Multilateral Investment Guarantee Agency (MIGA) of the World Bank. The government has ratified the provisions of the convention on settlement of investment disputes, which provides the mechanism and facilities for international arbitration through the International Center for the Settlement of Investment Disputes of the World Bank (ICSID). The U.S.-Sri Lanka bilateral investment treaty (BIT) was ratified by both governments in early 1993. There have been no investment disputes involving U.S. investors during the past few years. However, at least one major dispute involving a Japanese construction company remains unresolved. Sri Lanka has a well-developed system of laws and legal procedures. In Sri Lanka, Roman Dutch law remains the common law, applicable where other laws, statutes or judicial decisions are silent. Constitutional, commercial and criminal law is almost entirely statute law, and is essentially a codification of English legal principles. Roman Dutch law predominates in the law of persons and property. Both English law and Roman Dutch law apply in the field of obligations (contracts and delict torts). Performance Requirements/Incentives One hundred percent foreign investment is encouraged in enterprises which involve extensive use of foreign capital or sophisticated technology. With few exceptions, foreign investors are not expected to reduce their equity over the time or transfer technology within a specified period of time. Firms enjoying preferential incentives in the manufacturing sector are usually required to export 90 percent of production. Firms engaged in agriculture should export at least 70 percent of production. Such firms also are expected to perform according to a mutually agreed program. A certain level of employment is a condition in some enterprises, especially in the garment factories. To encourage investment in new arenas and export-oriented enterprises, the BOI is empowered to offer the following incentives: - Preferential tax at 15 percent per annum for a period of twenty years for (a) the manufacture and export of non traditional products and services (b) computer software and (c) growing and processing of agricultural products. (minimum investment $250,000) - Preferential tax at 15 percent per annum for large infrastructure projects (minimum investment $25 million) for a period of fifteen years. - Preferential tax at 15 percent for a period of fifteen years for the construction and operation of hotels. (minimum investment $250,000) - Preferential tax at 15 percent for a period of seven years for hospitals, housing projects, warehouses etc. - Preferential tax at 15 percent for a period of ten years for recreation facilities, telecommunication services etc. - Duty free imports of plant, machinery, raw material and other project related goods. - Duty free exports. - No restriction on repatriation of dividends, profits etc. - Free transferability of shares. - Right to 100 percent foreign ownership. - Double taxation relief with 25 countries. Apart from these incentives the BOI has introduced a "resident guest scheme" through which investors, professionals and their family members are entitled to receive a resident visa valid up to 5 years. Enterprises located in the export processing zones (EPZs) as well as those located outside the zones are eligible for these concessions. All of the above incentives are specified in law. Right to Private Ownership and Establishment The private firms lead the business sector in Sri Lanka. Private entities are free to establish, acquire and dispose of interests in business enterprises. Foreign ownership is allowed in most of the sectors. However, about eighty percent of the land in Sri Lanka is owned by the government, including most tea, rubber and coconut plantations. The government did privatize management of these estates recently, but not the land. The government launched an industrial privatization program in 1991, and 40 public enterprises have been privatized, with around 20 more awaiting action. Foreign investors have actively participated in this program, already acquiring majority stakes in 12 of the 40 privatized ventures. Protection of Property Rights Sri Lanka is a member of the World Intellectual Property Organization (WIPO). Intellectual property is protected through the Intellectual Property Act of 1979 which embodies legislation pertaining to copyright, industrial designs, patents, trademarks, trade names and unfair competition. All trademarks, designs, copyrights, patents must be registered with the government's Registry of Patents and Trademarks. Sri Lanka has also signed a bilateral agreement with the U.S. and is a signatory to the Paris Convention for the protection of Intellectual Property Rights. Registered trademarks are valid for 10 years, patents are valid for 15 years, and industrial designs are valid for 5 years. Patents are available for all areas of technology. Sri Lanka is not a member of the Universal Copyright Convention of 1952. It is, however, a party to the Bern Copyright Convention. Copyrights include exclusive rights to reproduce work, translate, revise otherwise adapt or prepare program derivative works, distribute copy of the works and publicly communicate the work. At present, copyright protection is not extended to computer programs and databases. However, under the U.S.