BiZnomics Deciphers: Port City of Colombo
The Port City is an artificially created area of 660 acres of land reclaimed from the Indian Ocean, and is located in the District of Colombo in the Western Province of Sri Lanka. It is a Special Economic Zone (SEZ), (called the “Colombo Port City Special Economic Zone”), an extension of Colombo’s business district. It is intended to facilitate foreign investments and doing business in Sri Lanka, with an emphasis on the service economy. Development of this SEZ is funded by the Chinese Government and is being developed by China Harbour Engineering Company (CHEC) Colombo Pvt Ltd (CPCC) with the support of the Government of Sri Lanka (GoSL). The total investment, USD 1.4 billion, is the largest received by Sri Lanka to date. Launched in 2014, the project is expected to reach completion in 2041.
The Macroeconomic Impact
Port City Colombo is an organic effect in this age of economic globalization and integration. Sri Lanka is a small island nation that is currently in a deep economic crisis. With limited natural resources, under-developed human resources, low purchasing power and high national debt, our country cannot run counter to this unstoppable historical trend and “decouple” our economy from market principles. Port City Colombo is an opportunity to gain much-needed foreign capital investment, which in turn would serve as a means of stabilizing the rapidly depreciating Sri Lankan Rupee.
The growth of exports, driven by FDI is will boost the economy and accelerate employment generation. This has been a tried-and-true strategy for countries irrespective of their size, or the structure of the economy. Countries as large as China, or as small as Singapore, and even centrally planned economies such as Vietnam have found SEZs as an intervention that provided much-needed foreign capital investment. A report by Price Water Coopers (2020) notes that at present, the annual FDI flows to Sri Lanka stand at USD 1 -1.5 billion. With the Port City Development Project, the FDI flows are projected to be USD 4.1 billion during the reclamation, infrastructure development and land lease stage, and USD 5.6 billion during the construction stage. During the operational stage, the reinvestment of profits was also considered as FDI and was estimated at USD 740 million per year. Hence, the expected flow of FDI would be sizable. As many of the discussions at Sri Lanka Investors Forum 2021 also indicated, Sri Lanka is well positioned for attracting FDI due to the Port City Development.
The Port City Development Project is expected to boost Sri Lanka’s Gross Domestic Product (GDP) in varying degrees during different stages. During the reclamation, infrastructure development and land lease stage, the value addition to the GDP is expected to be USD 4.6 billion. It is primarily the value of reclaimed land that gets added to the GDP directly. During the construction period, which may be spread across a 20-year timeline, the estimated value addition to the GDP is USD 13 billion. This translates into an annual value addition of USD 650 million during the construction stage, majority of which is attributable to the sale of residential units built inside the Port City. When the Port City reaches an operational stage, it is expected to contribute USD 11.8 billion to Sri Lanka’s GDP on an annual basis. This contribution will be driven primarily by the residential and retail sectors in the commercial space of the Port City. Sri Lanka’s current GDP value is USD 89 billion (Central Bank of Sri Lanka, 2018). Once the commercial establishments within the Port City reach a mature level, an estimated USD 550 million will be added annually to the GDP.
Sri Lanka’s Balance of Payment (BOP) will be negatively affected during the initial stages of land reclamation, common infrastructure development and construction. This is primarily attributed to the importation of raw materials for construction. However, this will be offset by the initial funding, and once the marketable lands and constructed buildings are sold, the foreign exchange gains will have a favourable effect on the BOP. Investments into Port City can only be made in foreign currency, and they have to come from overseas. Sri Lankans may invest their savings in offshore accounts as foreign currency investments into the Port City. The only investments that can be made within the Port City in LKR are limited to purchases made at the shopping mall, grocery stores, and funding for apartments and condos by locals. Port City is also marketed as a premier destination for meetings, incentives, conferences and exhibitions (MICE), casinos, shopping and other experiences, all of which may lead to exchange rate gains. During the operational stage, BOP is expected to improve as foreign exchange earnings from tourism and related industries and services exports such as IT, maritime and logistics, other professional services start to flow into Sri Lanka.
The government revenue to GDP ratio in Sri Lanka has been on the decline since the 1980s. GoSL maintained a healthy government revenue to GDP ratio at 20-25% up until the late 1970s, but by 2009, this has dropped to 14-15%. By 2015, this figure was 11%. There is serious concern over the inadequacy of government revenue, given the extensive expenditure commitments of every successive government. In recent times, there have been references to the inadequacy of government revenue to even meet the interest and amortization charges on previous borrowing.
The GoSL will have an opportunity to earn revenue from multiple channels of the Port City Development Project. At the initial land reclamation and common infrastructure development stage, however, the government will incur costs for providing certain infrastructure facilities such as electricity, water, and road access. Some concessions and exemptions on import duty may also have a negative impact on government revenue. However, GoSL will earn substantial revenue following the lease of its land plots (35% of the marketable land area) amounting to an estimation of USD 1.8 billion. The GoSL consolidated fund receive revenue in two forms. First being one a portion of the lease revenue earned (1%) between June 2023 – June 2028 from the government’s marketable land section, after deducting international promotional expenditure incurred by the PCEC, and second being the revenue received as local assessment rates and any other levies imposed by the commission.
