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Sri Lanka: an emerging destination for knowledge-based FDI

ICT has been recognized as the key to improve economic performance, productivity and efficiency, reduce transaction costs and greater control of activities of business firms. The rapid development of ICT has made possible for many companies to become footloose. Back-office functions can be conducted almost anywhere regardless the geographical location of company headquarters. Due to these key features, investments made in the ICT sector by both public and private sector agencies in many countries have been increased remarkably during the last few years. In particular, efficiency-seeking (eg. knowledge and skilled labour) global investors/companies have invested heavily in ICT related investments.

This phenomenon can be experienced in Sri Lanka also. The overall investment climate of Sri Lanka shows a substantial improvement in the recent past. The inflow of FDI to the country, for example, is on an upward swing. Sri Lanka received US $ 287 million FDI in 2005 and this has been increased to US $ 734 million in 2007 indicating a 39% increase during 2005-2007 period. Sri Lanka received the highest-ever level of FDI in 2007 surpassing the previous record level of US $ 604 million in 2006. This growth was achieved due to a combination of factors such as investment incentives offered by the Board of Investment of Sri Lanka (BOI), several overseas investment promotion missions undertaken by the BOI, constitutional guarantees on investment agreements, re-investments of the existing companies and BOI’s initiatives under the Nipayum Centre Programme to promote investments in less developed regions.

One of the significant developments of the composition of FDI in Sri Lanka is that the investments in manufacturing sector are at a decreasing trend. Data shows that 47% of total FDI in 2005 originated from the manufacturing sector. However, manufacturing sector’s contribution has decreased to 24% by 2007 (see Figure 1). This change is due to increased investments in the ICT sector.

The other outstanding feature is that the contribution of knowledge-based FDI (ICT related) is considerably increasing. In particular, FDI in Telecommunication sector alone has grown increasingly from 38.9% in 2004 to 54.9% in 2007. This growth is mainly due to increase of capacity of main fixed lines operators such as Sri Lanka telecom, Suntel, Lanka Bell and Dialogue and four mobile operators (Dialogue, Celtel, Mobitel and Hutch). As a consequence of presence of these foreign telecom service providers, the number of mobile subscriber level stood at around eight million as at end 2007. Consequently, the mobile telephone penetration rate (mobile connections as a percent of total population) increased from 17% in 2005 to 27% in 2006. Further, this figure has increased to 40% by mid 2008 which is more than twice when compared to India. These developments led to an increase in the national telephone density (per 100 persons) to 37 by end of 2006.

In addition, IT related FDI activities (computer software development, IT training centers, call centers and BPO activities) have also recorded a slight growth from 0.8% in 2005 to 1.2 % in 2007.

The overall contribution of knowledge-based FDI (telecommunication and IT related investments) has been increased from 39% in 2005 to 56% in 2007 recording a 16% increase over the relevant period.

The above analysis shows that ICT related FDI activities exhibit an increasing trend in Sri Lanka. This emphasizes the great potential to attract and develop more FDI into this sector given the availability of a variety of competitive advantages. However, it should be noted that knowledge-based FDI in Sri Lanka is mainly limited to telecommunication and IT/BPO related industries. The inflows of foreign investments to the fields of biotechnology, research and development (R&D) and pharmaceuticals etc., are not significant because of the unavailability of a suitable investment climate for such types of knowledge-based investments. The following section examines the key advantageous currently available in Sri Lanka to attracting ICT related investments.

Key advantageous
available to attracting knowledge-based FDI

Knowledge: a decisive factor

In the 1980s, the location decisions of many FDI firms were mainly based on the availability of low cost and unskilled labour. However, it is argued that although low cost and unskilled labour still remains a source of competitive advantage, its importance is diminishing in the attraction of FDI. Instead, ‘knowledge’ has become an important decisive factor in deciding the destination of contemporary FDI because knowledge is one of the most strategic resources for firms to innovate and improve their economic performance. As a consequence, there has been a switch in the global FDI from resource-based (natural-asset seeking) (e.g. low cost labour) FDI to knowledge-based, export oriented FDI. To tap these knowledge-based FDI, Sri Lanka’s knowledge sector offers opportunities for growth particularly given Sri Lanka’s good track record in literacy and secondary education enrolment.

Further, Sri Lanka’s workforce has many knowledge related competitive advantages such as a solid mathematical background that translates into a solution driven approach to software development, competitive wages, high productivity, creativity and hand to eye coordination. Such knowledge related advantages provide a conducive environment to attracting knowledge-based FDI into Sri Lanka.

Recent developments in ICT infrastructure

Developed information infrastructure facilities are a pre-requisite for the attraction of investments to the ICT sector. After the privatization of Sri Lanka’s telecommunication industry in 1997, a variety of new, faster and more efficient communication technologies have been developed in Sri Lanka such as Code Division Multiple Access (CDMA), Short Messaging Services (SMS) and dual band and multi Media Messaging Services (MMS). Further, Sri Lanka is connected to the SES-ME-WE 4 international fibre-optic submarine communication system, which was launched on 22, November 2005. This facility connects South East Asia to European countries through the Indian Sub-continent and Middle East. These modern telecommunication facilities operated by several service providers make the industry one of the most competitive in Asia. Sri Lanka has now emerged as a regional hub for telecommunications.