-Sri Lanka Bilateral Agreement, U.S. software producers receive copyright protection in Sri Lanka. Sri Lanka is a party to the Patent Corporation Treaty. Regulatory System The Sri Lankan government continues to review and revise laws, regulations and procedures to promote a competitive business environment, remove distortions, and eliminate red tape. The government has greatly liberalized trade and actively encourages private ownership, including foreign investment. Laws pertaining to tax, labor and labor standards, exchange control, custom and environmental norms have been designed. These laws strive to ensure an efficient mobilization of investment. Efficient Capital Markets and Portfolio Investment The financial system is relatively sophisticated, and basic legislation for private corporations is in place. Commercial banks are the principal source of finance. There are 23 commercial banks consisting of 17 foreign banks, and 6 domestic banks in the country. The domestic banks operate a wide network of branches throughout the island. All commercial banks operate foreign currency banking units (FCBU), and conduct off-shore business and finance projects approved by BOI. High interest costs (running over 18 percent) are a fact of life faced by the local business community, but foreign investors and BOI-approved local firms can raise finances through dollar interest rates. Two local, development banks provide development funds and equity. There are many companies involved in hire-purchase, leasing and other financing activities. There are four merchant banks and six venture capital companies. Most foreign owned firms must have foreign sources of financing for fixed and working capital requirements. Foreign majority joint ventures are not allowed automatic access to local credit markets. Such firms must get approval from the Central Bank on a case-by-case basis. Traditionally bank loans were the most widely used credit instrument for the private sector. However, recently leading private sector companies have started to raise capital through other credit instruments like corporate bonds, commercial paper, forward rate agreements etc. Rights issues are becoming popular among Companies listed in the stock exchange for rasing capital. Early this year a local blue chip conglomerate had a very successful Global Depository Receipt issue in the Luxembourg stock exchange. There is an active and relatively competent accounting profession in Sri Lanka, based on the British model. The source of accounting standards is the Institute of Chartered Accountants of Sri Lanka (ICASL) and standards are constantly updated to reflect current international accounting and audit standards. Due to a lack of an adequate enforcement mechanism problems with the quality and reliability of financial statements do exist. Accounting standards are not mandated by law other than for publicly quoted companies. Furthermore, auditors' opinions are not mandatory even for statements of publicly quoted companies. The World Bank has accordingly stressed the need for further improvements. USAID has provided technical and institutional assistance in this area. Moves are now underway to provide a mechanism for the enforcement of accounting standards, which will include penalties for non-compliance. The Securities and Exchange Commission (established under the Securities Council Act No 36 of 1987 as amended by Act 26 of 1991) regulates the securities market in Sri Lanka. Foreign investors can freely purchase up to 100 percent of equity in Sri Lankan companies in permitted sectors. In order to facilitate portfolio investments, country funds and regional funds are also allowed to invest in Sri Lanka's stock market; such funds must gain approval to operate in Sri Lanka. These funds make transactions through Share Investment External Rupee Accounts maintained in commercial banks. The Colombo Stock Exchange (CSE), while small by big emerging market standards, is one of the most efficient in the region. It has a fully computerized clearing and settlement system. The CSE is now in the process of automating trading, with the goal of moving to screen based trading by September 1995. Fifteen local and foreign joint venture brokers currently operate at the CSE. Political Violence Incidents of political violence, aside from those related to the ongoing insurgency in the North and East, have been relatively few in the past year. During a recent provincial council election campaign there were isolated incidents involving gunfire directed against candidates or their supporters. There were also acts of political "thuggery" and intimidation, including the tearing down of opponents' campaign banners/posters and efforts to disrupt rallies or keep participants from attending. One death resulted from a political incident in July. The beginning of the election campaign in July saw widespread