Moreover, GoSL may collect revenue up to USD 2.7 billion from custom duties, indirect taxes, taxes on earnings and other sources during the construction stage. Once operational, GoSL has the potential to earn USD 800 million annually from income taxes, import duties, and license fees. If the Port City were to have 2 casinos of 150,000 square feet with a GGR of USD 124 million each, the GoSL may earn up to USD 44 million per annum in license fees, levies and income taxes on casinos based on the current regulations. The Inland Revenue Department (IRD) will receive corporate taxes from companies operating within the Port City. This will be a welcome boost for government revenue and would support GoSL in managing its expenditure on development and welfare programmes whilst reducing the dependency on borrowing.
The expedited nature of the process in which the draft Port City Economic Commission Act was moved within the government and the courts, and the lack of engagement with the public about the project led to a plethora of speculations and suspicion over the governance of the Port City. There were concerns about the draft Bill violating the “one country, one law” principle as some parts allegedly contradicted the spirit of existing laws and the socio-cultural values of Sri Lanka. Following multiple petitions challenging the Bill in April and May 2021, and Supreme Court scrutiny, several amendments were made in a manner that protects the interest of the citizens of Sri Lanka. The third reading of the Colombo Port City Economic Commission Bill took place on the 20th of May, 2021 and was passed in Parliament with 149 voting in favour and 58 against the Bill.
Contrary to sensationalist speculations, the Colombo Port City Economic Commission Act (CPCEC) stipulates that the SEZ will be under the centralized rule of the democratically elected President of Sri Lanka, and not any foreign country. The Bill also stipulates that land in the SEZ cannot be sold on a freehold basis. The primary objective of this SEZ is to facilitate the ease of doing business in Sri Lanka. Setting up business operations within the zone is simplified in order to boost bureaucratic responsiveness. All licenses and approvals required for the business will be facilitated and obtained through the CPCEC which will act as a single window investor facility. The CPCEC has the ability to issue, grant and revoke registrations, licenses and authorizations. As such, the Commission will implement regulatory supervision and control over all investments and business within the Port City. The Commission has the authority to transfer, lease or sell marketable land within Port City, and the ability to charge fees for services provided by it. CPCEC will facilitate the granting of incentives and exemptions for the promotion of businesses of strategic importance, and will grant tax-breaks and other export-import concessions for investors.
As per the CPCEC Act, transactions within the SEZ will be mostly in foreign currency and not in LKR, though the latter could be used in restaurants or for retail purchases. The audit of the accounts of the Commission will not be undertaken by the Auditor General of the government, but by an appointed qualified auditor. Workers within the Port City will earn their remuneration in foreign currency and are exempt of income tax payments. An International Commercial Dispute Resolution Centre will be set up for the purpose of offering mediation or any other alternate dispute resolution services within the Port City on any dispute with the Commission, an employee, a resident or an occupier of the SEZ. Priority will also be given in the Sri Lankan courts, in relation to legal proceedings instituted on civil and commercial matters concerning any business carried on in the Port City. Such cases are to be heard promptly on a daily basis. The CPCEC also allows investors to start business operations within Sri Lanka, outside the Port City until the SEZ is in operation.
No Silver Bullet
The project’s economic impact, both direct and indirect, clearly indicates that the Port City would make a significant contribution to the national economy, in the areas of attracting FDI, GDP growth, BOP, government revenue and employment generation. The establishment of the Port City of Colombo or the passage of CPCEC is far from a silver bullet that could solve Sri Lanka’s economic crisis. The Port City Development Project is certainly a prudent way to encourage foreign currency inflows, which in turn will stabilize the Sri Lankan rupee’s exchange rate, and also create a favourable impact on GDP and the BOP in the short- to medium-term. However, there is unfinished business. One such area that needs strengthening is a framework for monetary stability in the SEZ. This is crucial in controlling sudden and large fund outflows from the SEZ. Policymakers must, therefore, specify a cap on outflows to protect the national economy.
Secondly, optimism regarding the Port City should not blind us to the reality that this project alone is not sufficient to achieve high GDP, BOP and currency stability. Agricultural revitalization and industrialization in Sri Lanka will not happen automatically simply because there is a Port City. As such, there is a need for an institutional framework to harness the potential macroeconomic benefits of the Port City for the expansion of the real economy. Currently, there is no plan in sight about how the capital inflow vis-à-vis Port City will be reinvested to rejuvenate industrialization and agricultural development in Sri Lanka.
Lastly, it is important to guard against local investors who may abuse the Port City to evade taxes that they owe to the national economy. The generous welfare state that we have achieved since our country’s independence in 1948 is our national pride. The provision of free healthcare and education should not, at any cost, be compromised. It is therefore imperative that the income tax regime that is applicable to Sri Lankan businesses continue in order to fund the welfare state. This requires stronger auditing mechanisms and surveillance on transactions to ensure that local companies do not find loopholes to abuse CPCEC to evade taxes due in the mainland, which in turn result in further decline in government revenue.