Emerging destination as a Centre of Excellence (CoE) for financial and accounting

Sri Lanka has been recognized as one of the emerging destinations as a CoE for financial and accounting outsourcing by Tholons, a US based outsourcing consultancy and investment firm. For the first time, Sri Lanka was included in the 2007 Global Services Location Index Survey conducted by the global IT consulting giant A.T.Kearney. This report analyses and ranks the most common remote functions, including IT services and support, contact centers and back-office support and reveal the relative cost advantage of the leading offshore destination. Sri Lanka was ranked 29 among the top 50 nations in 2007. The A.T Kearney report highlights that Sri Lanka offers many of the advantages as India, with similar labour costs, widespread use of English, strong education systems and increasingly open and well-regulated business environment indicating that Sri Lanka is a potential destination for location of IT/BPO related industries.

Confidence placed by leading foreign companies

The international investor community has already placed its confidence in Sri Lanka by investing in ICT industry. Sri Lanka has been able to attract world-renowned companies engaged in sophisticated ICT related activities. Some of the international operators in the telecommunication sector are Maxis Telecom (Malaysia), Bharti Airtel (India), Telekom Malaysia, Celltel (Sweden), Millicom (US), Telia AB Sweden, Nortel of Canada, Hutchison Whampoa HK, and VSNL India. In addition, Sri Lanka has been able to attract leading international IT related firms (see Table 1). These firms are engaged in a variety of activities including conducting market research, high-end investment research outsourcing, human resource management and development solutions for overseas clients.

Strong institutional presence

Since the 1990s, scholars and sub-national governments have placed emphasis on the development of local ‘institutional capacity or ‘institutional thickness’ in order to foster and attract foreign direct investment. It is argued that fostering and ‘embedding’ of foreign investments is heavily dependant on local institutional capacity. In this connection, institutions are useful to embed ‘footloose’ industrial firms in a specific location and reduce their tendencies for relocation. Institutions also help to lower the risks, enhance competitiveness of existing firms and enhance innovative capacities.

Sri Lanka provides a sound institutional support, both public and private, with regard to the development of ICT industry. A variety of institutions are in existence dedicated to the development of ICT industry. Some of the prominent agencies involved in catering to ICT industry in Sri Lanka are given below according to their orientation.

Policy formulation institutions:

Information Communication Technology Agency of Sri Lanka (ICTA), Computer Society of Sri Lanka, Telecommunication Regulatory Commission of Sri Lanka (TRC).

Education/Training institutions

The University of Colombo School of Computing, University of Moratuwa, The Sri Lanka Institute of Information Technology (SLIIT), National Institute of Business Management (NIBM), Charted Institute of Management Accountants (CIMA), Institute of Charted of Accountants (ACA) and Association of Computer Training Organization

Associations

Computer Society of Sri Lanka (CSSL), Sri Lanka Association for the Software Industry, Software Exporters Association.

Additionally, moves are underway to establish an umbrella organization for the IT and BPO sectors, utilizing the highly successful benchmark established by National Association of Software Service Companies (NASSCOM) of India.

ICT related infrastructure development institutions

Sri Lanka Telecom Pvt Ltd, Board of Investment of Sri Lanka (BOI) and Telecommunication Regulatory Commission of Sri Lanka (TRC).

Presence of these specialized institutions fulfills a variety of needs of the investor requirements and they provide a boost to the development of ICT industry in policy formulation and capacity building. As highlighted above, some of these institutions train and produce qualified ICT graduates and develop manpower skills at all levels to meet the growing specialist labour demands of the country. One of the fundamental competitive advantages enjoyed by foreign firms has been the ability to employ qualified graduates. Further, the high level of interaction among these institutions (both public and private) has led to greater efficiency in the industry.

Attractive investment
incentives

Sri Lanka also offers attractive investment incentives to investors engaged in the ICT industry. A tax holiday ranging from 3-12 years, duty free import of capital goods and exemption from exchange control (if export oriented) are some of the lucrative incentives offered by the BOI. These incentives intensify the growth potential of attracting ICT related FDI.

Thus, Sri Lanka exhibits most favorable key advantageous for attracting knowledge-based FDI. However, it should be noted that Sri Lanka also currently encounters several challenges in attracting knowledge-based investments and unless correct policy measures are formulated and implemented, we may miss the opportunities available in attracting such investments.

The government has already implemented commendable key measures such as e-Sri Lanka initiative which has been helpful in developing e-government solutions, human resources in ICT, building information infrastructure and extends the benefits of ICT to impoverished regions. Similarly, it is also important to pay particular attention to the following key areas which will be useful in enhancing the business climate for attracting knowledge-based FDI.

Key policy areas

Skilled labour is one of the major requirements of the efficiency-seeking foreign investors. Therefore, an effective education system has a significant role to play in developing a skilled labour force that caters to the requirements of the knowledge-based economy. In particular, the structure of curriculum of universities of the country should be structured according to the current labour market orientation. At present, approximately 65% of the university students follow social science and humanities related subjects in Sri Lanka while in China, 50% of students at the university level study science or technology related subjects. This shows that Sri Lanka’s university education system is not yet geared towards global demand.

Further, availability of information infrastructure plays a vital role in attracting knowledge-based FDI. Current issues such as high telephone costs, connectivity charges, low internet penetration rates, and lack of IT professionals could retard the growth and attraction of investments.

In creating a conducive environment for knowledge-based industries, the development of R&D culture is also important. Although, FDI in this sector is currently negligible, there is scope for the development of R&D services given the strong presence of institutional framework. Initially, what we require is to improve linkages among private sector, universities and research institutions and encourage engaging in more R&D activities.

Concluded

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