skirmishes between UNP and SLFP supporters. Post-election violence has been a problem in Sri Lanka in the past but did not erupt after provincial council polls in 1993 or 1994. Bilateral Investment Agreements The Government of Sri Lanka has signed investment protection agreements with the United States (signed in May 1993) and the following 17 countries: Belgium Peoples Republic of China Denmark France Germany Italy Japan Korea Luxembourg Malaysia The Netherlands Norway Romania Singapore Sweden Switzerland United Kingdom (Extended to Hong Kong) OPIC and Other Investment Insurance Programs The U.S. and Sri Lanka concluded an agreement in 1966 (and renewed in 1993) that allows the Overseas Private Investment Corporation (OPIC) to provide investment insurance guarantees for U.S. investors. OPIC currently insures banking, manufacturing and service investments in Sri Lanka. Early in 1993, OPIC led an investment mission to Sri Lanka. Sri Lanka's membership in the Multilateral Investment Guarantee Agency (MIGA) offers additional safeguards against non-commercial risks. Labor Labor is available at a relatively low cost. The literacy rate is high at 88 percent, and English is widely spoken and understood in practically all parts of the country. However, there is a shortage of technical and managerial personnel. Most foreign investors find it necessary to use expatriate staff in key positions, at least in the early years of the project. Expatriate personnel are permitted when there is a demonstrated shortage of qualified local labor. Most permanent full-time workers are covered by laws pertaining to minimum hours of work, minimum wage, leave, the right of association, and safety and health standards. The minimum wage level as of January 1, 1995 will be Rs 2000 ($40) per month. Labor relations laws are adequate. Foreign Trade Zones Sri Lanka has three free trade zones called export processing zones. There are over 150 foreign export processing enterprises operating in the zones. Present government policies now permit foreign investors to establish factories in almost any part of the country and still enjoy preferential treatment. Capital Outflow Policy As a developing country itself, Sri Lanka does not encourage investment in other countries and still remaining exchange controls on capital flows. In practice, however, there are a number of local firms which have made recent investments offshore, including in the U.S., Bangladesh, and Vietnam. Most investments have been joint ventures and related to export trade. Foreign Direct Investment Statistics The data provided below reflect the best information available. Investment flow figures by sector and by country provided by the BOI are incomplete. Also they do not include foreign investment coming through non-BOI sources such as investments in the Banking sector. About 142 foreign companies have export-oriented factories in the three free trade zones run by the BOI and over 150 foreign investment projects are located outside the zones. A few foreign multinationals have factories producing mainly for the local market. U.S. Investment is modest; the best estimate is $35 million. Total net foreign investment into Sri Lanka between 1979-1993 is estimated at $850 million. The flow of inward foreign investment during the 1992-93 period increased remarkably with $121 million in 1992 and $189 million in 1993. Estimated Total Foreign Investment by Sector (in $ millions) Total Annual Inflow Total End 1991 1992 1993 End 1993 Food & beverage 3 6 2 11 Textiles/apparel,leather 126 30 28 184 Chemicals, rubber and plastic 104 10 13 127 Non met. mineral products 19 3 2 24 Fabricated metal, machinery 44 7 1 52 Other manufactured 43 21 38 102 Services 93 33 105 231 Unclassified 107 11 - 118 Total 540 121 189 850 Source: BOI, Central Bank, Finance Ministry and Embassy estimates Estimated Total Foreign Investment by Country (in $ millions) Total Annual Inflow Total End 1991 1992 1993 End 1993 South Korea 84 37 27 148 Australia 79 2 10 91 Sri Lanka 69 - 76 145 Hong Kong 44 5 11 60 Singapore 43 32 8 83 Japan NA 2 8 - USA NA 1 5 35 United Kingdom NA 3 3 - India NA 3 3 - Other/unclassified NA 36 38 - Total 540 121 189 850 NA: not available Source: Board of Investment, Central Bank, Finance Ministry, and Embassy estimates Major Foreign Investors A breakdown of current investment value by firm is unavailable. Major U.S. investors include: Eveready Battery, Smart Shirts (a subsidiary of Kellwood Industries), Citibank, American Express Bank, CPC International and Marriott Corporation. In the past six months over $30 million worth of new U.S. investments have been approved by the BOI. The new investors from the U.S. include Cargill Inc., Intellicall and 3M. The Major non-U.S. investors include: Lever Brothers, Nestle's, British American Tobacco Company, Mitsui, Pacific Dunlop/Ansell, Prima, FDK and S.P. Tao. Leading foreign investors which have acquired stakes in privatized companies include Norsk Hydro of Norway, Kabool Spinning and Textile of Korea, Mitsubishi Corporation of Japan, C. Itoh of Japan, and Tongyang Nylon Co. Ltd. of Korea.